tax help- muy importante for success....
Real Estate Investor · new york, NY · Member since 2008 · 127 posts · 6 votes
I suppose I could ask my cpa but Ill see what you guys think on this first so he doesnt bill me for consultation fees...situation: my partner and I wish to finance a property. due to the deplorable lending market, its nearly impossible to get an investment mortgage right now without going full doc. my partner has a 780 fico. what she doesnt have however is 2 years of decent tax returns. shes worked for all cash and documented very little income for the past several years. now I think its come back to bite her in the ***. even an 850 fico requires some sort of doc (even stated) showing a reasonble income for the past 2 years. 1) how do we get around this? 2) if we do finally get some properties under our belts, would you suggest directly documenting all rental income as taxable personal income? (we have an s-corp and could essentially pay ourselves very little income to save on taxes) but while she might have to pay alot more in taxes, she will at least have a decent tax return documented to show the bank for future financing... am I right/wrong? thanx for expert opinons
The days of no-doc "liar loans" are coming to an end (as they certainly should). I don't know how you can get around that if you are using bank financing, unless you just use your credit to buy the properties. I don't like partners anyway, but that's another topic.
If your tax question is whether to consider all rental income as taxable income (by not claiming expenses), I would say that is a very poor idea. Paying a bunch of extra taxes to make your tax return look better is not necessary or desireable. Any competent banker should be able to back out the expenses and depreciation to understand your true financial situation.
Good Luck,
Mike
What do expect? She has been breaking the law and not playing by the rules for years by not claiming that income and now she has found a game that requires her to play by the rules and she can't, because she been breaking them all along.
Welcome to real world.
No matter how you look at it, she has been breaking the law. I have been paying taxes on my salary since I was 14 yrs old. This allows me to claim maximum unemployment and/or SSI, if I need to and all the other benefits that comes along with showing the government your yearly income. She choose not to do this and benefited from it by not having to pay tax on those funds, unfortunately, she also looses all the benefits that comes along with reporting that income to the government and one of those happens to be showing that she has been a law abiding citizen by paying what she is suppose to. My renters pay in cash and I don't have to document that, but I do, because I want to be able to show that as income. This was a conscious decision I had to make when I started.
I am not judging her or you in any way. I find every loop hole I can to get out of paying more tax then I have to, but when you hide your income from the government there are consequences to those actions. Tell me, how was she able to get a car loan or any other type of loan without being able to document her income? Has she ever got a loan by herself? In the very near future she will run into the same problem on all types of loans, not just Mortgages. Credit is going to tighten up on all loans.
the rent you take in is income. You get to reduce the income you pay tax on by claiming expenses you used to operate your business. What is left is what you pay tax on. What mike said was not to understate your expenses to overstate your income on a tax return.
TC and I are saying exactly the same thing: follow the law and pay the taxes you owe (and not one penny more).
The gross rents are NOT what you will be paying taxes on. From that gross rent, you will deduct the operating expenses, interest expense, depreciation, etc. (per your CPA or tax preparer). The profit or loss is what you owe taxes on. If you are a full time owner of a rental property business, you will normally pay little or no income taxes because the depreciation and expenses will wipe out your profits (on paper).
Mike
For rental properties, taxable income and cash flow are two wildly different things. Why? Depreciation. All the actual cash-out-the-door type expenses like interest, insurance, property taxes, maintenance, paint and carpet affect both taxable income and cash flow. Depreciation, however, is not cash out of pocket, so it doesn't reduce your cash flow. It is deductible from your income when calculating taxable income. So, your taxable income can be very small, or even negative, even though you actually have money in your pocket.
On the other hand, principle payments are not deductible but they do affect your cash flow.
A investor friendly lender will understand the difference between cash flow and taxable income, and will be able to help your though that.
However, no lender is going to give any consideration to unreported taxable income. If you want to fix that, go back and file corrected returns and pay the taxes and penalties that are owed. Then, in the future file and pay taxes correctly.
Jon
The trick is that you're not making the payments on the new loan, nor any of the 10 you already own out of that $12,000 a year of cash flow. You're making the payments out of the NOI (net operating income, rent less expenses.) Same for the new one. So, if you're collecting $1000/month/property in rent, and have expenses of $500/month/property, your NOI is $500/month/property for a total NOI of $60,000/year. An investor friendly lender or mortgage broker is going to understand that, and work with you to get the loan.
For commercial properties, the ratio of the NOI to the debt payments is called the "debt service coverage ratio" or DSCR (or some variation on that theme.) If you have a property that has a good DSCR, typically 1.2 or greater, and you have good credit scores (to show you're not a deadbeat), and you have some money invested in the deal, you'll find a loan. Not exactly the same with single family investment properties, but lenders do understand this same math.
Even if you're getting $100/month/property in cash flow, your taxable include may well be -$200/month after depreciation.
The lender is NOT going to just look at your AGI if you have significant income from rentals.
This is a totally different situation than your partner's unreported income. There you have no AGI on your tax form because real, taxable income is not getting reported. Here you have little or no AGI because of legitimate use of the tax code to apply the property deductions to minimize your tax. If you handle both situations in accordance with the law, you will be able to find lenders who will give you money.
Jon
Yes, you're wrong. More importantly, you're thinking like an employee instead of an entrepreneur. Employees think about how much money they make in terms of their W-2 or tax returns. Entrepreneurs want their tax returns to show taxable income of as close to ZERO as possible while still making as much real money as possible. For that purpose, the rental property business is excellent because of the depreciation the government allows us to take.
In the rental business, your tax return can easily show a taxable income close to zero, even though you're really making a lot of money. I have literally borrowed millions of dollars with a (paper) taxable income that wouldn't qualify me to buy a used Yugo! The bank understands the reality of the situation and can easily back out the numbers when looking at my tax returns.
Why is this allowed (encouraged) by the government? Because they want to encourage the private sector to provide housing for the public. The government understands that they are VERY POOR LANDLORDS and that the private sector is needed to provide housing. A good example can be seen in my city where there are literally DOZENS of government owned houses that are boarded up. The government allowed the wrong tenants to move in (druggies) and they literally destroyed the houses after turning the area into a crime-ridden slum. Now, the government is trying to get the money to tear down the houses! That's just a small example of why the government provides incentives for the private sector to provide housing.
Good Luck,
Mike