Teaching Landlords to Find Their Quality Tenant!

As a landlord or manager of a real estate investment, when it comes to screening tenants for a rental property, things can get very confusing. And unlike analyzing a tenant credit report or rental application, understanding what a self employed tenant actually has as spendable cash after paying their income taxes can be difficult. Knowing the difference can be the determining factor in deciding if they are the right tenant for you. After all, a tenant who doesn't have enough cash to pay rent on time can quickly get far enough behind that eviction my be neccessary. This puts a serious dent in cashflow and profit.

Disclaimer: I am not, and do not proclaim to be an accountant. The information I give here is for the sole purpose of helping a landlord "guesstimate" what a self employed tenant applicant actually earns and pays in income taxes. It is not to be confused with professional tax consultation.

What follows is a simplified explaination of finding what a self employed person pays in income taxes. By knowing this figure, you can use it to help determine what their "take home" pay is. Remember, this has been streamlined to get you in the ballpark and not to be used for figuring out what taxes are due the government.

Note: There is a form titled 1040EZ. If you are shown such a form, you are in luck. All you will need to do with this form is find the total taxable income, and use that figure, (divided by 12 to convert it to a monthly figure) and you have your needed monthly income. You would then proceed to the income tax part of this page.

Alright, here goes.To begin with, although there are many federal tax forms, you will be concerned with the form titled 1040 and the form titled Schedule C. To figure out a person's income, begin with their Schedule C.

Schedule C is basically the self-employment form of an individual. First, find the section titled Part II Expenses. It will be located near the middle of the page. Directly under the Part II heading will be a column of numbers. You want to locate line "13" which reads:" Depreciation and section 179 expense deduction (not included in Part iii) (see page C-4)". Write the dollar figure from this line down. In the case of our Schedule C example, we will use a figure of $4,000 for this line.

Now look at the next form, which is a 1040 form. Look at the 1040 form under the topic Income. This too will be located near the center of the page. The very last line of this section should be line " 22". Now follow that line to the right of the page and you should see the words "total income" in bold print.Take the depreciation figure from their Schedule C ($4,000 as in our example) and add it to the figure reported on the "total income" line (We will use $48,000 in this example). The new figure, $4,000 + $48,000= $52,000, is the yearly cash income total.

Since this new figure is a yearly figure, you now need to divide $52,000 by 12 and you will have your required monthly figure ($4,333). Keep in mind that this number is a before tax figure, so jot down the letters B.T.(before taxes) after it so you remember to take taxes out in the expense part of the cashflow form when the time comes. (The cashflow form is one of the forms I use to determine if a tenent applicant has enough money left over for rent after paying their monthly bills. To better understand the use of this and my other forms, please order one of my many products for a much more indepth explaination of my system).

There are quite a few variables in figuring out a self-employed person's income on their tax return, but this simple two step process will get you extremely close to the income answer you're looking for.

Now, I wish that was all that needed to be said about figuring out a person's self-employment tax, but it isn't. With the thousands upon thousands of pages that represent our tax code, there are literally hundreds of little wrinkles that can throw a wrench in my explanation. Working with my accountant, we decided to list a couple of the ones you will most likely see.

The first has to do with line" 66a" on the Schedule 1040 entitled "earned income credit" (EIC). It can be located on the second page about mid-page under the section titled "Payments". I can best explain line "66a" this way: if a tax paying wage earner (they must have a job and pay income tax to qualify) is in the lower income tax bracket, and that income is low enough, they may qualify for EIC. When they do, line "66a" will show a dollar figure that is a credit to them. Add this figure to the first figure. This is more money in their pocket, some of which will hopefully be used for rent.

The second item worth mentioning has to do with the heading "Filing Status", which can be found in the top 1/3 of the 1040 form. If you look at #4, it represents filing status head of household. In a nutshell, this status is in your favor.The tenant applicant is paying less tax under this status. So, if your tenant prospect has enough after tax income to pay their bills and rent up to this point, seeing box #4 checked under "Filing Status", means they have enough income plus some.

