Tax Season for a new investor

Tax, SDIRAs & Cost Segregation
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Tax Season for a new investor

John Brito
Pawtucket, RI · Member since 2017 · 15 posts · 12 votes

Hello,

I purchased my first 3 unit in Dec 19 and I am in the process of looking for my next unit since my first was not with an FHA loan but home possible and I am going to use FHA in a better location for the next one.

I am doing my taxes this year and my CPA included all my rental income on 2 of the 3 units and included depreciation but after discussions with my loan officer and others, it seems like not taking major expenses is beneficial in the beginning of the real estate journey to show positive income on your rental properties. My current DTI is roughly 27% as my only debt is my mortgage. For DTI I can not use my current unit in the calculations but I can use 75% of purchased units rents. so if I do this I think my DTI would jump up to roughly 36% with the new FHA purchase.

So my question is do you think it is better to not take major expenses at the beginning of your real estate journey and just pay taxes on the gains in order to make your DTI look attractive as this seems to be an issue with some investors as they gain more real estate. Currently with no expenses added I would have to pay roughly 2,500 in taxes this due to rental income year but my accountant said that if you take expenses you get roughly 27% of the total expenses taken out so for every $1,000 you spend you can deduct 270 from your tax bill. Just trying to see what others' experience has been on this and is it worth it to pay the taxes in the beginning and then take more deductions after you build up your portfolio and have been showing that your units do increase your overall income.

Thank you for any input! I understand you will not be giving me tax advice but just from your experience I want to make sure I approach this correctly and I don't regret saving a little money now and then end up messing up future purchases such as in this blog post below 

 https://www.biggerpockets.com/...

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  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    5y

    Your lenders would prefer you take zero deductions, as it's best for them.

    Your best bet is to rely on a competent tax advisor who has a history of being able to execute.

    You might have some wiggle room by advantageously choosing between de minimis safe harbor or BAR rules, or by making an election to capitalize repairs and maintenance.  But, it's not a good idea take a frivolous tax position because it benefits the the lender and your debt-to-income ratio.

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    5y

    @John Brito

    Lending and taxation have always been in conflict with each other. The former makes you want to show maximum income, and the latter makes you want the opposite. Here're some pointers:

    1. You must show your true income and expenses in both cases. Adding bogus income or ignoring deductions can be mortgage fraud. Adding bogus deductions or hiding income is tax fraud. I'm not sure which one has shorter sentences, as I'd rather avoid both.
    2. The answer to this conflict is twofold. First, some deductions count for taxes but not for lending. The most important one is depreciation. You claim it on your tax return, and it does reduce your taxes. However, lenders (most of them) "add it back" for underwriting purposes and do not count it against you.
    3. Second, some deductions, for example repairs, provide timing flexibility: you may be able to take them all at once or take them slow over many years, known as capitalizing.
    4. Balancing the two considerations, taxes and lending, with these two approaches can be complicated and is best left for tax professionals.
    5. Also keep in mind that underwriting criteria vary greatly from lender to lender. Major national lenders are the least flexible. Smaller local lenders are usually more flexible, especially if they have experience with real estate investors. It pays to network with local investors and find out who are the best lenders in your area.
    6. There're many lenders, including private lenders and asset-based lenders, who do not care about your taxes and loan money based on the value of your properties and your credit score.
    7. Finally, sometimes you may discover that you're so far out of the loan qualifications that it does not make any sense to adjust your tax returns. In this case, you usually claim everything you can to minimize your taxes.
    8. One more thing: lending is a moving target; the rules changs often

    Good luck!

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  • John Brito
    OP
    Pawtucket, RI · Member since 2017 · 15 posts · 12 votes
    5y

    Hello @Michael Plaks Thank you for the detailed description! This was my first time doing my real estate taxes and it seemed very counterintuitive trying to balance lending and taxes. I am going to take your advice and speak with my CPA to see the best route. I need to make sure I place my expenses on my return as it would not make sense to place them on my returns in later years. This was very helpful as I was confused and my tax professional and mortgage lender didn't seem to have a clear answer on the route I should be taking. 

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  • John Brito
    OP
    Pawtucket, RI · Member since 2017 · 15 posts · 12 votes
    5y

    Hello @Eamonn McElroy thank you for the response and cutting to the point! You are correct it would not make sense to take a stance to please my lenders and potentially not honestly benefit my DTI as I think I will be in a good place regardless of my tax return. I luckily did not submit the return and told my CPA to hold off so I could understand what was going on a bit further.

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