Lets hear from the self employed

Tax, SDIRAs & Cost Segregation
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Lets hear from the self employed

Rich Hupper
Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes

On this forum ive noticed a good chunk of people have w2 income who are investing for the first time or becoming seasoned investors almost ready to give up their w2 job.

It seems like it is easier to get started in the rei world if you have w2 income. 

Can any of the 100% self employed people share their experiences? What lenders gave you loans?. What challanges did you face applying for loans? were you a single member llc or sole proprietor or some other entity? What other creative strategies got you into your first house or investment property?

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Chris MasonPro Member
Moderator
Lender · CA · Member since 2015 · 9k+ posts · 10k+ votes
7y
Originally posted by @Rich Hupper:

@Natalie Kolodij do you know what lenders look for on a self employed person's tax return to make their calculations? Is it adjusted gross income, net income, or gross income, or something else I am missing? 

Is it true that paying more taxes translates into more borrowing power?

 It's none of that. You can sneak preview for yourself here. There is a lot not covered at that link, that's just to give you an idea. One thing that you will not see at that link is the presumption that it's the same source of income over those couple of years. Meaning if "ABC Carpet Cleaning" had income in 2016 and then closed, and "XYZ Car Wash" opened in 2017, you don't get to average or mix those two -- "XYZ Car Wash" needs to be open for two tax years, "ABC Carpet Cleaning" will be calculated at $0 per year.

It's also the case that restructuring your business can in some cases reset that two year clock. Who is to say that "XYZ Car Wash" the Schedule C sole proprietorship (2016 tax returns) is the same business as "XYZ Car Wash LLC" (2017 tax returns)? It's "underwriter discretion" on that one, and "underwriter discretion" is a bad place to be, since you as the borrower have zero control over if the underwriter's milk went bad ruining her breakfast that day, and you (presumably) don't want a half million dollar real estate transaction dependent on the expiration date on a $4 carton of milk.

This is part of why CPAs and mortgage lenders are constantly at odds with each other, since great advice from a CPA focused on saving you tax dollars is often simultaneously horrible advice if you're goal is to buy a house next year and don't plan to pay cash.

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  • Account Closed
    Lender · Los Angeles, CA · Member since 2015 · 399 posts · 174 votes
    7y

    @Lee Bell

    Interesting idea.  You would have to pay more taxes of course, but maybe that's okay.  You would probably have to do it two years in a row since banks usually want two years returns.  Then, after getting the loan, file amended returns claiming the over payment getting back the overpaid taxes and substantial interest.  Not advising this but interesting.  Could perhaps be interpreted as being mortgage fraud.

    1Reply
  • Lee Bell
    Real Estate Appraiser · Isabella lake, CA · Member since 2018 · 628 posts · 491 votes
    7y

    I think saying you make more than you do is fraudulent. But, they want proof of income so not sure how you pull that off anway.

    0Reply
  • Rich Hupper
    OP
    Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
    7y

    @Natalie Kolodij Thank you

    0Reply
  • Marcie Martin
    Residential Real Estate Broker · Port Orchard, WA · Member since 2016 · 2 posts · 1 vote
    7y

    My husband and I are Realtors and have an S corp for our real estate business so we get W2's but we have found it easier to use hard money to flip homes to build our own funds for investment purchases. We have a business partner who is also a Realtor, self employed. 

    1Reply
  • Mark Fries
    Contractor · Jacksonville, FL · Member since 2017 · 1k+ posts · 2k+ votes
    7y
    @Natalie Kolodij Forget this topic...I want to hear more about your mobile home investing stories and experiences!!
    0Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y

    I hear you. Now want to hear our side? 

    Sometimes the letter requests from lenders are plain ridiculous. Gems like - please put on your letterhead that "Taking money out of your client's business account will not negatively affect his business." Without any numbers.

    Complying with such requests may not risk my license, but it would risk my sanity. :)

    3Reply
  • Matthew John
    Rental Property Investor · Metro Detroit, MI · Member since 2016 · 277 posts · 269 votes
    7y

    I am self-employed for almost 1 year now. A couple months ago I purchased a single family & duplex only a week apart. 

