February 20, 2023

Financing and tax strategy should go hand in hand. These two have cause and effect relationships with each other and it is important to consider them both when making decisions. In this week's part 2 podcast we cover the importance of being bankable as well as creating lender friendly tax returns. If you missed part one, listen to that first and come back here for the sequel.

The most overlooked part of real estate investing is being bankable. What does this mean? Being bankable is the ability to acquire financing. Leveraging money is one of the fundamental ways that we as real estate investors can create wealth and missing out on financing is one of the biggest hurdles that an investor can face. There is nothing worse than saving up, searching high and low for a property, and negotiating a price only to get turned down when you show up to the bank. To avoid this we need to know how banks qualify people who want to take out a loan and how we can present ourselves as competent borrowers. 

One of the easiest ways to qualify for a loan is with a W2. The good news is that this makes up 92% of tax filers. This method is a walk in the park compared to self-employed earners. On top of this, a couple can have 10 conventional loans in the name of each spouse. This means that the biggest obstacle is your debt to income ratio. A strategy that is often taken in these situations is to count income from rental properties in the DTI calculation in order to qualify. In many cases, it is even possible to count the future rental income from the property intended to be purchased. Is maxing out DTI the end of our investing journey? No, even with DTI capped out there are still ways to acquire financing. Commercial, DSCR, portfolio loans, and seller financing are all great ways to finance properties. During planning it is important to weigh each of these methods to decide which one will be right for you. 

What about self-employment? This is where things get a little more difficult. A lot more difficult. Qualifying for a loan as self-employed is very challenging as this presents more risk to creditors. For self-employed borrowers, banks will typically want to see two years minimum of profit history. With time to file and receiving proper documentation, this could mean three and a half years before qualifying for a loan. Along with this, your tax strategy could have a significant effect on your borrowing potential. A common mistake that sets people back is taking too many deductions in their first few years of being self-employed. You will often see these people making 120,000+ their first year or two and then buy a new vehicle because they want the tax deduction. This will be beneficial on their tax return because the IRS will see that they made less money that year, however, so will the bank. The bank will not add back the vehicle into income the same way that they would for depreciation on rentals. Before you decide to write off everything under the sun, it is important to consider how the write offs will affect your ability to borrow. To compound this, if you are just starting off - even if you are making a good profit - chances are that you are still in a lower tax bracket. Consider waiting to take your deductions until you are established with your creditors and find yourself further down the road in a higher tax bracket.  

One of my teaching lessons for LearnLikeaCPA is to play the balancing game of lowering taxable income, while also creating tax returns that are lender-friendly. LearnlikeaCPA.com has podcast after podcast on tax planning and financing. For more information, dive into some of our previous episodes. 

The last topic of this week's podcast is DSCR loans for less experienced investors. Financing all your properties with DSCR loans is rarely a good idea. These loans kill liquidity and can introduce more risk. If we take out one of these loans and the market shifts, we can be caught holding the bag. Oftentimes you can’t get your money out for three to five years unless you pay the prepayment penalty. You could end up suck with money tied down to these assets and end up losing money or missing out on better investing opportunities. If you are looking to go the DSCR route, consider buying the prepayment penalty upfront. This will help to avoid these problems and protect us from potentially dangerous situations.

Remember, tax strategy and financing are two sides of the same coin. Tax, lending, and legal questions will almost always tie back to each other. To fully understand one is to understand them all. Be sure to weigh all your options to ensure you make the best tax and financing decision possible. 

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