Tax: should I deduct or not, to qualify for a higher loan?

Question

I'm in the market for my first property.  Just got off the phone with a mortgage lender, and he suggested I don't go super aggressive with deductions this year (I'm self-employed as a musician, and most of my "jobs" are either cash or 1099 independent contractor).  The more I make on paper, the more of a loan I can get approved for.

I haven't sat down with my taxes yet, but I make roughly $20-30k/yr before deductions.  I have $50k sitting in the stock market that I plan on using as downpayment.  Is his advice sound?  Should I deduct nothing so that I can qualify for a higher loan?  Or should I deduct as much as possible?

Thanks guys!

Eric

Mimi H. · Answer

Yep, as @Patrick Liska may have alluded, most lenders are really not tuned in to knowing how to work with people with 1099 income. Some would go as far as to suggest that you shut down all of your 1099 income and go get a W2 job (I actually had someone suggest that once). Find a lender who understands 1099 income from the start otherwise it'll be an uphill battle. Hopefully your past 2 years of 1040s are tidy and you are fairly tidy with your bookkeeping, etc. You accountant should be able to run a P&L for you so it supports the case that you have a real business and that it's not just a write off for a hobby.

Patrick Liska · Answer

as @Mimi H. said, lenders will want at least 2 years tax returns, changing this year will not do anything for you. I have been self employed for about 30 years now, most lenders only follow specific guide lines from their companies and do not know any better, i have had to explain my tax returns to them for them to understand. Being self-employed ( or 1099 in your case) you are allowed more deductions than a normal W2 worker is, there for your returns will not show the same as theirs. you will have to fight a little to show you know how to run the business and know the numbers. i suggest you create a sheet with your net worth, bring that and all your numbers showing how your investment will profit even after all expenses, including the mortgage.

Mimi H. · Answer

Usually, lenders look at more than the most current year's taxes (for self employed, I've seem lenders go back 2-3 years). From a taxation standpoint, it would seem strange for you to be 1099 and have no deductions. You may want to find a better mortgage lender.

There's purchasing power, and then there's your own comfort with the mortgage amount. There are a lot of people who are over leveraged, so they can technically afford it, but it's not a comfortable position to be in.

You may want to consider how much you're comfortable paying per month and then working backwards to see how much that works out to be in the way of a mortgage (and if there is anything worth it - however you may want to qualify that) in your range. Even if you could get $200k more in a house, it's worthwhile to ask, is this what you'd want?

1099 deductions are pretty straightforward and if you've been in this role for a while, then years of your returns should have a similar pattern of deductions.

When it comes to deals, a lot of it boils down to risk (your tolerance), and running the numbers. When you do find something, you may want to consider running the deal by BPers for feedback. Even then you will find a range of responses.

Bill Gulley · Answer

I think what your lender is saying is that taking every deduction you can muster up as an expense will hurt your qualification ratios as they can't really amortize expenses in a pro forma income statement, what you claim is taken as an average expense in future years or your past years, For example, taking a deduction as office expense in your home is an actual expense against the income, but a lender is already counting that mortgage expense in another way. But, if you expense a part of utilities, they may still count that as an expense even when your utilities are built into the qualifying ratio.

In other words, dreaming up expenses to save on taxes will hurt your ability to qualify.

I know self employed folks have not taken obvious or entitled expenses, were willing to pay more just to have stronger income for borrowing, no law against paying more, but going too far, claiming more than you made will be mortgage fraud, applying for a loan. Don't go there.

Be careful with loan officers that get into giving tax advice or accounting to help you qualify, tax advice requires registration with the IRS and they are usually outside their expertise, an opinion is one thing, instructing you to do something can be illegal. :)

Eric Bate · Answer

Hm...

Maybe I should file for an extension in order to get this figured out.  Get some more opinions, and find an accountant who can guide me through this.

Chris Mason · Answer

Anyone following Fannie Mae guidelines, assuming they know the guidelines, will add it back. Among other things.

Chris Mason · Answer

@Eric Bate

You need to find a lender more knowledgeable than that, for starters. I typically look at a self-employed persons last tax returns, make a copy of the relevant 2-3 pages (5-7 if self employed AND a current landlord), and then mark them up with highlighter and red pen.

At the very least, if I don't know the CPA, you get three categories:

• A big number here hurts your purchasing power.
• A big number here helps your purchasing power.
• A big number here reduces your tax bill, but doesn't impact your purchasing power, so whatever else you do you should go wild with these boxes.

Then you give that to your CPA who will ideally tell you how far you can push it without breaking the law.

I've got someone in contract right now that did the whole "say you make a lot, go easy on the deductions" thing per some other lender's advice. His purchasing power is HALF of what the other lender said it would be, because the other lender did not specify. He'd have been in about $200k more house had he shopped lenders for IQ a little harder.

@Mimi H. relevant to a conversation we were having.

Eric Bate · Answer

I haven't located a property yet.  First I'm trying to sit down and figure out what I can afford.  I'm planning on house-hacking a MFR, so living in one unit while renting out another.  At the moment I pay close to $1000/mo in rent, and I'm still able to put 10% of my income into savings.  Once I get out of my apartment, that $1000 could go straight to mortgage instead of rent (though I'd rather it go into savings, as much as possible).

Joel Owens · Answer

What is the price of the house you are buying? Are you living in it or investment property? 20k  a year even with your large down payment I would think DTI is going to be an issue.