What to Claim on Taxes?

Question

Hello BP!

In a real estate podcast(possibly the BP one) I heard a guest mention that depending on what they claim on taxes could determine if they get approved for future loans. I am wanting more information on this topic so if anyone knows what episode and what part within the episode this could have been please let me know.

Also, if someone knows what I am talking about any further information would be great.

Thanks!

Pat L. · Answer

An investor/contractor, we financed into 6 multi-properties, is having that problem. We issue the required 1098's that he insists he 'didn't need or want' as he always showed large losses on his rentals. Now he can't get refinancing until he shows a 'reasonable' profit for at least 24 months.

He just took a bad fall , can't work & now is living (comfortably) off his rental income, yet as far as the IRS is concerned he doesn't make squat!!!

Michael Plaks · Answer

@Zac Lindquist

Don't know what exactly the podcast guest was discussing, but probably it was the classic Catch-22 of this business.

The two main things your traditional lender is interested in:

• your credit score
• your DTI - debt to income ratio

The higher your income, the more loan-worthy you are to traditional lenders.

Let's say you have a $70k salary, and that qualifies you for an $X loan. You then started in REI as a wholesaler, and you made $30k in assignment fees the first year. You also spent $20k on training and marketing, so you only made $10k after expenses.

Still, your income went up from $70k to $80k, so you now look better for the lender. However, your taxes went up by maybe $4k on that $10k of wholesaling income.

Now, your CPA points out that you had tons of driving related to being a wholesaler, and you can deduct it. You also had some deductible this and some deductible that... Suddenly, you have another $15k worth of deductions you did not realize you could take, and instead of $10k income you have a $5k loss from wholesaling.

You saved yourself $6k in taxes - yay! That is until your lender informs you that now you no longer qualify for that loan, because your income dropped from $70k to $65k.

And now you have to decide what is more important to you: lower taxes or a bigger loan. Gotta choose one or the other.

Keep in mind that you cannot just decide to forego some deductions to make your income look higher. This would break the IRS rules (yes, you must take deductions you're entitled to) and, more importantly, would be mortgage fraud.

What you might be able to do is instead of taking some deduction in one year spread that deduction over several years. Other deductions might be delayed into the future altogether. Yet others can be reclassified for a more favorable treatment by lenders. This is complicated and requires professional help, to stay in compliance with the rules.

PS. What @Ashish Acharya was talking about is another issue. He was talking about a deduction for depreciation on rental properties once you have them. The depreciation deduction is unique, because you can take it for tax reduction, but it does not reduce your income for the lenders. They add it back. So you have the best of both worlds.

Ashish Acharya · Answer

I think I know what you are asking. When lenders review your TaxR to analyze your  Income, they check to see if your portfolio is performing. They dont want to see you are losing money in your business or rentals.

While that is true,  the rental portfolio that shows Tax loss might not actually have a loss. I am sure you have heard the term depreciation in here. Depreciation will decrease your net rental income to loss. Lenders are smart enough to add back depreciation to actually analyze the performance of your portfolio.

Generally, your tax /financial advisors will have to analyze your goals to check if you have any expectation to leverage in the future, and if they should not be aggressive with the deduction in order to prevent the tax loss that might adversely impact your ability to get the loan.