Your Tax Write-Offs Could Affect Your Ability to Get a Loan: Here’s How

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Every year as we get ready for tax season, I put together a checklist for my clients to help them get organized for tax season with common questions such as: Did you get a W-2? Did you pay mortgage interests? Did you have any education expenses?

One question that I added to the checklist several years ago is: Do you plan on obtaining a loan or refinancing? From time to time, a client will give me a puzzled look and wonder why I would ask that question as part of their tax filing process. After all, that is typically not a question asked by a lot of CPAs.

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The Story

I have my client Nancy to thank for this question. Several years ago, I met a really sweet lady named Nancy at an apartment investing boot camp where I was teaching. Nancy had been a real estate investor for many, many years, but she did not take advantage of a lot of the tax write-offs she was legally entitled to. After working on some tax planning strategies with her, Nancy decided that she wanted us to also prepare and file the income tax returns for her and her LLCs.

The result was amazing, if I do say so myself! After going through her expenses and writing off all her rental expenses, education expenses, travel costs, and improvements on her properties, Nancy was looking at a huge refund on her taxes. In fact, Nancy’s refund that year was close to $20k. We were both extremely pleased with the results. Before long, Nancy was telling me about her plans to use the tax refund as a down payment on a new rental property that she came across in Memphis.

Related: Appealing Property Taxes: Why Investors Should Delegate This Task Out

You can imagine my surprise when my office receptionist came running into my office to tell me that Nancy was on the phone yelling about how mad she was. What could have possibly made her so mad? After all, didn’t she just get a huge tax refund from the government?

How Tax Write-Offs Can Affect Loans

After speaking with Nancy, I quickly found out the reason behind her anger. After making an offer on the Memphis rental, Nancy went to her lender to ask for a loan. She informed her lender that she would be putting a $20k down payment on this new property and was requesting a loan for the difference. To Nancy’s surprise, the loan broker took one look at her tax return and told her that she was not going to be eligible for the loan because her tax return showed a large loss on her income activities.

With all the legitimate tax write-offs, Nancy’s taxable income had gone down to almost nothing. With little net income to show on the tax return, it made it almost impossible for Nancy to get a loan from any bank. The good news is that Nancy was ultimately able to get a loan from a small, local bank. The bad news is that the rate and terms were not as good as what she was hoping for.

After my experience with Nancy’s loan issues, I started to think about what a huge problem this could be for our investor clients. From that point on, I started to ask all of my tax return clients if they were looking to get loans in the near future. I learned that knowing this can help us to be proactive in looking at how we file certain tax returns.

The truth is that, for the most part, any expenses we claim on the tax return can save you on taxes, but it can also reduce a person’s borrowing ability. However, there are certain things that can be done to strategically preserve a tax write-off without compromising one’s borrowing ability. For a lot of our clients, we recommend taking a team approach where we work alongside their loan broker to figure out the optimal way to report things on their tax returns. This is because there are certain items that are tax deductible but do not decrease your income for loan purposes.

Related: 3 Reasons You Should LOVE the Home Office Tax Deduction

An example of such an item could be depreciation expense. For example, a good lender will know that depreciation expense is generally a paper write-off only, and even though it decreases one’s tax bill, it will not reduce income for debt to income ratio calculations.

Another example could be discretionary retirement account contributions. I have worked with lenders who can help investors to add back certain types of retirement account contributions to income for loan purposes while preserving the tax deduction benefits.

In fact, whether you write off your car’s actual expenses or take the standard mileage deduction, it may have an impact on your borrowing potential as well.

Conclusion

The lesson I learned in my experience with Nancy is that we can’t just plan ahead for taxes; we must also plan ahead if we are looking to get loans. It is important to understand how much income is needed in order to obtain a loan as we begin the tax preparation process so that we can start with the end in mind.

As we get into the tax filing season, be sure to talk with your CPA ahead of time to let them know if you are looking to get a loan. This way, they can help you to prepare your taxes strategically to save on taxes and preserve your borrowing potential.

Have you ever run into issues when applying for a loan due to tax write-offs? Will you be taking this information into account come tax season?

Leave me your questions and comments below!

