Why Your Tax Write-Offs Are Hurting Your Mortgage Application

Your write-offs can be completely legitimate and still make a conventional mortgage hard to get. Underwriting isn’t judging your business strategy. It’s measuring the income your tax returns document, and your CPA’s job is to make that number as small as the law allows.

I explain this to business owners every week. Your CPA did exactly what they should. The lender just reads the result differently.

Why do tax write-offs reduce my mortgage income?

Because a conventional lender starts with the profit shown on your return, not the money that moved through your bank account. Fannie Mae’s Selling Guide has lenders analyze the net profit or loss on your Schedule C and adjust it. Every dollar of expense you deducted comes off the top.

Here’s a hypothetical with simple math. These are made-up numbers, not a program I’m offering.

• A business owner deposits $240,000 over 12 months. After a long list of legitimate write-offs, his Schedule C shows $60,000 of net profit. That’s $5,000 a month.
• The same year, 50% of his deposits is $10,000 a month, which is what a bank statement program might count as income.

Same business, same year. One lender sees $5,000 a month and the other sees $10,000.

What can a lender add back?

Some write-offs are non-cash, meaning no money left your account. Fannie Mae’s guide says lenders add back recurring items on Schedule C including depreciation, depletion, amortization, casualty losses and business use of the home. It also says to subtract non-recurring items, including any meals and entertainment exclusion.

Continuing the example, if $15,000 of that owner’s deductions was depreciation, his income for qualifying becomes $75,000 a year, or $6,250 a month. Better, but still short of $10,000. That’s the gap I’m trying to measure on the first call.

The edge: timing your CPA conversation

Here’s what your CPA probably hasn’t told you. If you plan to buy a home or refinance in the next year or two, you have a choice to make, and it’s yours, not mine. You can keep taking every deduction and use a program that qualifies you on deposits. Or you can talk to your CPA and financial advisor about reporting more income for a year or two so a tax-return loan works.

I can’t give tax advice, and neither choice is automatically right. The point is that it should be a decision, not a surprise. A borrower who learns this in month one of a purchase has no choices left. Someone who learns it a year ahead has several.

What if my returns don’t qualify me?

I look at a bank statement loan, which qualifies you on 12 months of personal or business bank statements. Most lenders call these non-QM (non-traditional) loans. A Qualified Mortgage, or QM, is the CFPB’s category for a loan built with safer features. A non-QM (non-traditional) loan sits outside that box but still has to meet the federal ability-to-repay rule. It just proves your income with deposits instead of returns.

Because the lender takes on more risk, in my experience the rate typically runs about 1% to 2% higher than a traditional loan, and it varies by file and market. Some borrowers talk it over with their financial advisor and decide the tax savings are worth more than the rate difference. Others plan to report more income for a couple of years and refinance later. I say it this way: marry the house, date the rate.

Should I start with a bank statement loan?

No. I always read your returns first, because the cheapest valid option comes first. Freddie Mac allows one year of returns in some cases, when the business has been in existence for five years or more, according to Freddie Mac’s income documentation. Check the conventional options, then move to bank statements only if the returns don’t work. My post What Is a Bank Statement Loan and How Does It Work? walks through the order.

A pitfall I see: the surprise at underwriting

This is a hypothetical, but it’s a pattern I see a lot. A buyer gets a pre-approval based on what he told a loan officer he earns. Two or three weeks into escrow, underwriting reads his returns and the write-offs leave too little income. The loan is declined with the closing date close. A review of your returns on day one would have caught it, and I’ve seen buyers find me at that point looking for an emergency fix. It can sometimes be turned around, but no one can promise the original closing date.

Questions to ask before you apply

1. What is my net income on each of the last two returns?
2. How much of my deductions are non-cash, like depreciation?
3. Does the standard 50% expense factor get me to the income I need?
4. Am I planning to buy or refinance in the next 12 to 24 months?
5. Should we talk about my tax strategy before the purchase, not after?

See also my business owner mortgage page and the common mistakes in 7 Bank Statement Mistakes That Slow Underwriting.

I’m a mortgage broker with NEXA Lending, and I work with borrowers in all nine states where I’m licensed (CA, CO, TX, FL, GA, NC, SC, TN, VA). As a broker, I can shop your loan across a wide network of lenders instead of being stuck with one bank’s programs. This is educational, not tax advice. Programs, rates and approval depend on your full file, and individual rates vary.

Sources: Fannie Mae Selling Guide B3-3.3-03, Schedule C income (opens in a new tab), Freddie Mac, Income Calculator FAQ (one year of returns for a business in existence five or more years) (opens in a new tab), CFPB, What Is a Qualified Mortgage (opens in a new tab).