It’s hard to imagine that we haven’t all heard of the IRS by now. In fact, if you have just about any type of regular income, then you realize how much money you give to the IRS every month.
Fortunately, the IRS gives a little break on taxable income for those who have rental homes.
Here’s how it usually plays out: as the property owner, let’s assume you receive $2500 per month in rent ($30,000 per year). That’s fantastic!
Since you have received $30,000 of rental income for the year, you’re required to declare on your upcoming tax return that you received this income. The benefit to having an investment property (rental) is that you can claim deductions to lower the taxable income. That’s great! Right? Not necessarily every time. In fact, it could hurt your chances of qualifying for another home loan.
I have had clients who normally show at least as much in deductions on their tax returns as they had earned rental income. The benefit here is that if there are $30,000 in qualified deductions when there was $30,000 in income, then there would be little to no tax liability. Unfortunately for those who declare MORE expenses/deductions than rental income, this is where it can hurt your next chance of qualifying for a home loan.
If you declare $30,000 in rental income and also declare $42,000 in deductions/expenses, then your net income will be approximately NEGATIVE $12,000. (30000 – 42000 = -12000).
FYI- your rental income and expenses will be displayed on your personal federal tax return form 1040 on Schedule E.
In this scenario with negative -$12,000, as a lender, we have to reduce your total qualified annual income, i.e. employment income, retirement income, disability income, etc… by $12,000! Lenders also look at annual income from a monthly basis, so $12,000 / 12 months = $1,000 monthly loss.
More specifically, let’s assume your total qualified income is from your full-time job where you earn an annual salary of $50,000. This equates to $4,167 per month. However, since we have to decrease your $50,000 in qualified income by $12,000, due to your rental property losses, your actual monthly qualified income would be $3,167 per month (4167 – 1000 = 3167).
Assuming you’re maximum home loan qualification was for $425,000 and that was based on your total employment income of $4,167, you would no longer qualify for that much because the lender would only be able to qualify you based on $3,167 per month. That’s nearly $75,000 difference in loan qualification amounts or $350,000.
Bringing it all together:
If you’re self-employed or have a farm or rental properties, and you’re thinking of applying for a home loan, it’s best to contact your trusted lender sooner than later and have them review all of your documentation. This will prevent a last minute home loan application to buy a home for sale that popped up on the market at the final hour on a Saturday evening; only to find out that you can’t qualify (and may not qualify for another year or two)!
This same calculation applies to those who are receive a 1099 each year, i.e. real estate agents, Uber/Lift drivers, Farmers with schedule F, or even those who have an LLC (which is usually reported on a schedule C).
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Terry Roberts is a U.S. Marine Corps Veteran and specializes in residential mortgages, including new construction, conventional, FHA, and VA home loans. He has helped more than 10,000 clients start the home buying process across America.
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