Common Tax Write-Offs Lenders Can Add Back
One of the biggest hurdles for self-employed borrowers is that their tax returns are designed to minimize tax liability, not maximize qualifying income. A good accountant will use every legal deduction available. While this saves you money on taxes, it results in a low adjusted gross income (AGI), which is the primary figure lenders use. Fortunately, underwriting guidelines allow for certain 'paper losses' or non-cash expenses to be added back to your net income. This process gives a more accurate picture of your actual cash flow.
Common add-backs include:
- Depreciation and Depletion: This is the most common and significant add-back. If you deducted $20,000 for the depreciation of business equipment or property, that full amount can be added back to your qualifying income because it's not an actual cash expense.
- Business Mileage: Lenders use a standardized rate (less than the full IRS mileage deduction) to calculate the actual expense of using your vehicle. The difference between what you deducted and the lender's calculated expense can be added back. For example, if you deducted $11,000 using the standard IRS rate but the lender's calculation only attributes $5,000 as a hard cost, you could add back $6,000. (The data, information, or policy mentioned here may vary over time.)
- Business Use of Home: The amount you deduct for your home office can typically be added back to your income.
- One-Time Major Purchases: A significant, isolated business expense that is unlikely to recur may be added back with proper documentation and a letter of explanation. For example, if you spent $30,000 on a one-time equipment overhaul for your Los Angeles business, a lender may disregard that expense when calculating your average monthly income.
- Amortization: Similar to depreciation, this is a non-cash expense that can be added back.
What is a Profit and Loss Statement and How Can It Help?
A Profit and Loss (P&L) statement, also known as an income statement, summarizes your business's revenues, costs, and expenses during a specific period. For a mortgage application, a year-to-date P&L is crucial because it provides the most current snapshot of your business's health. While tax returns show what happened last year, a P&L shows what's happening right now.
An underwriter will compare your current P&L to your previous two years of tax returns to look for consistency and growth. If your P&L shows that revenue is up 20% over the same period last year, it strengthens your file significantly. A well-prepared P&L, often signed by you and your CPA, demonstrates professionalism and financial organization, building confidence with the lender.
Do I Need Two Full Years of Tax Returns in Los Angeles?
The industry standard for self-employed borrowers is to require two full years of personal and business tax returns. Lenders use this history to calculate a stable and predictable monthly income. They want to see that your business is not a brand-new venture and has a track record of profitability.
However, there are exceptions. Some loan programs, including certain FHA and conventional loans, may allow for just one year of tax returns if you have a strong financial profile. This typically requires:
- A high credit score (usually 700+). (The data, information, or policy mentioned here may vary over time.)
- Significant cash reserves.
- A history of success in the same industry or a similar line of work prior to becoming self-employed.
If your business is less than two years old, qualifying for a traditional mortgage in a competitive market like Los Angeles can be very challenging, making alternative loan options more attractive.
How Lenders View a Recent Increase in Business Revenue
A recent, significant jump in revenue can be a double-edged sword. While growth is positive, underwriters are trained to look for stable, reliable income. A sudden spike might be viewed as a one-time event rather than a new sustainable income level.
To have a recent revenue increase work in your favor, you must be able to document why it happened and that it is sustainable. For example, did you land a major long-term contract? Did you expand your services? Lenders will typically average your income over the past 12-24 months. If your income has increased steadily over that period, it will be viewed favorably. If your income was $100,000 two years ago and $250,000 last year, the lender may be conservative and average the two, or they may use the lower figure if the increase cannot be fully justified as stable.
Should I Ask My Accountant to Prepare My Taxes Differently This Year?
Yes, but this requires strategic planning well in advance of applying for a mortgage. There is a fundamental conflict between preparing taxes to pay the least to the IRS and preparing them to qualify for the largest possible loan. You cannot do both simultaneously.
If you know you plan to buy a home in the next one to two years, have a conversation with both your mortgage strategist and your CPA. You might decide to claim fewer deductions to show a higher net income. This will mean a higher tax bill, but it could be the key to getting approved for the home you want in Beverly Hills. Forgoing $15,000 in deductions might cost you $4,000-$5,000 in taxes, but it could increase your qualifying income by $1,250 per month, potentially boosting your borrowing power by over $150,000.
What Are Bank Statement Loans and Are They a Good Alternative?
Bank statement loans are a powerful financing tool for self-employed borrowers whose tax returns don't reflect their true cash flow. Instead of using tax documents, lenders analyze 12 or 24 months of personal or business bank statements to determine your income. They calculate your average monthly deposits and apply a standard expense ratio to arrive at a qualifying income figure. (The data, information, or policy mentioned here may vary over time.)
Pros:
- No tax returns or K-1s required.
- Your tax deductions do not impact your qualification.
- Allows you to qualify based on your business's gross revenue and cash flow.
Cons:
- Interest rates are typically higher than traditional loans.
- A larger down payment is often required (usually 10-20% minimum). (The data, information, or policy mentioned here may vary over time.)
- Not all lenders offer them, so you need to work with a broker who specializes in this niche.
For many successful business owners in Los Angeles, a bank statement loan is the most practical path to homeownership.
Documenting Business Funds for a Down Payment in Beverly Hills
Using funds from your business account for a down payment is common for self-employed individuals, but it requires clean documentation. You cannot simply transfer a large sum from your business account to your personal account right before closing.
To do this correctly, you must provide:
- Business Bank Statements: At least two months of statements for the business account showing the funds are available.
- A CPA Letter: You will need a letter from your accountant stating that withdrawing the funds for the down payment will not negatively impact the operations of your business. This is a non-negotiable requirement for underwriters.
- Clear Paper Trail: The funds must be 'seasoned'—meaning they have been in the account for at least 60 days. The transfer to your personal account must be clearly documented.
Common Application Mistakes by Self-Employed Borrowers
- Commingling Funds: Mixing personal and business expenses in one account makes it extremely difficult for an underwriter to analyze your business's true financial picture. Always maintain separate accounts.
- Inconsistent Income Reporting: The income stated on your loan application must align with what's documented in your tax returns and P&L statements. Any discrepancies will raise red flags.
- Applying Without Current Financials: Not having a year-to-date P&L and balance sheet ready will cause delays. Lenders need to see up-to-the-minute information.
- Making Large, Undocumented Deposits: Large cash deposits that cannot be sourced from your business operations are a major problem and can jeopardize your loan approval.
- Choosing the Wrong Lender: Many traditional banks and retail lenders have very rigid guidelines for self-employed income. Working with a mortgage strategist who has access to dozens of lenders, including those specializing in self-employed borrowers, is essential. Navigating a self-employed mortgage in Los Angeles requires a specific strategy. If you're ready to see how your true business cash flow can get you approved, a consultation can map out your best options and connect you with the right loan for your financial picture.
Ready to see how your business's true financial strength can translate into buying the home you deserve? Apply now to connect with a specialist who understands the nuances of self-employed income.
Author Bio
David Ghazaryan is the expert mortgage strategist and founder behind iQRATE Mortgages. With a mission to fund home loans that traditional banks won't touch, David specializes in helping clients with unique financial situations, including those recovering from foreclosure or bankruptcy. He expertly crafts smart, strategic, and stress-free mortgages by leveraging a vast network of over 100 lenders to secure competitive rates for investors and homebuyers alike. Praised for exceptional customer service, David has helped hundreds of families with a 97% satisfaction rate, guiding them to the mortgage they deserve.
References
Fannie Mae: Self-Employed Borrower Income
Consumer Financial Protection Bureau: Documents for a Mortgage