About Author

Amanda Han

Amanda Han of Keystone CPA is a tax strategist who specializes in creating cutting-edge tax saving strategies for real estate investors. As real estate investors herself, Amanda has an in-depth understanding of the various aspects of investing including taxation, self-directed investing, entity structuring, and money-raising.

43 Comments

  1. Uyenchi Ho

    Thank you for the post. I was planning to write off as many things as I possibly can, but after having read your post, I have to be careful about this approach. Yikes!

    Another reason I love BP – you learn so much – especially learning things you didn’t know that you didn’t know.

    Amanda, where are you located? Maybe I’ll use you as my tax advisor. 🙂

  2. Boy no kidding. I ran into this when buying a 4plex last year after thinking I had been clever and using a large loss carry forward to drop our taxable income for 2013 down to half of what it would have been otherwise. The lenders, unfortunately, were pretty literal minded and couldn’t use common sense on reviewing the loan app. As you described I finally found a smaller lender who was reasonable and was able to close. But the story doesn’t end there, I’ve also run into it this year when refinancing our home – the 4plex is viewed as a liability since we haven’t owned it for a year, despite it’s past rental history. So, the income doesn’t count for us, but the mortgage payments, insurance, and taxes count against us. We finally had to go to a specialty lender and pay a higher rate.

  3. Mark F.

    Underwriters will usually back out depreciation, but they’ll take into account the usual rental expenses such as taxes, insurance, repairs, advertising costs, professional fees, mortgage payments, management, etc.

    If you do run into debt-to-income (DTI) ratio issues because of your write offs, having money in reserve (401K, IRA, savings, checking, etc.) can often make the difference needed to get you approved. It won’t work in every scenario, but if you’re just over the required DTI threshold, having money in the bank might make it work.

    • Amanda Han

      Great points Mark! I have had clients who ask if it would make sense to not claim property taxes and insurance on taxes to show higher net income. My gut is to say to to that as the bank will likely factor that in regardless of what is shown (or missing) on the tax return. Thanks for your comment!

      • Mark F.

        Hi Amanda, your gut is absolutely right. If your client left off advertising expenses or repairs, an underwriter probably won’t assume those expenses. On the other hand, they absolutely will want to know what the taxes and insurance are (along with any mortgage insurance and HOA dues) and will include them in your client’s DTI.

    • William Morrison

      Mark I just went through this with my Mortgage Broker after retirement from a full time job.
      Oh and one year wont fix it as it seems they want two years of Tax Returns. At least that’s been my experience with each of my loans.
      My Debt-To-Income was high for two reasons. One I claim every thing I can on my real estate, although most is a carry forward because I’m a passive investor. Two, I maxed my 401k including the old guy rules the last two years before retirement and worked less because I could.

      My broker basically took my schedule E apart and built what it would be with only the items you listed, ” usual rental expenses such as taxes, insurance, repairs, advertising costs, professional fees, mortgage payments, management, etc. “. I have not had luck with banks either locally or nationally getting them to work with me and their rates have never been close.
      What always makes me smile is that several times my loans have been sold within weeks or months to the very banks whose rates were quit a bit higher.

      The reserves helped as well.

      It also helped that I have held some properties for a long time with a history as a landlord. If your in your first couple years they look at you as a risk because in the first one to about five years the number of those who quit as they realize toilets and tenants are not for them is high.

      Another thing that has changed over time is the way they deal with credit cards. Years ago they treated the sum of my credit limits as debt even is not used. Now they liked my high credit limits “with low” usage. The ratio worked in my favor.

      Bottom line I’m prepared to help my Mortgage Broker this time with my Schedule E as I head his way again. I don’t have to with my LLCs and Partnerships because I am not guaranteeing any debt. My investment is the only risk, so they stand alone, and he was able to treat those passive losses differently as well.

  4. Amy A.

    Very timely article for tax season! I ran into this problem last year when I wanted to take $50k out of a home I had purchased for cash, fixed up, and rented. However, although I couldn’t get a loan for a single family home, I did get a loan for around $500k for a 12 unit. This was from the very same bank that rejected the loan that’s one tenth the size! Commercial loans are a different species.
    This year I’m talking to a lender while preparing my taxes so I can get my cash back out of that house.

