Why mortgage lenders want tax returns

"If you take in $1,000 a month in (rent), but you have $900 a month in expenses for owning the property, then you really only have $100 a month in positive rental income," she says. "And if you take in $1,000 a month, and you don't report that on your tax returns, you can't use that income at all."

Business losses. These include losses incurred by a spouse's business, according to Metzler.

For example, suppose one spouse earns $100,000 per year as an employee. The other spouse has a business that generated a $40,000 loss shown as a write-off on the couple's tax return. The lender will subtract $40,000 from $100,000 to yield a combined taxable income of $60,000. That might not be enough income to qualify for as large a loan as the borrower wanted.

Depreciation expenses. On the flip side, depreciation expense taken on a home office, business equipment or other asset could increase a borrower's loan-qualifying income, according to Blackwell.

"I want to stress 'may,'" Blackwell says. "An underwriter may be able to add that back."

Capital gains. These also may be counted as income -- or not.

"If the capital gain is a one-time event, we probably won't count it as income because the borrower can't show it to be sustainable," Blackwell says.

Too many tax deductions

Lenders' scrutiny of tax returns can present a big challenge for borrowers who are self-employed, according to Peter Ogilvie, president of First Residential Mortgage Corp. in Santa Cruz, Calif.

"Many self-employed borrowers -- real estate agents to shoe store owners -- are having a really difficult time getting loans because their accountants and bookkeepers are trained to minimize their income to save them on taxes," he says.

The solution isn't easy: Taxpayers need to "bite the bullet," to use Ogilvie's expression, and build up their taxable income for two years before they can qualify for a loan. Some may have to forgo deductions to which they believe they are entitled and pay more income tax so they can show more income on their tax return to qualify for a loan.

Borrowers who try to amend a prior year's tax return to show more income after the fact may be disappointed to learn this strategy won't work. Instead, an amended tax return can trigger a loan denial, according to Metzler.

"The very creative loan officer would say, 'Go back and amend your tax return to show some income, so you can qualify,'" he says. "So now there is a new rule that says you cannot qualify for a mortgage if your tax return has been amended."

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