We are at the oh so pivotal point in the year where many people are scrambling to get all forms submitted
related to their personal tax returns. At first glance, most people look for ways to have the lowest tax liability
possible. While that should be your goal
the majority of the time, if you are in a position to try and purchase real estate,
then your planning becomes a little more involved. Today, I want to focus on what your tax
return says about your borrowing potential.
Adjusted Gross Income
So this figure is what the federal government considers as
your taxable income amount. Located on Line
37 of a typical 1040, it is the final figure after taking your gross income
(say your salary, ordinary dividends, your net business income/loss, etc) and
subtracting the coveted self-employment insurance deductions, tuition/education
expense deductions and HSA account deductions among a few others. As your AGI decreases, so does the amount of
house you can afford.
Self-Employed Business
Income/Loss
Self-employed persons are treated with more scrutiny than
W-2 employees. Your earnings are
considered more volatile. Lenders are
looking for consistency among your business tax returns and/or schedules within
the last two-year period. If your sole
income comes from your own business, it might be of more benefit to let go of
some deductions in order to keep your income figure high enough for the amount
of house you believe you can or want to afford. This is a very grey area and that is why I would recommend speaking to a
CPA or a financial advisor. There might
be benefits of forgoing loss carryovers, depreciation on some assets, you might
need to tweak how you pay yourself with the use of W-2 income, etc. 1-5 year plans are something that should be
evaluated every year as your business and financial goals change.
Income and Deduction
Verification From Additional Sources
So this is such a tedious process that the majority of
buyers find aggravating, but it proves to be a necessary part of the lending
process. Say you are a sole proprietor and
only receive 1099-Misc income; the lender will most likely look at your tax
returns, they will request the corresponding 1099-Misc that you received along
with proof of funds entering your possession (by way of bank records). They will also request profit/loss
reports. Everything needs to have a
paper trail. If you operate a business that
is heavily geared towards cash transactions, you are opening yourself up to
potential disappointment. If you do not
have verifiable evidence to back your figures, then they never happened in the
eyes of the lender.
Averaging Your Annual
Income
This happens when something is seen as not the average
course of business or is not viewed as reliable income. Say you are a W-2 employee that earns $60,000
annually. Your past two year’s returns
verify that but last year you earned an additional $10,000 bonus. That is a substantial jump. Your
lender may average the two years or determine that is not likely to happen
again and they will use the lower figure. You need to be prepared for either outcome.
While there are other factors that play into your financing
potential like credit score, past mortgage history, etc, your tax return is at
the heart of your important figures. Regardless of what type of financing you are trying to qualify for, at
the very least the lender will ask for these documents. Be prepared and go into the qualifying
process with an informed expectation. It
could save you headache and disappoint further along in the home buying
process.
-Published by guest writer Jana Lambros
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