Non Conforming Unit & Taxes-Investment Property

[Mario Morales]

A friend has a two-flat investment property, with both units currently rented out. The garden unit is non-conforming but fully equipped with 3 bedrooms, a living room, and a full bathroom. It will also be rented out. When it comes to reporting this income, beyond the importance of being truthful on taxes, a few key questions arise:

1. Are there any advantages to reporting higher rental income on your 1040?
2. Will an appraiser disregard the income from the non-conforming garden unit when assessing the property for refinancing?
3. Is it likely that an underwriter will consider the income from the non-conforming unit?
4. Can the reported income to the IRS be leveraged to benefit the investor when applying for a loan or refinancing?

[Kevin Sobilo]

@Mario Morales, a few thoughts:

1. Yes there are advantages to reporting higher income. If you use certain types of financing the income is used to justify the loan amount. For example DSCR (Debt Service Coverage Ratio) loans look at tax returns to see how a property performs in terms of income and expenses to see what loan amount is justified.

2. You might need to specify what exactly is nonconforming about it? Is it only zoned to be a single family? If so, yes an appraiser may ignore the income from the second unit. HOWEVER, for 1-4 unit properties comparable sales is the predominant method appraisers use to establish value not income. The income approach to valuations is used for 5+ unit properties by appraisers.

3. Its possible underwriting might balk at a nonconforming unit because in theory it could be shut down at any time and that income could evaporate.

4. See #1.