    I had to bring 2 different credit partners in (mom and girlfriend) because they had jobs. It was certainly a pain to creatively lock down both deals, but I made it happen & I've made a great ROI on both!

    Now I'm looking for more deals, but I lack cash to keep doing it myself. This is where we have to take it a step further and find a Cash AND Credit partner. Don't think I can keep using relatives that won't take equity, but I'm willing to sacrifice some of the reward to continue building my portfolio! 

    What also helped was my first few deals. I tell everyone about them and people become interested in real estate & ask if they can do a deal with me. 

    2Reply
  • Cody L.
    Rental Property Investor · San Diego, CA · Member since 2013 · 3k+ posts · 4k+ votes
    7y

    self employed guy here. 

    I’ve said this a few times but when you don’t have a “real job” you can, for the most part, forget about 1-4 family lending. 

    I can get a $10m commercial loan way easier than I could a $100k SFH loan. In fact I decided to just pay off my primary residence loan as it was in the high 5% (got the loan ~14 years ago) and I couldn't refi. So I said "f you then. Send me a payoff" and paid it off (iron I'll you with proceeds of a multi family refi that's was done at 5% even)

    1Reply
  • Cody L.
    Rental Property Investor · San Diego, CA · Member since 2013 · 3k+ posts · 4k+ votes
    7y

    Yeah I love it when 1-4 fam lenses tell me I should take less write offs, and pay more taxes, then they’ll give me a loan

    I say “we’ll all things being equal if I simply expense less so I pay more in taxes wouldn’t I be in a WORSE financial position?”

    But 1-4 fam lenses are not making decisions based on your situations. They just need your tax return to say $x or more and your credit to by Y or higher. 

    Commercial you can have years of negative income and if you had a track record of performance, a down payment, and are buying property that pencils out, you’re good to go. 

    IMO It’s foolish to pay more in taxes than youre legally required just to beef up your reruns so a 1-4 fam bank will approve you. 

    2Reply
  • Ken NyczajPro Member
    Investor · Grasonville, MD · Member since 2017 · 453 posts · 415 votes
    7y
    @Rich Hupper I’m 100% Self Employed in an outside sales position. My income is good but after expenses my AGI was not lendable to buy a property to flip. I’d suggest bringing in an equity partner or having a co-signer on the loan. I brought in equity partners and one had strong w2 income. If you can find great deals people will look to partner with you. We formed an LLC in Maryland through a lawyer.
    0Reply
  • Ian WalshBusiness Member
    Lender · Philadelphia, PA · Member since 2016 · 2k+ posts · 1k+ votes
    7y

    I have been self employed for over 10 years.  It has it's ups and downs.  Keep the w2 until the investing outweighs it.

    0Reply
  • Alex Franks
    Rock Hill, SC · Member since 2015 · 1k+ posts · 597 votes
    7y
    Originally posted by @Rich Hupper:

    @Alex Franks and @Carl Fischer so it appears I should probably get a w2 job again.

     @Rich Hupper I was just getting a haircut the other day. The same lady knows a good friend of mine. He left a good job of 19 years. To pursue real estate. I told him don't do it. That was 8 months ago. She said I needed to go see him. It's tough to get started so keep the w2 income until your passive income surpasses that number.

    Alex

    1Reply
  • Daniel DietzPro Member
    Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
    7y

    Jumping back to 'the tax benefits' of real estate investing, one big one for self employed can be savings on the SE taxes, if I understand my tax guy correctly. 

    Let's say I have 60K in taxable self employment income (K-1 in my case). My SE taxes would be roughly 9K on that. Now bring in the real estate income. After expenses other than depreciation, let's say that figure is 10K. But, I have 30K of depreciation, so now that income *shows* -20K, even though there was a positive cash flow of about 1K per month. 

    So now we have 60K of K1 income -20K of 'rental loses' = 40K of taxable income. I just saved 3K of SE taxes. 

