How to Verify, Determine Income from Real Estate Investments

We’ll explain how to treat real estate when calculating a household’s income and assets.

The regulations for the tax credit program require site owners to use the rules found in HUD Handbook 4350.3 to calculate the annual income of applicants and residents. During the process of certifying or recertifying households, you may learn that an applicant or household member owns real estate.

In these instances, real estate investments can be considered an asset or a business generating income for the applicant or household. We’ll distinguish between these two options that will inform how you treat the real estate property when calculating the household’s income and assets. We’ll also give you a Model Form: Use Real Estate Worksheet to Help Determine Cash Value, Rental Income to help you and your staff calculate and verify the figures listed as an asset on income certifications.

Business Income or Household Asset?

The net income derived from an applicant’s real estate holdings will either be categorized as business income or income from an asset. HUD says, “If the person’s main business is real estate, then count any income as business income . . . Do not count it both as an asset and business income” [HUD Handbook 4350.3, Exhibit 5-2 (A)(3)].

Main business. Evidence that an applicant or household’s main business is real estate would be that out of all of their income sources, the real estate generates the most income. In this relatively rare instance of an applicant whose main business is real estate, the net income from the real estate is counted.

This income will mostly likely be documented on IRS Schedule E (Form 1040). This form is used to report income or loss from rental real estate. When real estate functions as a main business, annual net income is calculated by subtracting annual mortgage rate interest payments and tax-deductible expenses such as taxes, insurance, and maintenance from the revenue or rental payments from the business. Most important, in these cases, the real estate is not counted as an asset.

Household asset with income. If real estate isn’t the main business of an applicant or household, then the real estate property is an asset, and net income, if the property is rented, is considered income from an asset. According to the HUD Handbook, “It may be necessary to consider the family’s equity in the property as well as the expense to sell the property. To determine the family’s equity, subtract amounts owed on the property from its market value” [Handbook, par. 5-7].

In other words, when determining the cash value of a real estate asset, the amount a family would receive if the family turned the asset into cash, you would verify the fair market value of the property, calculate the outstanding mortgage balance to determine the family’s equity, and then subtract the expense of selling the property such as real estate agent and legal fees from the equity.

Example: Suppose an applicant owns a rental house. The market value is $100,000. She owes $60,000. The cost to sell this house would be $8,000. You would determine the cash value of this asset by subtracting the mortgage amount from the market value to get $40,000 in equity. Then you would subtract the cost of selling the asset (real estate commission, other costs of sale) from the equity to get $32,000 as cash value for the rental house.

If the owner of the real estate is also renting the property, you would need to know the annual rental payments that the owner receives, minus any tax-deductible expenses such as mortgage interest payments, taxes, insurance, and maintenance expenses. The result is the income that the rental property generates, which you must include when calculating the household’s income.

Cash Value, Income Verifications

In performing the necessary calculations, it usually takes several documents or sources to verify the figures used to determine cash value and any income.

Fair market value. The fair market value is the amount that another person would pay to acquire an asset under current market conditions. Here are two ways to determine a property’s fair market value.

• Online real estate listing sites. You can print out and place in household files estimates from various online real estate listing sites such as zillow.com or redfin.com. These sites provide an estimate of market value, based on comparable recent sales in the area. Double check with your state housing agency to make sure they accept these estimates to be used for fair market values.
• A tax assessment statement. Your local assessor’s office is tasked with evaluating every piece of real property in the county and determining its value for property tax purposes. That value is based on property data and the current real estate market. If a tax assessment is used, be sure to clarify if assessed value equates to market value. Generally, the assessed value of a property is some percentage of market value. Some assessment statements include the market value, but if the market value isn’t explicitly stated, it can be calculated if the assessment ratio or percentage is known. This may be given in the statement or you can contact your local assessor's office to document the ratio.

Cash value. Once a property’s market value is established, then you will need verifications on the outstanding mortgage balance and estimates of the expenses of selling or converting the property to find the cash value of the property.  

• Mortgage statement. A mortgage statement providing the outstanding principal balance can be used to establish the equity in the property.
• Costs to sell. These costs include broker and legal fees. This is a bit trickier if a broker isn’t involved. A local real estate broker may give you a range of percentages for selling fees common for the applicable area. Your state housing agency also may provide an estimate for real estate broker and legal fees in your jurisdiction.

Rental income. Owners may utilize various documents, such as a current lease, recent rent checks, or the latest IRS Schedule E (Supplemental Income and Loss) to verify rental income [HUD Handbook 4350.4, Appendix 3].

Mortgage interest. HUD allows mortgage interest to be deducted from rental income in addition to operating expenses. Early in a mortgage’s repayment period, a higher percentage of the payment is applied to interest. Consequently, a higher percentage of the payment is allocated to principal later in the loan period. This allocation of the monthly repayment over the life of the loan will be in an amortization schedule provided by the lender. You can use this document to establish the interest payments over the 12 months following the certification date. If an amortization schedule isn’t available, you can recreate an amortization schedule using a spreadsheet template using basic information available in a mortgage statement.

HOTMA’s Asset Limitations

Starting Jan. 1, 2024, HUD is implementing Housing Opportunity Through Modernization Act (HOTMA) provisions for its Multifamily Housing programs. Although how cash value of real estate and income will be calculated won’t change, HOTMA establishes new household asset limitations preventing households that own real property “suitable for occupancy,” or assets over $100,000, from receiving rental assistance from HUD. However, the 2016 HOTMA statute indicates that housing providers can establish exceptions or use their own discretion in enforcing the new limits on residents currently served through HUD rental assistance.

While HOTMA’s changes to HUD’s Section 8 program will impact the LIHTC program because tax credit law requires owners to use HUD rules regarding income calculations, it’s important to note that HOTMA’s household asset limitations regarding households owning real property are for HUD housing and don’t apply to LIHTC programs.