    • Walter W.

      Good point. I suspect that it was the difference between the Fannie/Freddie requirement for the single family home and the Bank’s commercial underwriting standards on the 12-unit. The commercial side seems to be more rational!

  5. This seems dishonest, but have you ever considered leaving a property off your taxes altogether until you get financing (on another property) and then filing an amended return? It would not have even occurred to me until I had to file an amended return due to a 1031 exchange that had not been completed in time. This was going to create a nightmare for me since I had two kids in college whose financial aid was also involved. Since the properties were sold at the end of November, I had not finished the transactions for the purchase of the new properties by the deadline to file taxes and the FAFSA for my kids. I was advised to just leave the entire event off my taxes until I knew the values of the replacement properties, so I filed an amended return in June.

    I see no reason why this same technique cannot be used in other situations. If the banks are going to be ridiculous, then I have no problem with leaving things off that will cause them difficulty in underwriting. After the loan closing, fix the taxes. I am sure that banks have the ability to call your loan payable, but what bank is going to think to ask if you amended or plan to amend your taxes? I personally have never seen that question on any loan app.

    It depends on your own ethics, of course.

  6. William Allen

    Good article, I thought I would have and trouble on the last investment property loan I got because another one I had won’t be reported on my tax return until this year. However, the lender accepted my lease and bank statements as proof of rental income and I got the loan no problem. I just started working on my taxes for 2014 and this exact topic caused a few adjustments. I will be looking for a loan on a house toward the end of march and now I am considering whether to file last years return before I apply or after.

  7. Jim Cunningham on

    The elephant in the room is that this discussion could have been the meat of a discussion about the so called “Liar Loans”, which IMHO, is a complicit scam by both the banks and the govt.
    It’s also a very good way to expose that as the sham it is, and if anything, the loan app should be considered entrapment by the govt, fraud by the banks and if a collusive connection could be solidly made (and I think that is obvious on its face), it should rise to RICO against both:
    Just as taking your *legal* deductions lowers your adjusted gross, loan proceeds are not considered income and if I remember correctly (haven’t done anything since 2008, imagine that!) I did not list them with the gross and then back them out on the tax form, I simply did not list them, though I understand either way is OK.
    I treated properties I held like a farmer rotates his fields; regardless how I went into a property, I rarely paid what it was worth, and whenever seasoning allowed, I’d cash them out so long as the rent was maybe a hundred or two above the note (15 year works best), which had all costs packed in. and which the tenant paid for me, but I got all the tax bennies on.
    I operated mostly off of that untaxed cash float, and most of what I spent it on was deductible, so owing any significant tax was never an issue until I sold, once they changed the law so that instead of being taxed on your adjusted basis, you could elect to be taxed on what you dragged from the closing table – didn’t have to tell ME twice – I’d have the atty (Georgia is not a title closing state) pay off other loans, personal credit cards, you name it, out of closing so that I dragged so little cash and controlled exactly what my exposure would be.
    Point being, the end result is that you’re covered up in cash and have lots of stuff, but just no taxable income to show the lender! 🙂
    The scam on the lender’s part, is they are well aware that you may have cash flow that is not taxable income, and in addition to your returns, they want maybe 3 years bank statements to support whatever level of monthly income you allege, and such that the loan requires. In the tightly drawn scenario with Nancy, there is nothing ambiguous about where the money came from, she simply took advantage of *legal* deductions to lower her tax liability, so there is no additional risk to the lender, and to demand a higher cost and rate accordingly, I think is arguably fraud. As an aside, I also never used big banks – even with great credit, they treat you like it’s THEIR property and you are if anything, a junior partner with no say, so I’d rather pay another half point or so in cost and rate to have a broker deal with the rude, greedy assholes for me!
    The best part is the entrapment by the govt: the Loan App is a federal form.
    I tend to ANALyze everything, and the spot where you listed your “income” bothered me, because I understood that most of my cash flow was not income, and seemed it would not be proper to list it in that spot. So I asked my broker where I was supposed to list the remainder of the money that made up my cash flow, and he told me there is no other spot for it.
    Now, both the banks and the govt know that you can easily have additional money legally, and such that should be considered by the bank in determining your ability to repay the loan, so neither should have a beef with you listing that money for consideration, and they don’t – they just don’t give you a separate spot to list it, and do so only in order to charge you more and expose you to federal charges.
    But they call that a “Liar Loan”, when you list “income” other than what shows on your tax return, in that spot. The definition of income on your tax return is one thing, and the definition of income on the loan app is another – and no one disputes or purports to have a problem with this, unless they want to “F” with you later over just anything – they automatically have you violating federal law by listing your income higher than it actually is, even though they forced you to do so, and doing so was considered perfectly OK as a way to prove your total monthly cash flow – and that’s entrapment.
    I’d be interested to see what percentage of “Liar Loans” were anything other than the lack of another place to list your legally gotten but untaxed gains.
    Consider this: When the bank lets you submit bank statements, at least in my experience, they ask for those in ADDITION to your tax returns, so is it even believable that anyone other than a complete idiot or total crook would actually give evidence against themselves, and on a federal document, that they are lying about their taxable income?
    It’s an absurd contention to automatically assume that anyone giving both their returns and bank statements has misrepresented their taxable income to both the IRS as well as the bank and the federal govt, on the app., and a rudimentary examination of your cash sources would quickly and easily make that determination. But that’s what the law says – you’re LYING.
    So that means that the IRS and by virtue of the app, the entire federal govt as well as the bank, understands that you are NOT lying about your income, but by intentionally causing you to list it as income (since it’s the only place to do so), they are causing you to break the law – and that is entrapment.
    As stated above, I believe it’s fraud for the banks to go “Ooooohhhhh, gosh, this is TERRIBLE!!! We see that you came by this money legally, but simply aren’t taxed on it, and that there is nowhere else to list it on the app, but this magically indicates that you are a bad risk, so we have to CHARGE YOU MORE!!!
    From my perspective, it is more than obvious that both the banks and the govt are actors in this ongoing criminal enterprise they have devised to both illicitly charge people more money than standard, applicable lending practices allow for, and in addition, automatically expose you to federal charges anytime they want to find a reason to get you – not sure if they can prove whatever crime they are really after you on? No biggie – if you’ve EVER done a loan that depended on bank statement support, they say you’re automatically guilty of violating federal law, and before you know it, you’re plea bargaining for things you did not do because they hold a crime over your head that they know you really did not commit.
    Anyway, THAT’S the elephant in the room of this conversation!! 🙂