    Dan Dietz

    [email protected]608-524-4899
    1Reply
  • Brie SchmidtBusiness Member
    Moderator
    Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes
    7y

    I have been 100% self employed since 2014.  I have done commercial and residential loans since then with minor hiccups.  I started a business in 2014 that is my primary source of income now and by the time it got ramped up enough to use 2 full years of income it was after I filed the 2017 tax returns.  Luckily the other business had enough income before then that it was not a big deal.  

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    0Reply
  • Linda WeygantPro Member
    Investor and CPA · Arvada, CO · Member since 2015 · 2k+ posts · 3k+ votes
    7y
    Originally posted by @Account Closed:

    @Lee Bell

    Interesting idea.  You would have to pay more taxes of course, but maybe that's okay.  You would probably have to do it two years in a row since banks usually want two years returns.  Then, after getting the loan, file amended returns claiming the over payment getting back the overpaid taxes and substantial interest.  Not advising this but interesting.  Could perhaps be interpreted as being mortgage fraud.

    This is definitely mortgage fraud.

    For self employed people, you need to deduct your normal and necessary business expenses.

    Where you have a little bit of wiggle room is in the personal expenses that you can choose to make business expenses such as Home Office, Mileage on a personal vehicle or the portion of your cell phone or internet bill that you allocate to business.  You can opt not to declare those because they are personal expenses.

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  • Marco Morales
    Investor · Chicago, IL · Member since 2017 · 39 posts · 13 votes
    7y

    I've recently joined the self-employed world after being laid off from my W2 after 14 years. I'm seeing this as an opportunity to go all in with REI and pretty excited about it. I bought my first multi-family in 2011 and the goal is to scale up. I'm looking into getting my broker's license as my next move.

    I was curious if any of you have had experience utilizing your 401k for REI investing. I'm considering also moving it to a self-directed IRA and possibly investing through that. Looking into ways to use my 401k to expand my portfolio is new to me, and now being self-employed it seems like a way to work around using traditional lenders that require a W2.

    1Reply
  • Aram V.
    Miami, FL · Member since 2017 · 64 posts · 13 votes
    7y
    Originally posted by @Jay Hinrichs:

    I bet @Chris Mason  can shed some light on this.

    from my perspective and i have been 1099 or self employed from day one of getting in real estate 44 years ago. when i am making good money that shows positive net income on my tax returns I can get a loan for my personal resi ( best rates) and investment loans 10 mortgages  like most folks.. after that its community banks.. and again no problem as long as your profitable. 

    Your community banker is more adroit and fully analyzing your returns adding back into your earnings your depreciation..  were conventional lenders have a much harder time..  

    but with a 740 fico and above some cash in the bank and 1 or 2 years tax returns showing positive income and your DTI is good then no problem..

    the issue comes when you tax returns show no or negative income.. thats were you simply are going to have a hard time.

    if your not paying income tax.. its tough. you pay a lot of income tax its easier.  its a fine line there.

    "tax returns showing positive income"  What's a good percentage of positive net income that would be a attractive to banks on a tax return?

    0Reply
  • Ryan Evans
    Rental Property Investor · Cleveland, OH · Member since 2016 · 653 posts · 769 votes
    7y

    I've given up on conventional loans completely. I've been self-employed for several years, but I have an odd habit of moving to another state or country on a whim and taking 2-6 months of the year off of working to travel and focus on other things. 

    I have to use a virtual mail service because I move around so much. In addition to having a stable income, apparently, banks want you to actually know which state you live in! hah. So now I'm working with commercial style lenders that look at properties as a business. 

    Through all that I've still managed to pick up 7 units by age 27 through a combination of cash and private money. So for all you people with decent paying w2 jobs, you've really got no excuse :) 

    2Reply
  • Aram V.
    Miami, FL · Member since 2017 · 64 posts · 13 votes
    7y

    I'm in the middle of my 2nd year of Self-Employment and it's been a challenge. I claimed losses on my first year, unaware of how unattractive I'd be for a loan, DUH! So I'm collecting all my income and expenses and I'm being careful not to write off too much stuff.

    Does anyone know what's a "good" percentage of positive net income that would be a attractive to banks on a tax return?

