Right now many Americans, especially the self-employed, are reviewing their 2015 expenditures to make sure they’ve claimed every legal deduction before filing their Federal and State income tax returns.
It’s a smart thing to do, unless you want to buy a home in 2016 and need to show a higher income in order to qualify.
As many of the self-employed have learned, taking every possible deduction often gives an inaccurate picture of their ability to make mortgage payments. It reduces their “paper income” to a near-poverty level. The higher your income, the bigger the home loan you’ll qualify for. If you reduce it to less than your monthly house payment, you aren’t going to qualify at all.
If you plan to purchase a house this year, it might be in your best interests to forgo some of those deductions and spend a few thousand extra in State and Federal income taxes this year. You’ll reap the benefit in future years when you deduct the taxes and interest paid on your new home.
If you’re self-employed…
Talk with your lender or a financial advisor before deducting large expenses such as those for a business vehicle or a home office. Learn which deductions they can add back to your income as “paper only” expenses. Then consider eliminating your deductions for smaller expenses such as business meals and travel.
If you’ve made a large one-time purchase, save the documentation and take it along to your lender. Explain why you made the purchase, why it was necessary at that time, and why it will not be an ongoing expense. If you’ve made equipment purchases that could be written off in the first year – shift them over to the depreciation column and take only a portion of that expense.
Caution: Don’t go freelance this year if you want to buy a home.
At least, don’t go freelance until after your transaction has closed.
All self-employed people must show a two-year track record of earnings before being considered for a mortgage loan. It doesn’t matter how many years of experience you have in the field. Lenders know you may or may not make it when running your own business.
If you’re drawing a paycheck…
Individuals with W-2’s that prove their income generally have an easier time becoming approved for a loan than those with self-employment income, but still do need to be careful about deductions. For instance, if you use Form 2106 to deduct unreimbursed business expenses, you may want to skip them this year.
Don’t change employers unless you stay in the same field and have roughly the same earnings. Your new employer will have to provide you with a verification of employment letter (using the I-9 Software) to reassure your lender that your earnings will not decrease.
If you’ve been unemployed for an extended period of time in the past two years, be ready to explain the reasons why.
If you have rental income and expense…
You’ll have to show your lender your Schedule E to verify actual rental income and expenses for 2015. So this year, you might want to forgo the deduction for mileage for the trips you’ve made to check on your properties, or the $200 you paid for a new kitchen faucet.
Remember that you could be seeing positive cash flow from your rental properties, but still show a paper loss due to depreciation. Depreciation is one expense that will not be deducted from your rental income when your lender calculates your total income.
The small (and large) deductions that add up when reducing your income for tax purposes also add up when reducing your income for loan qualification purposes.
If you want to buy a home this year and need to show a higher income in order to qualify, forgo some deductions. Go ahead and pay that additional tax. It will come back to you tenfold when you file your taxes in years to come.
And best of all – you’ll be living in the house you love.
18170 Dallas Parkway
Dallas, TX 75287