  8. Jim Cunningham on

    Sorry if this posted twice – says it posted, but I could not see it.

    The elephant in the room is that this discussion could have been the meat of a discussion about the so called “Liar Loans”, which IMHO, is a complicit scam by both the banks and the govt.

    It’s also a very good way to expose that as the sham it is, and if anything, the loan app should be considered entrapment by the govt, fraud by the banks and if a collusive connection could be solidly made (and I think that is obvious on its face), it should rise to RICO against both:

    Just as taking your *legal* deductions lowers your adjusted gross, loan proceeds are not considered income and if I remember correctly (haven’t done anything since 2008, imagine that!) I did not list them with the gross and then back them out on the tax form, I simply did not list them, though I understand either way is OK.

    I treated properties I held like a farmer rotates his fields; regardless how I went into a property, I rarely paid what it was worth, and whenever seasoning allowed, I’d cash them out so long as the rent was maybe a hundred or two above the note (15 year works best), which had all costs packed in. and which the tenant paid for me, but I got all the tax bennies on.

    I operated mostly off of that untaxed cash float, and most of what I spent it on was deductible, so owing any significant tax was never an issue until I sold, once they changed the law so that instead of being taxed on your adjusted basis, you could elect to be taxed on what you dragged from the closing table – didn’t have to tell ME twice – I’d have the atty (Georgia is not a title closing state) pay off other loans, personal credit cards, you name it, out of closing so that I dragged so little cash and controlled exactly what my exposure would be.

    Point being, the end result is that you’re covered up in cash and have lots of stuff, but just no taxable income to show the lender! 🙂

    The scam on the lender’s part, is they are well aware that you may have cash flow that is not taxable income, and in addition to your returns, they want maybe 3 years bank statements to support whatever level of monthly income you allege, and such that the loan requires.

