Tax Deductions for Real Estate Agents – Entertainment Expenses

There are plenty of ‘tax tips’ articles out there for real estate agents.  However, most of these articles provide nothing more than a general, overall understanding of what expense categories are considered eligible for federal tax deductions.  This article will attempt to help conceptualize what types of real-life entertainment expenses can be eligible for tax deductions under federal law.  However, this is an overview, and should not be considered a substitute for sound, personalized advice from a tax professional.  Also, this primer does not provide legal advice–you need to take steps to ensure that your advertising campaigns comply with applicable federal, state, and local regulations.

This article will cover:

  • The specific IRS reference that helps determine deductible entertainment expenses
  • Eligibility criteria
  • The 50% rule, which provides the general guidance for deducting entertainment expenses
  • Exceptions to the 50% rule
  • Examples of entertainment expenses that real estate agents can claim

What Does the IRS Say About Entertainment Deductions?

The IRS policy regarding tax deductibility of entertainment expenses is contained in Chapter 2 of IRS Publication 463, Travel, Entertainment, Gift & Car Expenses.  Chapter 2 specifically discusses business-related entertainment expenses, and outlines what is eligible, and what is not.

According to Chapter 2, you can deduct entertainment expenses only if they are both ordinary & necessary and either the directly-related test or the associated test.

Before we go further, below are the IRS-defined terms outlined above in bold:

  • Ordinary expense: One that is common and accepted in your trade or business.  For example, providing appetizers & bottled water as part of an open house is common and accepted in the real estate world.
  • Necessary expense: One that is helpful and appropriate for your business.  Verbatim from IRS Pub 463:  “An expense doesn’t have to be required to be considered necessary.”   Using the above example, providing appetizers isn’t required to conduct an open house, but can be considered a necessary expense for tax purposes.
  • Directly-Related Test: To meet the directly-related test for entertainment expenses (including entertainment-related meals), you must show that:
    • The main purpose of the combined business and entertainment was the active conduct of business
    • You did engage in business with the person during the entertainment period AND
    • You had more than a general expectation of getting income or some other specific business benefit at some future time.
    • An example would be taking a prospective client out for a cup of coffee to talk about their needs
  • Associated Test: If your expenses do not meet the directly-related test, they may meet the associated test.  In order to do so, you must show that the entertainment is both:
    • Associated with the active conduct of your trade or business. This means you can show that you had a clear business purpose for having the expense.  That purpose might be to get new business or to encourage the continuation of an existing business relationship.  Hosting a networking event would meet this requirement as long as you’re able to document that this is to grow your business.
    • Directly before or after a substantial business discussion. Unless you can show that you actively engaged in the discussion, meeting, negotiation, or other business transaction to get income or other specific business benefit, it will not be considered a substantial business discussion.  This meeting doesn’t have to be for a specific length of time, but you must show that the business discussion was substantial in relation to the meal or entertainment.
    • The IRS points out a couple of additional points:
      • Meetings at conventions: If you attend meetings at an industry convention or similar event, this would be considered a substantial business discussion as long as your reason is to further your trade or business.
      • Directly before or after business discussion. If the entertainment is held on the same day as the business discussion, it is considered to be held directly before or after the business discussion.

What is the 50% rule, and how does it pertain to entertainment expenses?

Simply put, the 50% rule means that you’re allowed to deduct 50% of the total business-related meal and entertainment expenses.  This rule applies to employees or employers, and to self-employed persons, including independent contractors.  If you are reimbursed by your employer or clients, then they would be eligible to deduct 50% of the meals and entertainment expenses from their costs, not you.  This limit applies to business meals or entertainment expenses while:

  • Traveling away from home on business
  • Entertaining customers at your place of business, restaurant, or other location, or
  • Attending a business convention, reception, business meeting, or business luncheon

In essence, any entertainment expense that is allowed is subject to the 50% limit.  However, there are exceptions.

What are the exceptions to the 50% rule?

There are 5 exceptions to the 50% rule, but the following are the ones that might apply to real estate agents:

  1. Employee’s reimbursed expenses. If you are under an accountable employee reimbursement plan, then your employer should not consider your reimbursed expenses as income.  This is a wash:  you don’t have income, you don’t get the deduction.
  2. Self-employed. If you are self-employed, and your client or customer reimburses you or gives you an allowances for expenses in connection with your services, then your client or customer is eligible for (and subject to) the 50% rule, not you.
  3. Advertising expenses. If you provide meals, entertainment, or recreational facilities to the general public as a means of advertising or promoting community goodwill, you are not subject to the 50% rule.  IRS cites TV & radio sponsorships or distributing free food and beverages to the general public as fully deductible.  Keep in mind, an open house would be considered open to the general public, but a limited or private showing would not.

