Being self-employed comes with many perks – freedom, flexibility, and the ability to be your own boss. However, it also comes with its own set of challenges, especially when it comes to finances and taxes. One common mistake that many self-employed individuals make is writing off every possible expense to reduce their tax liability. While this might seem like a good idea in the short term, it can cost you big in the long run. Here’s why.
The Tax Write-Off Dilemma
As a mortgage loan originator who works with many self-employed clients, I’ve seen firsthand how tempting it can be to write off as many expenses as possible to lower your taxable income. From office supplies to travel expenses, there are countless deductions available. However, this strategy can backfire if you’re planning to invest in significant assets like real estate in the future.
The Importance of Showing Proof of Income
When you’re self-employed and looking to make a substantial investment, such as purchasing a home or an investment property, lenders will require proof of income. This is where writing off too many expenses can become a problem. Every deduction you take reduces your reported income, and this lower income on paper can make it much harder to qualify for a loan.
Lenders typically look at your income over the past two years to determine your ability to repay a loan. If your income appears too low because you’ve written off too many expenses, the bank or lender may decide that you don’t have enough income to qualify for the loan you need.
The Consequences of Lower Income on Paper
If your reported income is too low, you might find yourself needing a non-QM (non-qualified mortgage) loan. These loans are designed for borrowers who don’t meet the standard requirements for a conventional mortgage. While non-QM loans can be a good option in certain circumstances, they often come with larger down payments and higher interest rates, which can cost you significantly more over the life of the loan.
Smart Financial Planning for Self-Employed Individuals
To avoid these pitfalls, it’s essential to balance tax deductions with the need to show sufficient income for future investments. Here are a few tips:
- Work with a Tax Professional: A tax professional who understands the unique challenges of self-employment can help you find the right balance between maximizing deductions and maintaining a healthy reported income.
- Plan Ahead: If you know you’ll be looking for a loan in the next few years, start planning now. Consider reducing your deductions and increasing your reported income in the years leading up to your loan application.
- Keep Detailed Records: Maintain accurate and detailed records of all your income and expenses. This will not only help you with tax preparation but also provide the necessary documentation when it’s time to apply for a loan.
- Consult with a Mortgage Advisor: Before making any major financial decisions, consult with a mortgage advisor who can help you understand how your reported income will impact your ability to qualify for a loan.
Conclusion
While it might be tempting to write off every possible expense to reduce your tax liability, it’s important to think long-term. By maintaining a healthy balance between deductions and reported income, you’ll be in a stronger position to qualify for loans and make significant investments in the future. Plan smart, invest wisely, and consult with professionals who can guide you along the way.
If you have any questions or need personalized advice, don’t hesitate to contact me at 720-250-7764 or nick.ross@edgehomefinance.com. I’m here to help you navigate the financial complexities of self-employment and achieve your investment goals.
