The purpose of this article is to help Sole proprietors understand how their deduction choices will affect the income calculation lenders use, so that you have the information necessary to determine if a deduction will hurt your ability to get a home loan.
There is a simple Excel calculator on the Calculators Tab that you can use to easily calculate the income a lender will use to qualify you for a home loan. The tips below help explain the calculation.
Home-based Businesses
Small businesses typically file a Schedule C of the Federal tax form 1040. Many of those businesses are home-based. If you work from home and have a space dedicated to your business, the IRS allows you to use the “Business Use of Home” write-off on Line 30 of Schedule C. This is an advantage when you apply for a home loan because lenders add that back to their income calculation.
Some accountants think that using the Business Use of Home write-off may trigger an audit. Others say that is nonsense. Those who think it may trigger an audit break up the home office expenses into other categories (Rent and Utilities). The problem with this approach is that lenders do not add back Rent and Utilities. Those expenses usually apply when you rent a space outside your home.
The reason we add back “Business Use of Home” is that we already account for the full housing payment in our calculation. We don’t need to “double hit” you for the same expense.
The lesson is that if you can legitimately deduct Business Use of Home, it benefits you from a tax perspective but does not hurt you when you apply for a home loan.
Meals Expense
There is a full article about this subject in the Insider Secrets for Self-employed People section. Briefly, you can write off 50% of your business meals expense, but lenders deduct 100% of the expense. So, it does not benefit you to be aggressive in the Meals deduction section.
Depreciation and Amortization
Most lenders add back expenses deducted as Depreciation, Amortization and Depletion because those are non-cash deductions (i.e. they are not actual dollars out of your pocket). If you have significant Amortization deductions, I recommend that you ask your lender if they add that back before you apply for a home loan with them. For some reason that I do not understand, some banks aren’t smart enough to know that Amortization is a non-cash deduction like Depreciation.
Mileage Expense
Lenders add back the mileage deduction at the IRS allowed rate. As of 2019 that is 25 cents per mile. I am surprised how many clients don’t take advantage of the mileage expense deduction. If you keep track of the miles used exclusively for business and write it off, that will not hurt your home loan income calculation.
I hope these tips and the calculator help you prepare well for home loan approval. As always, if you have any questions please call me at 877-728-2008 or email CustomerCare@HollyGustlin.com