What types of entertainment expenses are deductible?

The following descriptions and examples are directly from Publication 463:

  • Includes any activity generally considered to provide entertainment, amusement, or recreation.  Specific examples include:
    • This includes cost of food, beverages, taxes & tips.  You or your employee must be present when the food or beverages are provided.
    • Trade association meetings. You can deduct entertainment expenses that are directly related to and necessary for attending meetings of certain exempt organizations if the expenses are related to your active trade or business.  This includes business leagues, chambers of commerce, real estate boards, trade associations, and professional associations.
    • Entertainment tickets. Generally you can only deduct the face value (without service fees) for tickets, even if you paid a higher cost.  Skyboxes or luxury seats to a sporting event are specifically limited to the cost of a nonluxury box seat ticket.  However, you can separately deduct food and beverage costs for skybox or luxury seats, subject to the 50% limit
      • Charitable events. There is an exception in which you can deduct the full cost of the ticket if the event’s main purpose is to benefit a qualified charity, the entire net proceeds go to the charity, and the event uses volunteers to do substantially all of the work.
      • Example: you buy tickets to a golf tournament organized by the local volunteer fire department, where the proceeds go to purchase new fire equipment.  The event is run by the volunteers.  The full cost of the tickets are deductible.

What types of entertainment expenses are not deductible?

The following descriptions are specifically excluded under Publication 463:

  • Club dues & membership fees. While business memberships are generally deductible, they are NOT deductible if the primary purpose of the organization is to provide entertainment activities for their members.  For example, dues for a local real estate group, whose primary goal is to meet for the purpose of business development, are deductible.  However, dues to a country club whose membership rules require their members to be members of the real estate industry, would not be.
  • Entertainment facilities. Generally, you cannot deduct any expense for use of an entertainment facility.  This includes depreciation expenses or rent, utilities, maintenance, or other costs.
  • Spouse expenses. You cannot deduct the cost of entertainment of your spouse or a customer’s spouse.
    • However, if you can show that there was a clear business purpose, and the customer’s spouse joins you because it’s impractical to entertain the customer without the spouse, then you can deduct the cost for the spouse. This also extends to your spouse, if they join to accompany the customer’s spouse.
  • Any item that could be considered either gift or entertainment will generally be considered entertainment. However, if you give a customer packaged food or beverages that are clearly intended for later use, then that will be considered a gift, and subject to gift rules.  Gift rules are different from entertainment rules, and are covered in IRS Publication 463, Chapter 3 – Gifts.
    • For example, taking a client out for a celebratory glass of wine would be considered entertainment, but a bottle of champagne would be considered a gift.

As a real estate agent, it’s important for you to be able to keep every dollar that you can.  Tax efficiency is a very overlooked way of reducing your costs, especially on things that you might do every day.  I hope this article clarified how you can deduct entertainment expenses as a part of your business.  However, if there’s a real estate entertainment expense that you think may qualify, please post it in the comments section below.  If you have any questions or concerns, please feel free to visit my website, or email me at:  forrest@westchasefinanicalplanning.com.

Tax Deductions for Real Estate Agents – Advertising & Marketing

Introduction

There are plenty of ‘tax tips’ articles out there for real estate agents.  However, most of these articles provide nothing more than a general, overall understanding of what expense categories are considered eligible for federal tax deductions.  This article will attempt to help conceptualize what types of real-life advertising and marketing expenses can be eligible for tax deductions under federal law.  However, this is an overview, and should not be considered a substitute for sound, personalized advice from a tax professional.  Also, this primer does not provide legal advice–you need to take steps to ensure that your advertising campaigns comply with applicable federal, state, and local regulations. Continue reading Tax Deductions for Real Estate Agents – Advertising & Marketing

3 Tax Concerns When Selling A Home

For real estate agents, this topic might seem like a no brainer.  However, your clients might not know the tax implications of their pending transaction, and this article can be used as a conversation starter with them.  Feel free to use this article to engage your clients in their critical thinking so they can make the right decision.

