How do tax losses affect mortgage qualifying? The answer depends on what type of loan you are getting.
VA Loans
If you are a veteran and getting a VA loan, business and/or roll over losses must be considered in the debt ratios. Even if your main job is as a salaried wage earner on a VA loan, you’d count losses from a side business. And even if tax losses come from a non-borrowing spouse, you would have to count those losses on a VA loan.
FHA Loans
FHA loans require tax losses to be counted against a mortgage borrower if they are a 25% or greater owner of the business.
Conventional loans
On Conventional loans you would likely be getting a loan backed by either Fannie Mae or by Freddie Mac. On a Conventional Jumbo loan, which are non-agency loans (also called non-conforming loans) the rules will be different from one bank to another. Below is what each of the agencies says on tax losses.
Fannie Mae says if the client has other income that qualifies them for the mortgage, we do not have to consider the tax losses from a business. If the only income from the client is self-employment income, then those losses must be counted against the borrower.
Freddie Mac says we must always count tax losses.
Below are some examples that will help you.
Example 1 – self-employed mortgage borrower:
- Tax year 2021 = $30,000 self-employed income loss
- Tax year 2022 = $100,000 self-employed income gain
- Income used is a two year average, or $35,000.
Example 2 – Salaried wage earner, $84,000 a year salary, with a self-employed side business:
- Tax year 2021 = $30,000 income loss from side business
- Tax year 2022 = $30,000 income loss from side business
- Income used would be the $84,000 salary because I’d go with a Fannie Mae loan in this scenario. FNMA says if there is other income that qualifies the borrower for the mortgage we do not have to use the business losses.
Example 3 – Salaried wage earner, $84,000 a year with a rental property.
- Tax year 2021 = $3,000 positive cash flow income from rental property
- Tax year 2022 = $5,000 loss from the rental property
- = $2,000 loss on rental property over a 2 year average
- Income used is the $84,000 salary, minus the $2,000 two year average loss for the rental income = $82,000 income used to qualify.
What if a business is closed?
If a self-employed business has closed it is possible that those losses will not be counted against a borrower. What is proof of closure of a business? This might be evidence of sales of assets of the business, such as the building where it operates. Or proof of the sale of the business to a non-family member. There may be other items underwriters would review to determine if a business is closed.
Example 4 – Salaried wage earner, $84,000 a year, with a self-employed side business that closed:
- Tax year 2021 = $30,000 income loss from side business
- Tax year 2022 = $30,000 income loss from side business
- Tax year 2023 business closed*
- Income used would be the $84,000 salary because we’d document that the business is closed.
*Documentation is needed showing a business is legally closed. For example, obtaining a final K1 from the prior year’s tax returns that show a business is closed.
How about rental property losses due to one-time expenses?
All the above loan types will likely exclude non-recurring losses. However, it has to be documented as to why they’ll be one-time or non-recurring losses. Non-recurring losses are more common with rental property due to renovations or one-time repairs.
To exclude losses on a rental property a mortgage lender would need to document that expenses are “one-time” expenses. The repairs would need to be documented and structural like a new roof, foundation repairs, etc. Those repairs do not happen frequently.
Whereas updating carpet, painting walls, replacing appliances or general property updates are considered re-occurring expenses. And a landlord should update their properties. Those costs are a cost of doing business and must be counted.
Example 5 – Salaried wage earner, $84,000 a year with a rental property with one-time expenses.
- Tax year 2021 = $18,000 positive cash flow income from rental property
- Tax year 2022 = $20,000 income loss from rental property, due to a $40,000 one time documentable renovation.
- Rental income analysis over a two year average would be $19,000 positive cash flow from 2021.
- 2022: you’d take the $20,000 loss but add back the $40,000 renovation = $20,000 gain.
- The two year average rental income of this property would be $19,000.
- Income used is the $84,000 salary, plus the $19,000 2 year average for the rental income
- = $103,000 income used to qualify the mortgage borrower.
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Brian Martucci is a loan officer for Capital Bank Home Loans, a division of Capital Bank, N.A. He has been in the mortgage industry since 1986 and has served in a number of roles, including loan processor, loan officer, mortgage broker, branch manager, and vice president. Brian Martucci – NMLS# 185421. His opinions do not necessarily reflect the opinions and beliefs of Capital Bank Home Loans or Capital Bank. Capital Bank, N.A.- NMLS# 401599. Click here for the Capital Bank, N.A. “Privacy Policy”.
