Bank sees Carryover losses seen as liability in refinancing
Member since 2019 · 2 posts · 0 votes
Bank sees Carryover losses seen as liability in refinancing
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Don KonipolBusiness Member
Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes@Lance Anderson
You have described the great dilemma of small business/investment. Do you minimize profits shown on your tax return so that you pay the least amount in taxes or do you bypass current deductions so that you present the best picture for financing?
When you take depreciation deductions you get current tax savings, but that depreciation is recaptured as ordinary income when you sell the property. So, in effect rather than lowering your capital gains profits at time of sale, these depreciation deductions increase the profit shown, and may result in being taxed at the higher ordinary income tax rate. This is known as paying taxes on “phantom” income.
5 Replies
- 6yRyan BlakePro MemberLender · TX · Member since 2018 · 936 posts · 713 votes
@Lance Anderson You are probably going to need to seek out a portfolio lender (a bank that will keep the loan in house and not sell on the secondary market). This is because you as a borrower will not easily fall into a safe category of loans. Also expect the interest rate to be higher than a standard conforming loan.
- 6yDon KonipolBusiness MemberInvestor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
@Lance Anderson
You have described the great dilemma of small business/investment. Do you minimize profits shown on your tax return so that you pay the least amount in taxes or do you bypass current deductions so that you present the best picture for financing?
When you take depreciation deductions you get current tax savings, but that depreciation is recaptured as ordinary income when you sell the property. So, in effect rather than lowering your capital gains profits at time of sale, these depreciation deductions increase the profit shown, and may result in being taxed at the higher ordinary income tax rate. This is known as paying taxes on “phantom” income.
- Investor · Dallas, TX · Member since 2009 · 718 posts · 913 votes6y
Based on what you are stating, I don't think the banks are perceiving the carry over loss as a liability on your tax returns. Rather it's the poor performance of your rentals that you are reporting on your income taxes that's hurting you. It's basically what @Don Konipol is saying. You have to strike that right balance between minimizing profits on tax returns vs. making yourself look good for financing purposes. I see a lot of newer investors take every deduction they can get, be aggressive in expensing vs. capitalizing, generate massive losses to make their rentals unprofitable for tax purposes, and then find out banks take them at their words on their tax returns and ding them for it. To be clear, I'm not talking about taking depreciation; that's mandatory and every lender I know adds it back in when looking at rental income.
- 6yAndrew PostellPro MemberLender · Fort Worth, TX · Member since 2016 · 8k+ posts · 6k+ votes
@Lance Anderson You've got some good comments above but this is probably a difficult question to answer in this type of a setting. Certainly the "TYPE" of loan you are applying for will make a difference but even some LENDERS will view tax returns differently. What looks bad to one lender might look ok to another. So some questions that we need to answer for you:
- Which loan is best for me?
- Which lender is best for me?
- How do I structure my loan to look best to a lender?
So let's start with "Which loan is best for me?":
Generally speaking there are 2 permanent loan types for "buy and hold" investors: Conventional and Portfolio.
Conventional - I'll define these as loans that come from Fannie Mae and Freddie Mac (if you recognize those names). These loans are all 30 year fixed rate loans. They have the lowest rates we can find and since they are 30 year fixed...they allow us to cash flow better...which helps us qualify for other loans later. The draw back to these loans is that they are more paperwork heavy than the other "portfolio" types of loans....but if you have ever received a loan on your primary home, it's likely that you will go through the same type of paperwork here with conventional lending. Fannie/Freddie money = Fannie/Freddie rules. NOT the bank's own money.
Portfolio - I'll define these loans as loans that come from the bank's own "portfolio" of money. Sometimes referred to as "commercial" loans. These loans are a lot more flexible than "conventional" loans. Bank's money = Bank's rules. If they like you, then maybe they will lend to you. But since there is a limit to how much money the bank has access to....their rate will be higher...and usually a shorter term. The most common portfolio style loan in Texas is a 20 year adjustable rate loan. These loans are easier to get but the terms are different.
Fannie/Freddie types of loans will rely on your tax returns...but if we can qualify, then the terms will be better. Porfolio loans may not care about your tax returns at all! I say "May" because since each bank will lend it's own money differently there could be some that do care...but for the most part most will be ok with just using the income from the property itself and ignore the income from the tax returns.
Now let's tackle "Which lender is best for me?":
Normally we speak about working with smaller, local lenders. Those tend to be the most flexible when it comes to working with investors. But how do you know for sure? I would encourage you to ask the questions below to really find out.
Questions for Lenders
- When do you start using rental income to help me qualify? (the answer needs to be immediately)
- When do you start using “After Repair Value” on my property?
- How long do you need me to be on title to refinance? (this is important if you do need a short term loan to purchase then refinance out - and the answer should be 1 day...very important that it is 1 day on title is all that is needed to refinance)
- What is my minimum down payment required? (if they only require 15% down on a single family home that is usually a good sign that you are working with a flexible lender)
- How many loans can I have with you?
- Can I change title to my LLC?
- Do you sell your mortgages?
- What is your loan minimum?
- Can you explain to me what your reserve requirements are?
The final piece of the puzzle, "How do I structure my loan to look best to a lender?":
The main crux here is that you should be showing your real estate business on your federal tax returns. Even if a lender is willing to overlook your income your federal tax returns can be used to validate that you have experience in this field. Some lenders may want that. BUT....let's say you still want to try to get those great rates/terms on Fannie/Freddie money....how do you structure your returns? I wrote an article on this here at Bigger Pockets that you can find HERE
*WHEW* I know that was a lot but hopefully this helps point you in the right direction. Thanks!
- Member since 2019 · 2 posts · 0 votes6y
Thanks for the feedback guys, much appreciated, will digest and take action.
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