For self-employed Australians, there's an uncomfortable truth: the strategies that minimise your tax bill can also minimise your borrowing capacity. This guide explores the complex relationship between tax returns and home loan approvals, helping you understand how lenders assess income and what you can do to maximise your borrowing power without paying more tax than necessary.
The Tax Minimisation vs. Borrowing Capacity Dilemma
Every self-employed borrower faces a fundamental tension:
The tax perspective: Lower taxable income means lower tax. Your accountant helps you legally minimise your taxable income through deductions, depreciation, superannuation contributions, and business expense claims.
The lending perspective: Lenders use your taxable income to determine how much you can borrow. Lower taxable income means lower borrowing capacity.
The result: Many self-employed borrowers find they can afford repayments comfortably but can't borrow enough to buy the property they want.
Understanding this dynamic is the first step to navigating it successfully.
How Lenders Calculate Self-Employed Income
Lenders use specific methods to assess income from tax returns. Knowing these methods helps you understand (and potentially improve) your borrowing capacity.
Net Profit Method
Most lenders start with your business's net profit:
For sole traders: Net profit from business = Assessable income for lending
For companies: Wages + Directors fees + Dividends = Assessable income for lending (Company profits retained in the business typically don't count)
For trusts: Trust distributions received = Assessable income for lending
Averaging Income Over Multiple Years
Lenders typically assess 2 years of tax returns:
Standard approach: (Year 1 income + Year 2 income) / 2 = Average assessable income
If income is increasing: Some lenders will use:
- The most recent year only
- A weighted average favouring the recent year
- A combination approach
If income is decreasing: Most lenders will use:
- The lower of the two years
- Or the average (which will be lower than recent year)
Income Trending
Lenders pay attention to income direction:
Increasing trend: Generally viewed positively, may allow use of higher recent income
Stable income: Preferred by lenders, indicates reliability
Declining trend: May result in:
- Lower income assessment
- Additional questions about business viability
- Requirements for current year trading figures
Understanding Add-Backs: Your Secret Weapon
Add-backs are non-cash or one-off expenses that lenders add back to your assessable income. They can significantly boost borrowing capacity.
Common Add-Backs Accepted by Lenders
Depreciation
Depreciation is a non-cash expense that reduces taxable income but doesn't affect your actual cash flow.
Example:
- Net profit: $80,000
- Depreciation claimed: $15,000
- Adjusted income: $95,000
One-Off or Non-Recurring Expenses
Unusual expenses that won't repeat can often be added back:
- Equipment purchases (expensed rather than depreciated)
- Relocation costs
- Legal fees for one-time matters
- Setup costs for new business ventures
- Extraordinary repairs
Interest on Investment Loans
Some lenders add back interest paid on:
- Investment property loans
- Margin loans
- Business loans for income-producing assets
Rationale: If you're using borrowed money to generate income, the interest is a cost of that investment, not a reduction in your earning capacity.
Motor Vehicle Expenses
Some lenders add back a portion of motor vehicle claims:
- Particularly if using the log book method
- Recognises that vehicle costs are often partially personal
Superannuation Contributions Above Compulsory
Discretionary super contributions can sometimes be added back:
- Must be clearly above the mandatory requirement
- Shows available cash flow being directed to savings
- Varies by lender policy
Add-Backs That May Not Be Allowed
Not all expenses can be added back:
Ongoing operational costs:
- Rent
- Wages for employees
- Regular supplies
- Utilities
Required business expenses:
- Insurance
- Professional memberships
- Mandatory compliance costs
Personal expenses incorrectly claimed:
- Adding back expenses that were inappropriately claimed is problematic
- Lenders may question the accuracy of financials
Maximising Add-Backs
Work with your accountant:
- Identify all eligible add-backs
- Ensure clear documentation of one-off expenses
- Separate genuine add-backs from ongoing costs
Document non-recurring items:
- Keep invoices for unusual expenses
- Note the non-recurring nature in your records
- Be prepared to explain to lenders
Be realistic:
- Don't try to add back everything
- Exaggerated add-backs damage credibility
- Lenders will scrutinise claims
How Many Years of Tax Returns Do You Need?
Standard Requirements
Most lenders require:
- 2 years of personal tax returns
- 2 years of business tax returns (if applicable)
- 2 years of Notice of Assessments (NOA)
- Most recent financial statements
One Year of Tax Returns
Some lenders accept 1 year if:
You meet additional criteria:
- Strong deposit (often 20%+)
- Prior industry experience
- Stable or growing income
- Clean credit history
Documentation requirements:
- Most recent tax return
- Current year BAS statements
- Accountant verification of current trading
- Explanation for limited history
No Tax Returns (Low Doc)
Low documentation options exist but have trade-offs:
Alternative verification:
- Accountant's declaration
- BAS statements
- Bank statements
Trade-offs:
- Higher interest rates
- Lower LVR limits
- Fewer lender options
What If Your Income Varies Year to Year?
Variable income is common for self-employed borrowers but requires careful handling.
Lender Assessment Approaches
Averaging method: Most lenders average variable income, smoothing out fluctuations.
Declining income policy: If income dropped significantly, lenders may:
- Use the lower year
- Request explanation
- Require current year evidence
Industry considerations: Lenders may be more understanding if:
- Your industry is known for variability
- Variation follows predictable patterns
- You can demonstrate overall stability
Documentation to Support Variable Income
Provide context:
- Explain the variation in your application
- Highlight any unusual circumstances
- Show the overall business trajectory
Current year evidence:
- BAS statements showing current trading
- Bank statements demonstrating cash flow
- Accountant letter on current performance
Business explanation:
- Contract cycles
- Seasonal patterns
- Project-based work nature
- Growth investments that affected profit
Preparing Your Financials for a Loan Application
Timing Considerations
Before lodging tax returns: Discuss with your accountant:
- Your home loan goals
- Timing of the application
- Whether any adjustments are appropriate
After lodging tax returns: Review what was lodged and understand:
- Your assessable income
- Available add-backs
- How it affects borrowing capacity
Working With Your Accountant
Communicate your goals: Your accountant can't help if they don't know your plans.
