Will taking full depreciation from new tax law hurt my qualifying

13 Replies

I bought 3 rentals in 2018. With the new tax law I can deduct all rehab costs AND I can deduct the value of things like floor cabinets etc. (about 15-20% of the total purchase price of each unit!) which is a big deduction and takes me from owing 6k to getting a refund.

But, I need to make 100% sure that when the underwriter looks at my return for my future loans that he doesn’t consider my rentals to have negative cash flow (I did show positive cash flow, but after the depreciation deduction you could theoretically argue that they weren’t profitable).

My mortgage broker told me they will not count that write off as if I actually lost money, they understand it’s just a tax benefit and that I actually earned cash flow. My CPA also agrees that most likely I can take the deduction and it won’t come back to bite me.. But I need to know for sure because I plan to buy many more rentals!

Any underwriters on here?? Any CPAs that have dealt with this? Or any other investors that found the answer? What are you all doing?

@Greg Gaudet - I can't speak as an underwriter or CPA, but I can speak as someone who directs my CPA to take every deduction permissible under the law. My buying and rehab activity in 2017 caused my taxes to show a "paper" loss for the year, despite the cash-flow coming in. Thus in 2018, two banks denied me for refinances for this sole reason, even though they could see the "loss" was created by deductions. I got around this by moving on to commercial loans under my LLC, which resulted in a higher rate for each - but I wanted to get out of doing things in my personal name anyway, so it was not a problem and ultimately was for the best.

@Greg Gaudet

Lenders/underwriters are aware that certain expenses reported on your rental activity are "non-cash" expenses or "one-time" expenses and should not be used to calculate cash-flow going forward.

Depreciation/amortization are "non-cash" expenses that are normally added back

Repairs for a roof, replacement of a water-heater, etc are normally one time expenses over a long period. As such, they normally add those back.

The key is to work with a lender who works with real estate investors.

Ultimately, whether you qualify for the next investment property or not depends on if your profile meets the banks lending standards.
They normally want a minimum DTI Ratio, do you know what your ratio is like right now?

Debt to Income ratio is key. A tax "loss" is not the same as being under water - sounds like you are just fine. 

As mentioned earlier, take every deduction you are entitled to, you will be fine

Originally posted by @Greg Gaudet :

I bought 3 rentals in 2018. With the new tax law I can deduct all rehab costs AND I can deduct the value of things like floor cabinets etc. (about 15-20% of the total purchase price of each unit!) which is a big deduction and takes me from owing 6k to getting a refund.

But, I need to make 100% sure that when the underwriter looks at my return for my future loans that he doesn’t consider my rentals to have negative cash flow (I did show positive cash flow, but after the depreciation deduction you could theoretically argue that they weren’t profitable).

My mortgage broker told me they will not count that write off as if I actually lost money, they understand it’s just a tax benefit and that I actually earned cash flow. My CPA also agrees that most likely I can take the deduction and it won’t come back to bite me.. But I need to know for sure because I plan to buy many more rentals!

Any underwriters on here?? Any CPAs that have dealt with this? Or any other investors that found the answer? What are you all doing?

This is a great question.

Under Schedule E line item 18 (Depreciation) can be added back.

Under Schedule C Line item 13 (Depreciation) can be added back. Please note that if you take the depreciation deduction under schedule C you are not allowed to take the miles deduction under 44a or vice versa (Schedule C only)

This is for lending purposes only Sir.

Also, common sense needs to apply here. If you write everything off your chances of qualifying for a Fannie, Freddie or gov loan are going to be more difficult.

At the end of the day I strongly recommend using a loan officer or broker that has experience with rental income calculations.

I hope this helps and have a great day.

And just to add to my previous statement it's a great idea to have your CPA put together a draft of what he/she is about to submit to the IRS.  Have your Loan Officer or Broker look over this return before it's submitted so that they can do the calculations.  This way there won't be any guessing.  

Not all deductions can be added back!

@Basit Siddiqi

Thanks everyone for your input!

Before factoring in my rentals, my DTI is 16%.

But if you add my 3 rental mortgages and their HOA fees along with adding the $1,600/month cash flow they have left over, my DTI goes up to 40%.

This brings up another question.. how do I prevent my DTI from going over 43% as I accumulate more units? Especially since my focus is condos since houses start at 500k here; I get condos for 100k and rent them for 1700, but the HOAs are $600 and I think that counts toward my DTI, right?

Or does the bank not count the debt service on the mortgage towards my DTI if the rent more than covers all expenses?

@Greg Gaudet

The lender factors in both rental income and rental expenses when reconfiguring your DTI.

@Greg Gaudet   Depreciation on Schedule E will be added back, so you won't be penalized for that deduction.  

How are you calculating your DTI? Rental income is calculated from Schedule E if you've owned the properties long enough to be reported on there.

The taxes, insurance, interest, depreciation and HOA fees are added back to the net income or loss, then divided by 12. From that monthly average the PITIA is subtracted. That income or loss is then either added to the borrower's monthly liabilities or income (depending on whether it's a negative or positive number). The end result is that you're still getting hit for the monthly payment, but it's being offset against the rental income. It works out much better for your DTI this way.