    In the tightly drawn scenario with Nancy, there is nothing ambiguous about where the money came from, she simply took advantage of *legal* deductions to lower her tax liability, so there is no additional risk to the lender, and to demand a higher cost and rate accordingly, I think is arguably fraud.

    Similarly, to deny her the loan on that basis could be argued as a violation of a couple of her constitutional rights, as well as maybe adding a new twist to fed law against discrimination.

    As an aside, I also never used big banks – even with great credit, they treat you like it’s THEIR property and you are if anything, a junior partner with no say, so I’d rather pay another half point or so in cost and rate to have a broker deal with the rude, greedy assholes for me!

    The best part is the entrapment by the govt: the Loan App is a federal form.

    I tend to ANALyze everything, and the spot where you listed your “income” bothered me, because I understood that most of my cash flow was not income, and seemed it would not be proper to list it in that spot. So I asked my broker where I was supposed to list the remainder of the money that made up my cash flow, and he told me there is no other spot for it.

    Now, both the banks and the govt know that you can easily have additional money legally, and such that should be considered by the bank in determining your ability to repay the loan, so neither should have a beef with you listing that money for consideration, and they don’t – they just don’t give you a separate spot to list it, and do so only in order to charge you more and expose you to federal charges.

    But they call that a “Liar Loan”, when you list “income” other than what shows on your tax return, in that spot. The definition of income on your tax return is one thing, and the definition of income on the loan app is another – and no one disputes or purports to have a problem with this, unless they want to “F” with you later over just anything – they automatically have you violating federal law by listing your income higher than it actually is, even though they forced you to do so, and doing so was considered perfectly OK as a way to prove your total monthly cash flow – and that’s entrapment.

    I’d be interested to see what percentage of “Liar Loans” were anything other than the lack of another place to list your legally gotten but untaxed gains.

    Consider this: When the bank lets you submit bank statements, at least in my experience, they ask for those in ADDITION to your tax returns, so is it even believable that anyone other than a complete idiot or total crook would actually give evidence against themselves, and on a federal document, that they are lying about their taxable income?

    It’s an absurd contention to automatically assume that anyone giving both their returns and bank statements has misrepresented their taxable income to both the IRS as well as the bank and the federal govt, on the app., and a rudimentary examination of your cash sources would quickly and easily make that determination. But that’s what the law says – you’re LYING.

    So that means that the IRS and by virtue of the app, the entire federal govt as well as the bank, understands that you are NOT lying about your income, but by intentionally causing you to list it as income (since it’s the only place to do so), they are causing you to break the law – and that is entrapment.

    As stated above, I believe it’s fraud for the banks to go “Ooooohhhhh, gosh, this is TERRIBLE!!! We see that you came by this money legally, but simply aren’t taxed on it, and that there is nowhere else to list it on the app, but this magically indicates that you are a bad risk, so we have to CHARGE YOU MORE!!! Or again, as in the Nancy scenario, you may be denied the loan entirely, and I think them doing so on that specious basis is in violation of federal law.

    From my perspective, it is more than obvious that both the banks and the govt are actors in this ongoing criminal enterprise they have devised to both illicitly charge people more money than standard, applicable lending practices allow for, to improperly deny you the loan by virtue of you having taken your *legally* allowed deductions, and in addition, automatically expose you to federal charges anytime they want to find a reason to get you – not sure if they can prove whatever crime they are really after you on? No biggie – if you’ve EVER done a loan that depended on bank statement support, they say you’re automatically guilty of violating federal law, and before you know it, you’re plea bargaining for things you did not do because they hold a crime over your head that they know you really did not commit.

    Anyway, THAT’S the elephant in the room of this conversation – LIAR LOANS!! 🙂

  9. prempal singh

    in 2013 i ran the same issue. My DTI was high. My bank with whom i had 10 years of relationship, a quarter of million in brokerage account, asked me to close few credit card accounts just two days before the closing of a short sale.
    Of course they will not get my future mortgage business, but how literal these VP of the mortgage branches could be.
    May be an impact of a pendulum swinging too far to one side post financial crisis.

