Tax deductions – everyone’s favorite…except when buying a home. CPA’s earn a living finding proper deductions to lower their clients Federal tax bill. On the other hand, those same tax saving deductions can reduce qualifying income for a home loan. We call this a good old fashioned “conundrum”.
Tax Deductions Reduce Qualifying Income
For a moment, assume an applicant earns $65k per year. Also, pretend they deduct $10k in business related expenses from their Federal taxable income. As a result, a home loan underwriter may only allow $55k for qualifying income (income $65k minus $10k in expenses).
After all, this borrower spent $10k on outside business costs. Naturally, this means they had $10k less at their disposal. Hence, the underwriter’s income reduction.
Not All Expenses Are Costly
However, tax deductions are not all created equal. Certain business expenses do NOT need to be subtracted from income by an underwriter. For example, business mile deductions reduce taxes owed however do not equally reduce effective income.
The IRS allows a business mileage deduction based on depreciation costs, maintenance costs and gas on autos used for business. Typically, borrowers who deducted business miles on their taxes can add back the amount equal to the IRS allowance for depreciation portion of the business mileage deduction that year.
Adding Business Miles to Income for a Home Loan
Assume an AZ mortgage applicant drove 10,000 business related miles in a tax year. An Arizona mortgage lender adds this back in a year where the IRS allowed $.23 in depreciation costs per business mile driven like this:
- 10,000 miles x $.23 = $2,300 (total annual income add back)
- $2,300 / 12 months = $191 (total monthly income add back)
In other words, the Mortgage Lender can add $191 back to the borrower’s monthly income. In addition, there are more expenses that lenders add back such as depreciation.
By Jeremy House