At this point, we will stop confusing you. Do understand that there are other things that can alter their income. These include rental property they own (Schedule E), a business bank loan they are currently paying on,and other credits and deductions. Remember, I am trying to get 95% of you in the targeted, not bullseye range of guesstimating an applicant's real income. If you want a more in depth explanation, ask your accountant to explain "how to establish a self employed person's income"to you. You'll walk away with your head spinning.

OK. With all that said, let's recap. You have a tenant applicant who is self employed. You wish to determine if they have enough cash after taxes to pay bills including rent. You ask to see their tax return. On their 1040 (not 1040EZ), add lines 22 and 66a together. If they have an attached Schedule C, add in line 13. This is your before tax income.

Once you have figured out a self employed person's income, you will need to figure out what they pay in taxes. You will have a very difficult time doing so unless you understand our country's taxing structure, which always seems to be in a state of change and therefore, is very confusing at times. I am going to try to remove some of that confustion by giving you a loose guideline for guesstimating income taxes, but if you face the problem of having to compute income taxes very often, I would talk with an accountant and let him or her explain it to you.

What I'm going to do is give you an income chart and a tax rate or multiple like the government does, except all the figures in the chart are monthly figures instead of yearly figures as the IRS uses. I've done this to remove one step for you in the computing process, since you will want all figures to be monthly eventually. This chart is loosely based on the IRS guidelines. If you are an accountant or figure out taxes for yourself or friends, you will notice the income figures in the chart are rounded off and the tax rate multiples are not exactly the same as the government's. Please understand that I am trying to streamline the tax figuring process for use on the cashflow sheet (found in the 4th step of my book). Unlike the government, you do not need a "to the penny" answer for the tax figure. What you want to do is figure out with some degree of accuracy, what people pay in taxes. That is all.

Basically, there are two ways people file taxes: singly or jointly. Therefore, I will give two sets of numbers: one for people filing single returns and one for couples filing joint returns. Use the doubles column only when you have a married couple and you have no after tax income already stated from either party's pay on the cashflow chart. A stay at home spouse would probably be an opportunity for you to use the "double" column.

If you've already listed one spouse's after tax income on the cashflow sheet, use the singles column to figure out the remaining spouse's income if that income is before tax income.

Here's the chart, with the income bracket and tax rate multiple. (Remember, these are monthly figures!)

Income (single)------Income (double)-------Multiple (Tax Rate)

$0-$600 ---------------$0-$1200-----------------multiply by .00
$600-$2500 --------- $1200-$5,000-----------mulitply by .14
$2500-$6,000--------$5,000-$12,000--------multiply by .20
$6,000-$12,500------$12,000-$25,000------multiply by .24
$12,500 and up-------$25,000 and up--------multiply by .28

The simplest way you can use this chart is to take the prospective tenant's before tax monthly income: let's use the total from our example in the first part of the chapter. Our monthly income was $4,333 and they filed singly. Look on the chart to find out where the figure $4,333 fits. In this case, the figure falls between $2500-$6,000 of income. The tax rate is 20%, so multiply $4,333 by 20% or .20 and you will have a new figure of $867. ($4,333 x .20 = $867) This is roughly the monthly amount of income taxes the person pays per month.

Again, this is not the most accurate way to compute taxes, but it's relatively easy and will get you within a useable range for what you are trying to accomplish with the cashflow form. The figure will be off by a few dollars every month, but don't sweat it. The figures will be close enough.

I also need to state I am not an accountant, and if you wish to get closer with the tax bill, see your accountant for a more thorough understanding of tax laws.

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If you would like further infomation on this topic, please purchase my book "How to Find That Quality Tenant". Ask your locale bookstore or see my website at:www.findthatqualitytenant.com

I am not a lawyer, therefore, if you have any legal concerns with anything in this article, please contact the appropriate legal counsel.

The above article may be reproduced without my permission under the following conditions: author name, website, and contact information must accompany article and be prominently displayed, and the article must be reproduced in it's entirety.

Thank You. Don Conrad

Copyright 2006 Blue Collar Publishers
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e-mail: donconrad@findthatqualitytenant.com
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