Yay! Tax Season! What you need to know on claiming deductions!

[Andrew Postell]

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 of the page below and you can see the basic layout: Income and Expenses mostly. So the income is claimed at the top and the expenses are DEDUCTED toward the bottom. 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 (that's right, I used sexy to describe tax returns). 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. 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:

1. 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!

[Lucas Dargis]

@Andrew Postell Still working through it, but yes, it helped the loan officer understand what I was trying to he finally pushed it to the underwriter. Thanks again!

[Andrew Postell]

@Lucas Dargis ok, very good.  I'll keep my fingers crossed for ya that it all works out.  Glad this helped!

[Amy Konopka]

Remember when we had to Meomorize Lincoln's Gettysburg address in 4th Grade?!?! This is what kids should be memorizing.....

This is money...literally and figuratively. And just like so many Bigger Pockets Podcasts and books, I will read and reread until it becomes muscle memory.  TRhank you Andrew1!

[Andrew Postell]

@Amy Konopka thanks so much!  Greatly appreciated!

[Stephanie Medellin]

Quote from @Andrew Postell:

@Michael Plaks thanks for your patience here.  And you are correct, I don't know everything about taxes....just what we can add back for lending.  But if I am understanding you correctly, if it's shown on line 44a....then that data is then put on line 9 of the Schedule C?  Am I understanding that correctly?  If that's the case then please continue to do that....but don't enter it on Schedule E.  Schedule C is the best place for mileage.  I was told, and again this may not be right, that if you itemize your auto-deductions then you can't use the mileage method of deducting.  Was that correct information as you understand it?

 What we're adding back is the depreciation portion of the mileage deduction.  If the taxpayer deducts vehicle expenses based on the flat mileage rate, the mileage will be multiplied by the depreciation portion for that tax year (i.e. 26 cents per mile in 2022).  If actual vehicle expenses are deducted, it's my understanding that depreciation will be calculated separately and listed on Schedule C, line 13.  Either way, you're adding back the depreciation.

[Michael Plaks]

Quote from @Stephanie Medellin:

 What we're adding back is the depreciation portion of the mileage deduction.  If the taxpayer deducts vehicle expenses based on the flat mileage rate, the mileage will be multiplied by the depreciation portion for that tax year (i.e. 26 cents per mile in 2022).  If actual vehicle expenses are deducted, it's my understanding that depreciation will be calculated separately and listed on Schedule C, line 13.  Either way, you're adding back the depreciation.

You're doing it correctly, as opposed to the OP.

[Andrew Postell]

@Michael Plaks the original post here is not incorrect.  This is still how mortgage companies underwrite loans.  This is not me, at my company, this is our industry.  The original post is 100% accurate.

[Michael Plaks]

Quote from @Andrew Postell:

@Michael Plaks the original post here is not incorrect.  This is still how mortgage companies underwrite loans.  This is not me, at my company, this is our industry.  The original post is 100% accurate.

I was replying to a lender licensed in CA. She is doing it correctly, and she is in the same industry as you. Your post describes a MIS-interpretation of tax returns, and you can continue to point your finger at the "industry" - despite clear evidence that some people in your industry doing it differently (and doing it correctly). 

[Michael Plaks]

This is not my job to find errors in lenders' posts but since this lender insists on being wrong, let's use the actual guidance, shall we? 

FannieMae publishes their underwriting guide, Dec 2023 version:  https://singlefamily.fanniemae.com/media/37656/display

If we scroll down to page 388, there is a section "B3-3.3-03, Income or Loss Reported on IRS Form 1040, Schedule C" that says:

The following recurring items claimed by the borrower on Schedule C must be added back to the cash flow analysis: depreciation, depletion, business use of a home, amortization, and casualty losses.

Now compare the above to the list in this OP post. You will see that "Vehicle Miles (Line 44A) – can be added BACK as income" is NOT on FannieMae guidance and has been invented either by the OP or his company.

Now, as another lender @Stephanie Medellin correctly pointed out, mileage allowance does have a depreciation component that should be added back - but not the entire mileage allowance.

OP's statements on K1 income are also incorrect, but any reader can compare OP's statements to the actual FannieMae document that I linked - and draw their own conclusions.

[Sean O'Keefe]

Quote from @Michael Plaks:

Quote from @Stephanie Medellin:

 What we're adding back is the depreciation portion of the mileage deduction.  If the taxpayer deducts vehicle expenses based on the flat mileage rate, the mileage will be multiplied by the depreciation portion for that tax year (i.e. 26 cents per mile in 2022).  If actual vehicle expenses are deducted, it's my understanding that depreciation will be calculated separately and listed on Schedule C, line 13.  Either way, you're adding back the depreciation.