Tell them:
- When you plan to apply for a loan
- How much you want to borrow
- Your timeline for purchasing
Balance the priorities: Discuss the trade-off between:
- Tax minimisation
- Borrowing capacity
- Long-term financial position
Request lending-ready financials: Ask your accountant to:
- Clearly identify add-backs
- Provide supporting schedules
- Be available for lender queries
Financial Statement Presentation
Clear profit and loss statements:
- Separate one-off expenses
- Identify non-cash items
- Show consistent categories year-to-year
Balance sheet considerations:
- Accurate asset valuations
- Clear business vs personal assets
- Supporting schedules for major items
Reconciliation:
- Business accounts reconciled
- Tax returns match financial statements
- Clear audit trail
Timing Your Application Around Tax Lodgement
The timing of your loan application relative to tax lodgement matters significantly.
Best Timing Scenarios
Scenario 1: Strong recent year, older returns lodged
Situation: Your most recent year was excellent, and you've just lodged returns. Strategy: Apply immediately while recent performance is documented.
Scenario 2: Strong current year, returns not yet due
Situation: Current year trading is strong but returns aren't lodged. Strategy: Some lenders will assess current year figures with accountant verification.
Scenario 3: Older returns show better income
Situation: Recent years were affected by COVID, expansion costs, or other factors. Strategy:
- Apply before lodging new returns
- Or use lenders who accept accountant projections
Poor Timing Scenarios
Scenario 1: Applying mid-lodgement
Problem: Returns partially completed or recently lodged but not yet processed. Impact: Delays while waiting for NOA.
Scenario 2: Weak year just lodged
Problem: Just lodged returns showing decreased income. Impact: Lower borrowing capacity based on new figures.
Scenario 3: Significant gap since lodgement
Problem: Returns are old (e.g., 2+ years since lodgement). Impact: Lenders question why returns aren't current.
Alternative Income Verification Methods
When tax returns don't tell your full story, alternatives exist.
BAS-Based Verification
How it works:
- Lenders assess 12 months of BAS statements
- Income calculated as percentage of GST turnover
- Typically 40-50% of turnover = assessable income
Best for:
- Businesses with strong turnover but low net profit
- New businesses without full tax history
- Growing businesses reinvesting profits
Requirements:
- Must be GST registered
- 12 months consecutive BAS
- Statements must be lodged and consistent
Bank Statement Verification
How it works:
- Lenders review 6-12 months of business bank statements
- Assess deposits and overall cash flow
- Calculate maintainable income from banking pattern
Best for:
- Businesses with strong cash flow
- Mixed income sources
- Complex structures
Accountant's Declaration
How it works:
- Your accountant declares your income
- Based on their knowledge of your business
- Supported by their professional standing
Best for:
- Current year income verification
- Bridging gaps in tax return timing
- Supporting add-back claims
Frequently Asked Questions
Should I show more income on my tax return to borrow more?
This is a common question but requires careful consideration:
Don't artificially inflate income: This could be tax fraud and creates problems later when income returns to normal.
Do consider the trade-off: Sometimes paying slightly more tax now enables a property purchase that builds long-term wealth.
Work with your accountant: Find legitimate ways to present your true income without excessive minimisation.
Can lenders see my tax returns if I don't provide them?
No, but:
- Full doc loans require you to provide returns
- ATO can provide income verification on request (with consent)
- Lenders may request NOA which confirms lodged income
What if I have lodgement history with late returns?
Late lodgement history can affect your application:
- Some lenders have strict policies on lodgement history
- May indicate financial disorganisation
- Current compliance is most important
- Work with a broker to find appropriate lenders
My taxable income is zero or negative. Can I still get a loan?
Possibly, depending on circumstances:
If due to genuine losses: Difficult, as lenders need evidence of ability to repay.
If due to heavy deductions/add-backs: May be possible with:
- Significant add-backs available
- Strong bank statements showing cash flow
- Accountant verification of true income
- Low doc or alt doc lending
How do loss years affect my application?
Loss years significantly impact borrowing:
- Most lenders average including loss years
- May result in very low or zero assessable income
- Some lenders exclude genuine one-off loss years
- Current year evidence becomes crucial
What if my business is growing rapidly?
Rapid growth is positive but creates challenges:
The problem: Tax returns reflect past performance, not current.
Solutions:
- Lenders who assess current year trading
- BAS-based income verification
- Accountant projections
- Apply after lodging strong returns
Making Tax Returns Work for Your Home Loan
The relationship between tax returns and home loans doesn't have to be adversarial. With proper planning:
Short-term strategies:
- Identify all available add-backs
- Time your application strategically
- Use alternative verification where appropriate
Long-term strategies:
- Plan tax minimisation with borrowing goals in mind
- Maintain clean, well-organised financials
- Keep your accountant informed of property plans
- Consider a balanced approach to deductions
Working with professionals:
- Accountant: Optimise financials for both tax and lending
- Mortgage broker: Find lenders suited to your situation
- Together: Create a coordinated strategy
At NJS Financial, we understand the complexities self-employed borrowers face with tax returns and lending. We work with accountants and borrowers to find solutions that work.
Ready to discuss your situation?
Get started with our borrowing capacity calculator to see an estimate, or complete our free health check for personalised advice on your tax return situation and lending options.