  10. Mary B.

    Excellent article, Amanda. There are plenty of blogs about how to get a loan and how to get ”beat” uncle sam during tax season but this is a new very beneficial twist that not only real estate investors but all business owners should really heed. Thanks a million!

    Kudos,
    Mary

  11. This post made me chuckle. I have 500 units and plenty of cash flow and equity. Though I have a hard time getting a $300 target credit card. Single family home loans are out of the question. The way lending/credit is done is comical.

  12. Yes, this happened to me, I had to show 2 years return. 2013 I took as many deductions as possible and could not show strong income, but i was vigilant and knew about the Frank/Dodd law was going into effect 2014, yes this where the pain to prove where all your income is coming from.

    I asked the loan officer how much income should I show to get the loan. He did not want to comment, so I asked several loan officers this question and finally I realized THEY DO NOT WANT TO GIVE TAX ADVICE!!! So I asked how do you calculate your ratios? I got the answer and unfortunately this meant I had to pay the FULL TAX BURDEN no deductions for 2014. Even when I did that I still had 2013 low income.

    I reasoned with them that the asset will have CASH FLOW AND THAT CAN BE USED AS INCOME!!!!! for 2013 even though its 2014. DONE DEAL AND I GOT THE LOAN AND THE ASSET. Hope this helps!!!!!!

  13. Sandeep S.

    Great article from a great Real Estate aware CPA! I love your articles, Amanda.
    This problem is very real , of course. One little “trick” someone can use to make it favorable is to convert some of the repairs into capital expenses. This will convert immediate tax benefit into a slower benefit via depreciation but it will make the loan numbers look better. And IRS also will not mind it (as they are having to give deductions over the years)

    • Jerome Kaidor

      I always try to capex everything I can. If I sell the property, the buyers like it. If I apply for a loan, the lenders like it. It helps with my basis if I do sell.

      It can be complicated though. I pay my folks with time cards and work orders. Capex expenses may be on on either. One project may cover multiple work orders. And what about materials? At one property, my handyman dumps a pile of Home Depot receipts in my lap. At another, the maintenance manager has a Home Depot credit card. For that one, once a month, the store drops a pile of receipts in my lap. The items are listed in often incomprehensible abbreviations.

      I am trying to bring order out of the chaos by creating a “capex” table in my homemade landlording software.

      There may be an element of dishonesty in all this. If you’re selling the property, do you disclose the capex expenses? Are you lying if you don’t?

  14. Christopher Rodriguez

    @amanda if it were not for you as her CPA she would not have been able to get such a return. Your value to her exceeds the monetary value that is paid to you.

    For you have your clients interest in mind.

    I have not encountered this issue but plan to get a personal loan. So this is something I have to consider.

    Is there any tips you would advise in finding knowledgeable and client dedicated CPA’s such as yourself?

  15. Charles Moore

    Amanda, were some of Nancy’s deductions classified as “unreimbursed employee expenses” like mileage, supplies, etc.? After reading this post and planning on getting financing myself this year, I’ve been looking elsewhere online, and that category seems to come up most often. Did she also have any money-losing properties or businesses? Also, are the lenders looking at adjusted gross income as the final figure?

  16. My husband and I own a small cash business together, small as in just the two of us, no employees, this is our only significant income and we write off everything, as our entire lives revolve around our business. We make about 100,000 a year but just about everything is a business expense to us. Because of this our taxes show very little net income, we want to buy a house this summer as we are starting a family, but just got declined for a 17,000$ loan from a bank because our tax income shows so little even though we would have no problem paying the loan. What would be a better solution for us as far as taxes? We were thinking maybe writing our selves pay stubs, but I don’t even know where to begin with that, and would I pay taxes on the come we paid out to ourselves as well as pay taxes on the business income?

  17. Does creating a 501c3 with the partnership that is losing money? For example, if we make the horse business nonprofit because it really is a means of helping underprivileged kids, and moving the expenses on our individual tax returns to Charity because the money and time are actually donated to the 501c3, does that take the DTI risk away, or can they still use it as expenses on our DTI?
    Looking to do a Construction mortgage to add on to the house and upgrade some things.

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