- Passive losses from real estate investments he has an interest in, but is not required to fund
- Depreciation from properties he owns
- Interest on an acquisition and development loan that was expensed during the renovation which caused a large operating loss
- Deferred consulting fees into the current year that don’t show up on the most recent year’s tax return
I thought I had addressed these issues adequately when I forwarded the tax returns on to the lenders, but alas, a few still had questions.
When lenders, especially banks, receive your tax returns they input the data into a global cash flow calculator. This program takes the tax-based information from your return and removes the non-cash items and non-recurring cash items to arrive at a global cash flow number. This has the potential of making a bad tax return (one that ends in no or negative income due to deprecation) into a good one, or a good one (with a large, one-time gain) into a bad one.
Whether you think your tax return is going to cause heartburn or you believe it is fine as is, it’s always smart to do the following prior to passing them along to your lender:
- Always explain one-time events. If you sold a bunch of stock one year, the bank is not going to give you credit for that in the future. However, if you routinely sell stock let the lender know. Lenders count on consistent cash flow, not eradicate events.
- Include your own real estate cash flow schedule (required by most lenders anyway). Here is a template I use.
- Create a narrative explaining where you earn money and where it goes. Remember, you always want to make it easy to say yes.
- Consider creating your own global cash flow estimate. While this can be complicated and time consuming, it can be well worth the effort. You can find programs on the internet at various prices, but if you only take the adjusted gross income/loss (“AGI”) and remove the non-cash losses and add-back cash distributions not reported on your return, at least your leading the reviewer to a better overall picture.
The bottom line is if your return shows a strong net income/AGI and there are no large one-time capital gain items, then little additional explanation may be necessary. However, if you are like my client and show a negative AGI each year then further work is a must. Never send in a return unless you know the story it tells and it’s the story you want told. If not, don’t send it in alone.