Taxes for RE Professionals - Show high income, or write it off?

Question

Of course, I am involving my own tax professional for my personal tax returns but I wanted some insight from the rest of the community here. How do you look at your taxes in relation to the effect they have on purchasing power the following year? Do you keep your taxable income high to look better on paper or do you write it off as far down as possible to keep your tax burden low?

Eamonn McElroy · Answer

"Do you keep your taxable income high to look better on paper or do you write it off as far down as possible to keep your tax burden low?"

Most CPAs aren't going to leave off expenses so you can qualify for a loan.  e.g. Wade into mortgage fraud territory with you.  We have enough professional risk as it is...

If your tax pro is worth his or her salt, they will bring up various planning strategy and applicable elections to defer tax deductions to future tax years, thereby increasing current year taxable income.  Kind of the opposite of usual tax strategy but it may help you meet your goals if you see yourself applying for a loan in the next year or two...

Michael Plaks · Answer

@Jameson Sullivan

I see several separate issues in your question.

1. Claiming v. not claiming deductions for expenses you paid for. This is not a choice, you must claim them. If you paid $5,000 for a marketing campaign and choose not to deduct it for lending purposes - you may be committing mortgage fraud and sometimes tax fraud.

2. Deferring deductions. Some deductions can be legally pushed into future tax years, partially or even in full. For example, if you buy $5,000 worth of equipment, normally you can deduct $5,000 right away. But you also have an option of slowly deducting (depreciating) it over 7 years. If you take a $5,000 training program, you may deduct it immediately or sometimes treat it as a start-up expense for some future business and thus delay deducting it.

3. Choosing a method of deduction. If you bought $2,000 worth of appliances for your rental property, you have more than one method of deducting it. You can deduct it as repairs/maintenance ("de minimis safe harbor") or you can deduct it under bonus depreciation or you can deduct it under Section 179. The last two of the three methods are forms of depreciation, and most lenders will disregard it, known as add-back. In other words, the first method reduces your income for lending purposes, and the other two do not.

4. Choosing a lesser deduction when a choice is available. The best example is business driving. You (sometimes) have a choice of using either mileage allowance or actual expenses. You can choose the lesser of the two deductions if you're trying to minimize your deductions. Keep in mind that you're intentionally overpaying taxes this way. In other words, you're paying Uncle Sam a premium in order to qualify for a loan. It may or may not be worth it.

5. Income-based borrowing. Ultimately, you want to transition to asset-based lenders, as in private lending and commercial lending. They lend you money based on your assets and your credit, as opposed to your income.

Kory Reynolds · Answer

Definitely don't underreport expenses, as Eamonn noted that is fraudulent - you are misrepresenting your income to the mortgage company.

You can certainly work with your tax pro to make decisions that can draw out or accelerate expenses - taking or electing out of bonus depreciation, 179 depreciation, at what level  of expense you capitalize vs write off (de minimis safe harbor), election to capitalize repairs and maintenance you otherwise could have written off, making or not making small taxpayer safe harbor.

Of course talk with your lender to see what they add back - if they add back depreciation/179/bonus, then that isn't a reason not to accelerate. If they factor in repairs/maint, but not depreciation, perhaps you elect to capitalize and depreciate, or have a lower capitalization threshold.

Lots you can do, just report everything and work with someone to determine the most advantageous way to present it.

Natalie Kolodij · Answer

You need to discuss this with BOTH your lender and your CPA.

You don't want to pay extra taxes for no reason- plan which years your big expenditures happen so you can time around your lending needs.

Find out which expenditures to maximize becuase they get added back in for lending and won't hurt you.

Jeff Cichocki · Answer

@Jameson Sullivan,

Generally speaking, keeping your income low for taxes is more beneficial than keeping it high to get a loan. A good lender will look at the tax returns you provide and make adjustments for your paper losses (depreciation, etc.). Paper losses are bogus and hide your real income. Good lenders know that. There's more to a tax records request than just verifying your AGI.

If the lender your working with doesn't take this into account, you need a new lender not a new tax professional.

Just my 2.5 cents worth.

Good luck!

Reggie Rearden · Answer

I met with our lender Friday and asked the question about write-offs. We have a rental that we put $9K into due to the former tenants damaging Sheetrock, floors, ect. Our lender said that when we come in for a loan, she will take that type of expense into consideration. I will just bring in my 2018 and 2019 tax return with all of our business info AND overflow sheets as well as detailed P&L statements. If you have a good relationship with a lender, they will know that lending to you, even though you may have a lot of deductions, is a good move on the banks part.

Taxes for RE Professionals - Show high income, or write it off?

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