It’s tax season!
Yay! Can we detect sarcasm when
it’s typed out? Since April is fast
approaching that means many of us will need to file our Federal Tax
Returns. Even if you are filing an
extension I have tried to put some things together here that will help you
DECREASE your personal tax liability and INCREASE your income for qualifying
for a Fannie Mae and Freddie Mac type of loan.
This post is designed to help persons who may need a
Fannie/Freddie loan on a 1-4 unit property.
There are lots of reasons why this might be you…but alternatively there
are MANY an investor that are very successful WITHOUT Fannie Mae or Freddie
Mac. But if you would like to take
advantage of their rates and terms while at the same time decreasing your tax
burden then this post is for you!
Here’s what I mean:
When you file your tax returns there are certain deductions
that can be added BACK to your income to help you qualify for a Fannie/Freddie
type of loan. Keep in mind if you are doing
commercial/portfolio/other loan types then none of this may matter…but for
Fannie/Freddie it will.
SCHEDULE C
The Schedule C portion of your personal tax returns is where
most people file a business that is operated as a “sole proprietorship”. Basically any business that is not a
Partnership, S-Corp, C-Corp. Even a
single-member LLC can be claimed here as well.
I have included an image far below so you can see
the basic layout of Schedule C: Income and Expenses
mostly on this Schedule. So the income is claimed at the
top and the expenses are DEDUCTED toward the bottom of the form itself. These deductions are what we want to focus
on.
Deductions help REDUCE your taxable income. So if you made $100 (on line 1) but used $100
in advertising (line 8) your taxable income (line 31) would be $0. Now, this is just for an example….hopefully
no one is actually doing this as you would make $0 as a company. This
is however one of the main reasons self-employed persons report having issues
with banks – NOT ENOUGH TAXABLE INCOME. What
are you to do if you want to write everything off but still look good towards a
lender? Here’s your answer:
- Depreciation (Line 13/14) – can be added BACK as income
- Business Use of Home (Line 30) – can be added BACK as income
- Vehicle Miles (Line 44A) – can be added BACK as income
- Un-allowed Meals and Entertainment (Line 24B) – is
subtracted FROM your income
If you have a choice on HOW to deduct the items above then
you want to CHOOSE to try to deduct them in those categories. What I mean here is that many people deduct
their automobile expense in Line 9 – Car and Truck Expenses…..and you might be
correct that itemizing your automobile deductions might allow you to get a
HIGHER deduction when using this line….but your lender cannot add it back to
your income! However, Line 44A – Can absolutely
be added back to your income! So if you
have a choice of deducting in Line 9 or Line 44A…then choose LINE 44A for Fannie Mae!
Likewise, if you are working out of your home then you
should be FULLY realizing Line 30. This
will help reduce your taxes but get added back to your income (again, for
Fannie/Freddie loans).
Let’s use an example:
Let’s say your company earned $10,000. But you wrote off $5,000 in Depreciation (Line
13/14). $2,500 in Use of Home (Line 30). And claimed $2,500 in mileage (Line 44A)…then
your TAXABLE INCOME (Line 31) would be ZERO!
Oh no! But wait…..your lender
gets to add those 3 items back as income.
So your taxable income is still ZERO but your qualifying income is $10,000! Now imagine if this was $20,000….or $50,000…and
on an on! I hope you see where we are
going with this. And this is just ONE
Schedule. Ready for another?
SCHEDULE E
Schedule E is the SEXIEST Schedule to investors. This is where we show our properties and get
to write off everything! Cleaning,
Insurance, Maintenance, Taxes, and on and on and on.
And Schedule E has some very similar themes to it as well….some
deductions can be added BACK to your qualifying income while at the same time
REDUCING your taxable liability. Here’s
what you should know on Schedule E:
- Depreciation (Line 18) – can be added BACK
- Casualty Loss/Amortization/One-Time Expenses/HOA Dues (line
19) – can be added BACK
- Insurance (line 9) – Added Back
- Mortgage Interest (Line 12) – Added Back
- Taxes (Line 16) – Added Back
And this is why owning property is such a great method of
building wealth. Nearly all of your
normal expenses on a property can be deducted from your TAXABLE income but
added BACK to your qualifying income for a conventional loan!
Let’s examine an actual tax return SCHEDULE E below (all the way at the bottom of this post). Don’t worry, all the personal information has
been removed.
Line 3 is all the income that was made - $30,000! Wow!
But examine line 21 - $50 in taxable income…great job! But will this scare a lender? Not if you are claiming your deductions
correctly. This person claimed $4,758 in
insurance (Line 9), $6800 in mortgage interest (Line 12), $1200 in repairs
(Line 14), $8326 in taxes (Line 16), and $4000 in depreciation (Line 18)….for a
total of $25,084. So a taxable income of
$50…but a qualifying income of $25,084!
Now this is held against the expense that you have on the property
(mortgage, etc) but claiming your deductions is a MUST for Fannie/Freddie
loans. This subject can be explored at
length but for the sake of time let’s cover 2 things here quickly:
- LINE 6 – Auto & Travel
Remember above on Schedule C? If this person would claim this auto expense
as mileage on Schedule C then his qualifying income would be EVEN BETTER! Keep that in mind – business mileage on
Schedule C, Line 44A for Fannie Mae!
2. NOT REPORTING.
Now I have seem many a person not claim their deductions on
their returns. The most common item I
see is when they may have purchased it at the end of the year, and didn’t have
any income. YOU SHOULD STILL CLAIM YOUR
DEDUCTIONS! Remember, you are not
penalized on your loan to claim taxes, insurance, ONE TIME RENOVATION REPAIRS, mortgage
interest, and Depreciation! CLAIM THOSE
ALL DAY EVERY DAY!
But some of us file other things on Schedule E – Like Corporate
Tax Returns or Partnerships. Those get
reported here as well. And just like
with the others above there are some good deductions you should be taking
advantage of here as well.
S-Corp
- W2 income – that’s easy, you probably understood that your
W2 income can be added BACK
- K-1 income (box 1 & 2) – also pretty self-explanatory,
but just in case, it’s added BACK
- Amortization/Casualty Loss – Added BACK
- Depreciation 1120s (line 14 & 15) – Added Back
However….
- Mortgage Notes, bonds payable in less than 1 year (Schedule
L, line 17)- this is SUBTRACTED from
your income
- Meals & Entertainment (Schedule M1, Line 3b) –
SUBTRACTED from your income
- Non re-occurring Other Income (1120s line 5) – SUBTRACTED
from your income
Partnerships
- W2, K1 (box 1,2, & 4), Depreciation,
Amortization/Casualty Loss – all added BACK
- Non re-occurring Other Income, Meals and Entertainment,
Mortgage Notes payable in less than 1 year, AND Ordinary income from Other
(1065 line 4) – all SUBTRACTED from your income
*WHEW* What a lot of information and we could probably spend
ENDLESS amounts of time on this subject.
But this post was designed to help highlight what you should be targeting
to help you qualify for Fannie/Freddie (Conforming, Conventional) residential
loans on 1-4 unit properties. There’s a
lot here for sure so ask away if you have any questions. Thanks!
