How Tax Returns Affect Real Estate Investor Bank Financing

Question

I don’t see a clear answer to this on the forums.  I keep having bankers say “be careful with reporting losses on your taxes because it could make you unbankable.”  What does this mean?  How do you make sure that you don’t make yourself unbankable especially if you have a ton of write offs.

Natalie Kolodij · Answer

https://www.biggerpockets.com/blog/2015/01/15/tax-write-off-affect-loan-approval/

Amanda Han who is pretty well known on BP literally wrote about this and being strategic and planning- notice her suggestion wasn't "don't report all your expenses". It was planning legally, and strategically.

Natalie Kolodij · Answer

That's incorrect. And even if it wasn't- falsifying a tax return for the purposes of getting a  loan would be mortgage fraud.

Literally as a big warning in IRS Pub 596

"When figuring your net earnings from self-employment, you must claim all your allowable businessexpenses."

https://www.irs.gov/pub/irs-pdf/p596.pdfhttps://www.govinfo.gov/content/pkg/USCODE-2010-title26/pdf/USCODE-2010-title26-subtitleA-chap2-sec1402.pdf

You can also view revenue ruling 56-407 on the topic too

Natalie Kolodij · Answer

You're not allowed to file a false tax return.

That means it's as wrong to purposely leave off expenses so you seem more profitable....as it is to just make up more income to look more profitable. or to make up more expenses so you pay less tax.

You can be strategic with your tax professional, plan out when renovations are done, discuss upcoming rental purchases ect so that you can put some thought into which year bigger expenses report on.

The big ticket item on many tax returns is depreciation- and lenders add that back on rentals when it comes to determining lending.

Davido Davido · Answer

@Natalie Kolodij,  I stand corrected.  Thank you so much.

Davido Davido · Answer

@Johnoson Crutchfield, there are many comments that discuss limiting expenses and deductions to make sure income is high enough to qualify -in the Amanda Han article mentioned by @Natalie Kolodij .   That article appears to be right in the direction of your post.  Thank you for the link Natalie.  Amanda Han's article and the replies to it can be found here:  https://www.biggerpockets.com/blog/2015-01-15-tax-write-off-affect-loan-approvalNeither the article nor the replies specify the threshold or Debt to Income ratio that they needed to get the loans they sought.   In any event, the threshold debt to income ratio is likely to be different from bank to bank, from residential loan type to commercial, and from month to month as lending requirements vary according to the economical cycle.  However, each bank should tell you how much income and what debt to income ratio they require for the type of loan you seek.

Davido Davido · Answer

@Natalie Kolodij, for your benefit and for anyone else who reads this post, it is erroneous to suggest that I have been;"...trying to prove why/ how you should knowingly report a return that doesn't clearly state the actual amount of money your business made for the purposes of obtaining a loan you really can't afford because you inflated your income."

Nothing in my posts state that is what I do, what I want to do, or what I recommend doing.  Instead, my claim is,

"...the law has no problem with leaving expenses off your tax return."  "My claim is that on federal tax returns in which the filer does not claim the Earned Income Credit, there is no requirement to report any business expenses.  The IRS code defines expenses as allowed, -not as required."It is also misleading, erroneous, and (in my view) unethical for you to attempt to impune my reputation by reciting a questionable tactic that I've neither mentioned nor hinted at and then attempt to connect that tactic to me as something I advise.  Your last post ends with the statement that you've seen people;"Leave off expenses to get a loan- then switch tax prepares to amend pretending they didn't know about those expenses so that now they pay less tax by amending to claim those expenses. It's so unethical, it's fraudulent on several levels- and if you want to be the person publicly advising others (who'se tax returns you're not responsible for in any way) to do it then that's fine. That's your reputation."Nothing in my posts mentions or suggests any such activity.   Within this thread, amending returns to later add back expenses is entirely your idea.  I believe it is dishonest to attribute a tactic only you have mentioned to another BP poster.

You were correct that there is a possible requirement to report expenses when a tax payer seeks to claim the Earned Income Tax credit.  My point was that claiming the EIC would be an exception to the general rule that reporting expenses is allowed, but not required.

Of course you, or anyone, is entitled to personally believe; "That means it's as wrong to purposely leave off expenses so you seem more profitable.""If you know you have those expenses and leave them off on purpose...guess what? That's a false return.  And again- if you intend to use that return to obtain a loan leaving off expenses to show higher income is just as bad as literally making up extra income to a lender. It's an inaccurate tax return that you knowingly generated to make it look like you really earned more than you did to obtain a loan." However, such statements are not the law.  The IRS code defines deductions as "allowable", not as required, despite your personal view of how it should be.  I have no problem with your right to believe those statements.  Go ahead and state that for you, -leaving allowable expenses off a tax return form is wrong and for you such a return is "false" and or "inaccurate". And for you leaving expenses off a tax return is "just as bad as making up extra income to a lender."   I acknowledged your right to believe such things in my original post on this thread.

Th(os)e statements,  ..." may well be true in your moral opinion (not in mine), but the law has no problem with leaving expenses off your tax return.   The tax code places burdens to report income and allows, but does not require the reporting of expenses.Again, nothing I've written in this thread states that leaving expenses off a tax return is something that I recommend.  I personally believe that not including expenses is almost always disadvantageous.  Instead, the point of my posts is to clarify that the law (IRS Code) does not reflect your personal morality on this matter.  Still, prior to this specific post, nothing I'd written was intended to question your morality.  I pointed out that the IRS code is not a stringent as is your personal morality nor as stringent as your original post suggests the IRS Code might be.  No matter how you personally view a federal tax return that intentionally fails to report legitimate expenses, such returns are valid returns as a matter of law under the IRS code.

Further, when a tax return is requested by a lender, a valid return can be submitted without danger of it being mortgage fraud, even when the valid return intentionally does not include all the expenses that the lender expects.  Tax returns are intended for the IRS and must comply only with IRS regulations.  Lenders must request a separate statement of expenses if that is what they want.

If you know of any IRS code section (other than that dealing with claiming the EIC), then please share it.

Johnoson Crutchfield · Answer

@Davido Davido thank you!

Natalie Kolodij · Answer

Depreciation does not come into your appearing to be able to pay back a loan- lenders add this expense back as they know it's not a cash out flow.

Natalie Kolodij · Answer

What is this from?

I'm not going to sit on the internet and argue all day- but file a falsified return is not allowed, and using a falsified for loans is definitely illegal- so I'm not really sure why you're so dead set on trying to prove that you can.

Johnoson Crutchfield · Answer

@Johnoson Crutchfield

Thanks everyone for the replies. It seems this post when a different direction that intended. Specifically, I want to make sure that I remain bankable and wanted to know if there is a way to know before filing a return if I will remain bankable?  My bankers definitely don’t think it’s illegal to not report all expenses because it sounds to me like they want me to limit expenses and deductions to make sure income is high enough to qualify.  Any ideas on how to find out what the threshold is?

How Tax Returns Affect Real Estate Investor Bank Financing

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