Why We Need Your Tax Returns

     If you're shopping for a home mortgage loan, be prepared to provide proof of your taxable income.
During the housing boom, lenders rarely required borrowers to provide copies of federal tax returns.  Now, lenders ask the borrower for the entire federal tax returns covering a 2 year period, with all schedules, because a person’s full income picture is contained in the entire set of documents, not just the first two pages.  If a borrower has K-1 income/loss, those forms are also required.  If you have filed an extension, you should also provide a copy of the extension- and cancelled check(s) showing any estimated payment(s).
     Borrowers are often required to sign a Form 4506-T as well, which allows the lender to retrieve a tax transcript from the Internal Revenue Service.  Lenders use the 4506-T tax transcript to compare the borrower’s W-2s to reported income.  If the numbers match, all is well.  If not, the lender will dig deeper.
     Why the sudden interest in borrowers’ tax returns? The short answer is lenders are looking for income irregularities and evidence of loan fraud.  All aspects of the tax return are subject to examination - to determine what the borrower’s income is.  That means the lender not only will look at reported income, but also at other items such as:

Unreimbursed employee business expenses. 2106 business expenses are subtracted from income.  Examples include uniforms, union dues, mileage, expenses related to a cell phone used for business, marketing costs and training costs.  If somebody writes off $20,000 in business expenses, the underwriter would subtract the $20K for qualifying purposes.

Rental property income. This income must be documented and shown on the tax return, unless the property was purchased in the current calendar year. In that case, the rent must appear on a certian number of consecutive monthly bank statements.   Also of note - If you don’t report income that should have appeared on your tax returns, you can’t use that income at all.
If you plan to keep your present home, and rent it out when trading up to a new home, you need a min. 30% equity in that property in order to use the rental income.  You'll be required to pay for an appraisal on the current home to establish the equity percentage, and to provide a fully-executed lease agreement - with a paper-trailed security deposit from the tenants.

Business losses. These can include losses incurred by a spouse’s business.  The lender will subtract those losses to yield a combined taxable income for the household,  In some cases, that might not be enough income to be approved for a loan that a borrower may have otherwise qualified for.

Depreciation expenses. On the flip side, depreciation expense can often increase a borrower’s qualifying income, because it's a non-cash expense.

Capital gains. These also may be counted as income — or not.
If a capital gain is a one-time event, it probably won't count as income because it won't meet criteria for continuation into the future.

Self-Employment
Scrutiny of tax returns can be a big challenge for borrowers who are self-employed. Many are having a really difficult time getting loans because their accountants and bookkeepers are trained to minimize their income to save them on taxes.

Too Many Write-Offs
Many potential borrowers are faced with the challenge of building up their taxable income for two years before they can qualify for a loan. Some may have to forego certain deductions so they can show more income on their tax return to qualify for a loan.
But beware, borrowers who try to amend a prior year’s tax return to show more income is a strategy that won’t work. Instead, an amended tax return can trigger a loan denial.  There's a new rule that says you cannot qualify for a mortgage if your tax return has been amended.

Bonus Income
Bonus income is scrutinized - and anything that is non-cash (such as stock options) do not count.  The cash component should be ok - but it is averaged over a 2 year period.  If the most recent annual bonus is lower than the previous year, then averaging is not done - and the lower amount is utilized.