Every year, thousands of real estate professionals pay more tax than they need to because they fail to take all the deductions to which they are legally entitled.
The Internal Revenue Service will never complain if you don’t claim all the deductions you can. It’s up to you and your tax preparer to figure out what you can deduct, keep proper records, and claim deductions on your return.
Every dollar in deductions you fail to take can cost you 40-50 cents in extra taxes — money the IRS is happy to keep.
Two of the most often overlooked deductible expenses arise from doing business from your home.
Home-office deduction
Probably the No. 1 deduction real estate pros miss is the home-office deduction. Many erroneously believe they don’t or can’t qualify for this deduction. Untrue. Almost any real estate agent or broker who works as an independent contractor can qualify for the home-office deduction.
This is the case even if you work out of an outside sales office and/or spend most of your time on the road and at the properties you’re trying to sell.
In addition, many real estate pros are afraid to take this deduction because they have heard that it is a red flag for an IRS audit. The IRS says this isn’t the case.
The home-office deduction may have been an IRS audit flag over a decade ago, when the rules for claiming it were more restrictive than they are now. But there is no reason to believe that claiming it today significantly increases your chances for an audit.
It’s important to understand that you don’t have to spend all of your work time in your home office or even perform your most important business activities there to qualify for the home-office deduction.
You can qualify for this deduction if you have a home office that you use exclusively and regularly for administrative or management activities for your real estate business, and you have no other fixed location where you regularly perform such activities.
Administrative and management activities can include, but are not limited to:
- keeping books and records;
- setting up appointments;
- paying bills;
- maintaining client databases or contact lists;
- reviewing real estate publications; or
- engaging in real estate continuing-education activities.
This means that you can qualify for the home-office deduction even though your home office is not where you generate most of your income. It’s sufficient that you regularly use it for the administrative and management activities you regularly perform for your real estate business.
As long as you have no other fixed location where you regularly do these activities — for example, a desk you use at your brokerage office — you’ll get the deduction. Moreover, you can qualify for the deduction even if you could conduct administrative or management activities at an outside office but choose to use your home office for those activities instead.
The home-office deduction is particularly valuable for renters because it allows you to deduct a portion of your rent. The amount you can deduct is based on the percentage of your home that is used for your home office.
If you own your home, you have the option of deducting the home-office percentage of your mortgage interest and property tax payments as part of your home-office deduction. Since this is a business deduction, not a personal deduction, it reduces the amount of your business income subject to self-employment taxes, as well as reducing your income taxes.
The self-employment tax is 15.3 percent, so you can save $153 in self-employment taxes for every $1,000 in mortgage interest and property taxes you deduct as part of your home-office deduction. If you do this, you may not deduct this amount on your Schedule A (you can’t deduct the same item twice).
You can also deduct the home-office percentage you pay for utilities, home maintenance, insurance, and condo association fees.
There is one catch to the home-office deduction: You cannot deduct more than the net profit you earn from your business. If your real estate business earns very little or loses money, this limitation could prevent you from deducting part or even all of your home-office expenses in the current year.
If your deductions exceed your profits, you can deduct the excess in the following year and in each succeeding year until you deduct the entire amount.
There is no limit on how far into the future you can deduct these expenses; you can claim them, even if you no longer live in the home where they were incurred. So, whether or not your real estate business is making money, you should keep track of your home-office expenses and claim the deduction on your tax return.
Office expenses in the home
Many real estate pros believe that they can’t deduct any expenses they incur while working at home unless they qualify for the home-office deduction. This is a myth that has cost many real estate pros valuable deductions.
Even if you don’t qualify for or take the home-office deduction, you can still take tax deductions for expenses you incur while doing business at home. These are expenses that arise from the fact that you are doing business, not from the use of the home itself. These include:
Telephone expenses. You can’t deduct the basic cost of a single telephone line into your home, but you can deduct the cost of long-distance business calls and special phone services that you use for your business (such as call waiting or a message center). You can also deduct the entire cost of a second phone line that you use just for business, including a mobile phone.
Business equipment and furniture. The cost of office furniture, copiers, fax machines, and other personal property you use for your business and keep at home is deductible, whether or not you qualify for the home-office deduction. If you purchase these items specifically for your real estate business, you can expense them (deduct them in one year) under Internal Revenue Code Section 179, or depreciate them over several years.
If you use the property for both business and personal reasons, the IRS requires you to keep records showing when the item was used for business or personal reasons — for example, a diary or log with the dates, times and reasons the item was used.
Supplies. Supplies for your real estate business are currently deductible as an operating expense if they have a useful life of less than one year. Otherwise, you must depreciate them or expense them under Section 179.
Stephen Fishman is a tax expert, attorney and author who has published 18 books, including "Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants," "Deduct It," "Working as an Independent Contractor," and "Working with Independent Contractors." He welcomes your questions for this weekly column.