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July 9, 2024

Using Tax Returns for Income Verification: What Property Managers Need to Know

Daniel Berlind

As many property managers and landlords would agree, one of the most essential parts of effective tenant screening is verifying an applicant’s income to ensure they can actually afford the rent.

And while pay stubs and employment letters are often used, tax returns can provide a comprehensive, extremely reliable approach to income verification. This blog post highlights why tax returns are valuable, how to request and interpret them, and what to watch out for during the process.

Why tax returns can be useful for income verification

Tax returns provide a complete picture of a prospective tenant’s financial situation over a full year, including sources of income like salaries, freelance work, investments, and other revenue streams. On the other hand, pay stubs may not fully capture this type of detailed snapshot.

Tax returns are commonly the most reliable documentation for self-employed prospective renters, freelancers, or those with multiple income sources. They shed light on the total income earned and reported to the IRS.

In addition, rental applicants are less likely to falsify tax returns than other forms of income documentation. These documents are reviewed by the IRS and frequently prepared by tax professionals, ensuring more consistency and accuracy.

How to request and review tax returns from applicants

Always clearly state in your rental application process that you require the most recent tax returns, typically for the past two years. This gives a comprehensive view of the prospective renter’s financial stability and consistency over time.

It’s also important to ensure that applicants provide their tax returns securely, preferably via secure upload portals or encrypted email. After all, protecting sensitive information is vital.

Keep in mind that you can also request other supporting documents – think W-2 forms or 1099s – to cross-check the income reported on the tax returns. This can confirm the legitimacy and accuracy of the information provided.

Common signs of fraudulent tax returns

Fraudulent tax returns are on the rise and can rear their ugly head in many forms, especially in the context of landlords and rental properties. Here are some common red flags that may point to a fraudulent tax return:

Unreported Income. It could be a red flag if the potential tenant’s lifestyle appears inconsistent with their reported income.

Excessive Deductions. Inflated business expenses could indicate financial instability.

Mathematical Errors. Fraudulent returns commonly contain basic math errors or inconsistencies.

Rounded Numbers. Excessive use of round numbers – $20,000 instead of $20,032) can indicate fake income.

How to verify their authenticity

While tax returns are harder to fabricate, it is still recommended to look for any discrepancies or alterations. If you are still in doubt, consider utilizing third-party verification services.

Remember, not all income is the same. For example, freelance income can be variable, and investment income might not be sustainable, so it’s essential to understand the context of the income reported to make a better-informed decision.

What to do if you spot a fraudulent tax return from a potential tenant

Fraudulent tax returns can pose a significant risk to property managers and landlords. Detecting and addressing issues immediately is crucial for maintaining the integrity of your tenant screening process.

Here are some tips that focus on what to do if you suspect a potential renter has submitted a fraudulent tax return:

Verify the Fraudulent Indicators

Before taking action, ensure that the fraud signs are clear and convincing. Common indicators might include:

  • Inconsistent or incorrect information when cross-referenced with other documents (i.e., W-2s, pay stubs)
  • Missing signatures or preparer details
  • Obvious tweaks or mismatches in fonts and formatting
  • Unrealistic income numbers that don’t match the applicant’s employment status or other financial documents

Request Additional Documentation

Ask the prospective tenant to provide further documentation to support their income claims. This might include:

  • Recent pay stubs
  • Bank statements showing regular deposits
  • Employment verification
  • W-2 or 1099 forms

Use Verification Services

Consider using third-party verification services that specialize in verifying income and employment details to authenticate the documents. They can offer an extra layer of security and help confirm the authenticity of the provided documents.

Speak to the Applicant

Schedule a follow-up interview with the applicant to address the discrepancies. Ask specific questions about their employment history, income sources, and the documents provided. Many times, inconsistencies can be clarified through direct conversation.

Check with the IRS

While you cannot directly verify a tax return with the IRS due to privacy laws, you can request that the potential renter provide a tax return transcript directly from the IRS. The IRS Form 4506-T allows taxpayers to request a tax return transcript, which can then be submitted to you.

Evaluate the Risk

If fraud is confirmed or suspected, evaluate the risk of renting to this applicant. Consider aspects like the severity of the fraud, the applicant’s overall financial stability and history, and the potential legal implications of renting to someone who has provided fraudulent information.

Document Everything

Keep detailed records of all documents, communications, and steps throughout the verification process – they can be crucial if legal action becomes necessary.

Reject the Application

If you prove that the tax return is fake, it’s within your right to reject the application. Always follow fair housing laws and give applicants a legitimate reason for the denial based on your findings.

Report the Fraud

You may consider reporting the fraud to the authorities, depending on the severity of the situation. This might include filing a complaint with the IRS if you believe the tax return was falsified or reporting to local law enforcement if there is evidence of fraudulent activity.

Alternative income verification documents to consider requesting from potential tenants

Confirming a potential renter’s income is essential in the screening process. There are numerous other documents that you can request to get a better picture of an applicant’s financial status.

Here are some alternative income verification documents you can ask for:

Pay Stubs. Provide up-to-date information on an applicant’s income, showing both gross and net earnings over a recent period. They can help verify the consistency and reliability of the applicant’s income. Always request the most recent pay stubs, typically from the past two to three months, to ensure current and accurate income.

Bank Statements. Can verify the frequency and amount of deposits, which helps confirm the potential renter’s income sources and financial stability. Request statements for the past three to six months to get a transparent view of the applicant’s financial activity and consistency of deposits.

Employment Verification Letter. Provides direct confirmation from the employer about the prospect’s income and employment status, adding an extra layer of credibility. Ask for a letter that includes the employer’s contact information to double-check its authenticity.

Social Security Benefit Statement. This can be helpful for retired applicants or those receiving disability benefits, confirming proof of a steady income stream.

Unemployment Benefits Statement. For applicants currently unemployed but receiving benefits, this document verifies their income source.

Pension Distribution Statement. This document is also important for retired applicants who rely on pension income.

Profit and Loss Statement. Prepared by self-employed individuals that highlight their income and expenses over a specific period.

Tax Documents (W-2s, 1099s). These documents provide official income records and are useful for confirming both traditional employment and freelance income.

The Bottom Line

Using tax returns for income verification provides a comprehensive, accurate, and reliable strategy for assessing a rental applicant’s ability to afford rent.

By requesting, securely handling, and carefully reviewing these documents, you can make educated decisions and lower the risk of tenant default.

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