You're doing it correctly, as opposed to the OP.

yikes!

[Andrew Postell]

@Michael Plaks Ok, let's work under the assumptions that we can add back depreciation, depletion, business use of a home, amortization, and casualty loss...just like my original post states.  Right?  We are on the same page still?  And now can we agree that a portion of the business milage allowance has a depreciation component that should be added back....can we agree on that too?  I'm just repeating what you are saying...so hopefully we can agree there too?

All good now?

[Michael Plaks]

Quote from @Andrew Postell:

All good now?

All would be good once you retract this incorrect advice of yours  ;)

"...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!"

[Amy Konopka]

Sorta real estate related (since it affects my ability to get lending!!) but this is a general question I feel every CPA probably has an answer to: 

TCJA eliminated the deduction line on Schedule A for legal costs associated with trying to recoup (not sure if that word is the best word) costs for unpaid Alimony/or legal expenses.  Prior to 2018 alimony was taxable to the person receiving it and deductible to person paying.  It is now the opposite. I am currently paying taxes on Alimony received. 

However, my understanding is line item still applies IF I am paying taxes on my alimony, despite it being removed from Schedule A.  This makes sense-the IRS wants me to receive that taxable income because then I have to pay Uncle Sam Taxes on it. Therefore in “government fashion” it provides incentive for me to seek those payments being willfully withheld THROUGH the tax breaks on Schedule A.  

Where do I plug the numbers now for legal fees spent trying to recoup this lost taxable income? 

[Amy Konopka]

Sorta real estate related (since it affects my ability to get lending!!) but this is a general question I feel every CPA probably has an answer to: 

TCJA eliminated the deduction line on Schedule A for legal costs associated with trying to recoup (not sure if that word is the best word) costs for unpaid Alimony/or legal expenses.  Prior to 2018 alimony was taxable to the person receiving it and deductible to person paying.  It is now the opposite. I am currently paying taxes on Alimony received. 

However, my understanding is line item still applies IF I am paying taxes on my alimony, despite it being removed from Schedule A.  This makes sense-the IRS wants me to receive that taxable income because then I have to pay Uncle Sam Taxes on it. Therefore in “government fashion” it provides incentive for me to seek those payments being willfully withheld THROUGH the tax breaks on Schedule A.  

Where do I plug the numbers now for legal fees spent trying to recoup this lost taxable income? 

[Annmarie Hill]

Excellent post, but isn't mileage only added back as the portion allowed by the IRS, not in its entirety, so it wouldn't be a full 10K add-back in your example? I believe the add-back is about 22cents/mile for 2023 isn't it? My lender explained because there are still going to be those ongoing expenses of maintenance, gas, wear and tear ok the car so it's not all income. 

[Andrew Postell]

No worries @Michael Plaks.  We at least got part of the way.

If anyone actually read this far into the post, speak with your lender on this.  For most of us, we don't get to see what happens after our loans are submitted into "underwriting".  So, this is the attempt to open up the curtain for people who are trying to figure out what is possible and what is not.  Sometimes the front line person at your lending institution won't know any of this either.  That happens as well.  So, while this post is 5 years old - it is still accurate as this calculating methods rarely change.

If you need help trying to find "real estate friendly lenders" then read this post HERE.  It may not answer the "self-employed" question that we are answering her directly but it still provides good techniques on how to find lenders including what questions to ask them if you are a real estate investor.

[Andrew Postell]

@Amy Konopka this specific of a question I would recommend asking as a new post in this same forum. 

[Andrew Postell]

@Annmarie Hill correct, in that when you claim the mileage that the amount of the deduction is $X amount per qualified mile.  That amount changes every once in a while.  So, when I wrote this 5 years ago, I didn't put the actual amount...because that amount is outdated now.  If you claim that deduction, the amount of that deduction is given back to your qualifying income in that specific year.  So, if it's .22 per mile or .65 per mile...100% of that deductible amount is given back to your qualifying income when applying for a Fannie/Freddie loan...at least, good lenders will give this back.  You can read the IRS news release on it for 2023 HERE but always consult with your tax professional on what is used and how much you get.  Even tracking mileage can be a little annoying, but if you need that income for this loan type then it's worth tracking.  I use TripLog specifically for my mileage tracking.  

Hope all of that makes sense.