    0Reply
  • Robert VorhiesPro Member
    Rental Property Investor · San Tan Valley, AZ · Member since 2018 · 29 posts · 3 votes
    7y
    @Rich Hupper Hi, I bought my first house being 100% self employed. The lender just went full docs and I had to so a P and L report. 5 years after I bought my first house I incorperated my company and saved thousands of dollars in taxes. I created a C Corp. I hope that helps. Don't be afraid just do it. Good luck.
    0Reply
  • Aram V.
    Miami, FL · Member since 2017 · 64 posts · 13 votes
    7y
     @Robert Vorhies

    Which lender was this?
    0Reply
  • Matt R.
    Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes
    7y
    Originally posted by @Jay Hinrichs:
    Originally posted by @Steve Vaughan:

    I found myself arguing with my lender last fall when I refi'd a rental.  She kept trying to put me in the self-employed category.  I maintain I am a business owner and investor." I've never paid SE tax! Ever!" I yelled to the wind as if it mattered...

    Getting a loan is a pain for me, but would be worse if not for k-1 income from my 3 business entities that go back quite a few years.  The smartest thing I did was establish proper entities. My wife and I are members/shareholders so they have allowed us to qualify for loans separately, keeping our credit from being double-burdened.

    I found it funny how little assets (including cash) played in the conforming loan approval process. As unleveraged as I am, I had to pay off another loan to get my DTI ratio lowered. Granted it was $64k with a $1700 pmt, but I was still surprised. I had to use an asset they didn't care about (cash) to pay against something they did (liabilities). Get loans while you still have a w2 if possible!

    Chris, thank you for below. Interesting that Form 1120/s (corp/s-corp) income is separated from 1065 (LLC/partnership) income. I thought all k-1s were added up on the same line.

    bankers look at contingent long term liabilities  that's why I have been saying on this site.. max leverage over time while fun to build up doors.. it is not going to get you to the next level with bankers that want to see a more positive on your balance sheet and not massive amounts of debt..  

    And another reason you might want a decent % of dead as a dog barking equity... 

    1Reply
  • Account Closed
    Lender · Los Angeles, CA · Member since 2015 · 399 posts · 174 votes
    7y

    @Linda Weygant

    "For self employed people, you need to deduct your normal and necessary business expenses."

    The IRS requires this, or banks?

    I know IRS requires all income be declared but didn't think expenses too.

    If required by banks, then is it government related loans only, or all loans?  Maybe private money and/or bank portfolio loans have different requirements.

    This concept is an academic exercise as far as I'm concerned, I wouldn't do it nor do I recommend anybody else do it.  Not that anybody cares what I think.   

    1Reply
  • Aram V.
    Miami, FL · Member since 2017 · 64 posts · 13 votes
    7y

    I'm in the process of trying to cash out refi - Nightmare, but may have some light at the end of the tunnel. This is on their policy:

    "Self-Employed Borrowers
    Any individual who has a 25% or greater ownership interest in a business is considered self-employed MB Financial Bank generally requires that the borrower has a two (2) year history of the borrower's self­ employment. However, a person who has a shorter history of self-employment may be considered as long as the borrower's most recent signed federal income tax returns reflect receipt of income at a level similar to or greater than previous employment if the borrower was in the same line of work with similar responsibilities. One year tax returns may be acceptable per AUS findings

    All self-employed borrowers are required to provide copies of signed individual tax returns including all applicable schedules, for the previous two (2) years. Business tax returns for the most recent two (2) years are required. One year tax returns may be acceptable per AUS findings. "

    0Reply
  • Mary M.
    Rental Property Investor · Portland OR · Member since 2018 · 2k+ posts · 3k+ votes
    7y

    I have been self employed most of my life. 

    The conundrum is that to be loan worthy for conventional loans you need to show stable income. However most businesses (even the self employed) like to pay as little tax as possible so this means showing little income. 

    Basically you cant have it both ways.  So you have to plan far enough out. 

    My suggestion is to find a CPA to help and maybe not think of RE as a get rich quick scheme using little or none of your own money. 

    2Reply
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