Using Schedule E it would look like this (with sample numbers included):

Line 21- Income or (Loss): $1000

+ Line 9 - Insurance: $1000

+ Line 12 - Interest: $8000

+ Line 16 - Taxes: $6000

+ Line 18 - Depreciation: $6000

+ Line 19 - HOA: $2000

__________________________________

Total: $24,000

Monthly Average: $24,000 / 12 = $2,000

Monthly Average: $2,000 - Monthly Payment (let's use $1,850 for this example) = $150

$150 would be added to this borrower's monthly income, and the monthly payment of $2,000 would not be counted as a monthly expense because it's already accounted for here in this calculation. So in this example, the DTI is helped by an additional $150 of monthly income.

@Greg Gaudet your lender is going to look at your last two years tax returns, so they see actual income and know what portion is deductions.

I am curious what provision in the new tax law allows you to deduct rehab costs and flooring/cabinets immediately? Almost sounds like you are doing cost segregation but still I don't think those are immediate deductions, they still have depreciation time frame.

New tax law didn't really change residential rules, that I am aware. 

Originally posted by @Joe Splitrock :

@Greg Gaudet your lender is going to look at your last two years tax returns, so they see actual income and know what portion is deductions.

I am curious what provision in the new tax law allows you to deduct rehab costs and flooring/cabinets immediately? Almost sounds like you are doing cost segregation but still I don't think those are immediate deductions, they still have depreciation time frame.

New tax law didn't really change residential rules, that I am aware. 

Joe - I'm trying to translate this the best I can from my CPA - but I may have explained it a little funny... taxes are my weakness! I believe I could always deduct expenses for rehab costs; my understanding is that the new part is that you can deduct the value of the existing floor, cabinets, etc. (even if you didn't replace them) over a period. We decided the value of those items to be about 18% of the purchase prices for the 3 units I bought last year, and we're going to use most of that this year and carry over the remainder to next year. 

Originally posted by @Stephanie Irto :

@Greg Gaudet  Depreciation on Schedule E will be added back, so you won't be penalized for that deduction.  

How are you calculating your DTI? Rental income is calculated from Schedule E if you've owned the properties long enough to be reported on there.

The taxes, insurance, interest, depreciation and HOA fees are added back to the net income or loss, then divided by 12. From that monthly average the PITIA is subtracted. That income or loss is then either added to the borrower's monthly liabilities or income (depending on whether it's a negative or positive number). The end result is that you're still getting hit for the monthly payment, but it's being offset against the rental income. It works out much better for your DTI this way.

Using Schedule E it would look like this (with sample numbers included):

Line 21- Income or (Loss): $1000

+ Line 9 - Insurance: $1000

+ Line 12 - Interest: $8000

+ Line 16 - Taxes: $6000

+ Line 18 - Depreciation: $6000

+ Line 19 - HOA: $2000

__________________________________

Total: $24,000

Monthly Average: $24,000 / 12 = $2,000

Monthly Average: $2,000 - Monthly Payment (let's use $1,850 for this example) = $150

$150 would be added to this borrower's monthly income, and the monthly payment of $2,000 would not be counted as a monthly expense because it's already accounted for here in this calculation. So in this example, the DTI is helped by an additional $150 of monthly income.

Thank you for that example! I like to think I'm pretty decent at understanding numbers but that is confusing! lol Taxes are like another language to me.. But my lender just informed me that as of my last closing my DTI was 15.7%, which is a huge relief!

Originally posted by @Greg Gaudet :
Originally posted by @Joe Splitrock:

@Greg Gaudet your lender is going to look at your last two years tax returns, so they see actual income and know what portion is deductions.

I am curious what provision in the new tax law allows you to deduct rehab costs and flooring/cabinets immediately? Almost sounds like you are doing cost segregation but still I don't think those are immediate deductions, they still have depreciation time frame.

New tax law didn't really change residential rules, that I am aware. 

Joe - I'm trying to translate this the best I can from my CPA - but I may have explained it a little funny... taxes are my weakness! I believe I could always deduct expenses for rehab costs; my understanding is that the new part is that you can deduct the value of the existing floor, cabinets, etc. (even if you didn't replace them) over a period. We decided the value of those items to be about 18% of the purchase prices for the 3 units I bought last year, and we're going to use most of that this year and carry over the remainder to next year. 

My understanding is that rehab costs are incurred prior to putting the property into service. so they are all added to the basis and expensed over the life of the property. 

What you are talking about as far as flooring, cabinets, etc is cost segregation. That is not new. It is where you pull out certain costs and expense them on a different schedule. Generally you need to have a cost segregation study performed (CPA might have software for that). Still, I thought the rules on bonus depreciation applied only to commercial, so you would still need to depreciate those items over a period of years (although shorter than the 27.5 of the property). 

How would you all go about adding mobile homes to a trailer park? Is that an improvement to the land ? i started my mobile home park last year and added a trailer in 12/15/2018. Havent placed into service yet. 

any advise ?

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here