When a homeowner makes the decision to sell their home, it can be for any number of reasons: relocation, buying a bigger home, downsizing, or because it makes financial sense to do so.  As their real estate agent, you will be the first person your clients turn to when these questions come up.

Whatever the reason for selling a home, there are three tax considerations that warrant a further look.

Tax concern #1: Your realized gain

When selling any real estate, the IRS definition of realized gain takes into account a lot of things you may not have thought about.  According to the IRS, the basic formula for calculating your realized gain is:  Sale price – selling expenses – adjusted basis.  This means you need to calculate two things:  selling expenses & basis.  Properly calculating these two things could mean the difference of thousands of dollars in tax liability.

Selling expenses include any seller’s closing costs, real estate commissions, and any other related selling costs.  You should comb through your closing documents to make sure you’ve properly accounted for all selling expenses.  Do not include city & county property tax, but do include transfer taxes, if applicable.

Basis includes the original purchase price of your house, plus fees incurred during home closing, such as title insurance, legal & recording fees, or survey fees.  Basis also includes the cost of any major improvements, renovations, or system replacements.  The IRS makes a clear distinction between repairs that are a normal part of keeping a home in good condition (such as repairing leaks), and an improvement (such as replacing the plumbing system).

For a more comprehensive list of what can & cannot be included in selling expenses or basis calculation, you can refer to the IRS Publication 523, ‘Selling Your Home,’ which is user-friendly and available online.  Real estate agents:  Even if you’re not a tax practitioner, you probably are able to help clients figure out what constitutes selling expenses, as well as the difference between repairs and major improvements.

Tax concern #2:  Section 121

Under Section 121, the IRS allows a taxpayer to exclude the first $250,000 of capital gain ($500,000 for married couples filing jointly) on the sale of their primary residence if they meet certain ownership and use requirements.  If you owned the home for at least 24 months of the 5 years leading up to the sale, you meet the ownership requirement.  If the home was your primary residence for at least 730 days of the previous 5 years, you meet the use requirements.  If you’re married filing jointly, you must each meet the use requirement, even if only one person meets the ownership requirement to qualify for the $500,000 exclusion.  If you’re not married, but selling the house with someone else, you may each take the $250,000 exclusion as long as each of you meets the use requirement, and at least one of you meets the ownership requirement.  Even if you do not meet the requirements for a full exclusion, the IRS allows partial exclusions if you sell the home due to work or health related moves, or due to unforeseeable events such as death, divorce, natural disaster, unemployment, or other qualifying reasons.  IRS Publication 523 contains more details.  Real estate agents:  you should have this information at the ready in case someone asks about the tax implications, even if you aren’t prepared to give tax advice.

Tax concern #3: Long Term or Short Term Capital Gain?

If you owned the home for at least a year and a day, any gains are taxed at long-term capital gains rates, which range from 0% to 23.8%.  Otherwise, your gains are taxed at short-term capital gains rates, which are the same as ordinary income rates.  Long term capital gains rates calculations are based upon a taxpayer’s marginal tax bracket, but are more favorable.  For example, a taxpayer in the 15% tax bracket will pay 0% on a long-term capital gain.  If you’re considering the sale of your home at a profit within a year of purchase, you may want to consider whether you can sell it in a manner that qualifies the sale as a long-term gain.  However, if you’re selling your principal residence for a loss, you do not qualify for any type of deductible loss.  For real estate agents, this is worth discussing with your clients if you believe that timing is not on their side and they would be better off waiting.  For example, they may be trying to sell in the middle of winter, when no one likes looking at houses, or you’re trying to recommend some repairs in order to get their selling price.

This article is by no means an adequate substitution for unbiased advice, based upon the unique circumstances of your personal situation.  Before you make any major decisions, you should sit down with a fee-only financial planner in your area so that they can help you take into account all of the other factors that can affect your planning decision.  Having a relationship with a trusted professional who can help account for life’s changes is the best way for you to put together a plan that achieves your retirement goals.

Forrest Baumhover is a fee-only financial planner and the principal of Westchase Financial Planning.  To find out more about Westchase Financial Planning, go to www.westchasefinancialplanning.com.

 

 

Five Ways for Real Estate Agents to Maximize Tax Deductions

Tax deductions
How to maximize your tax deductions

Tax liability is one of the most important considerations for real estate agents for several reasons.  First, real estate agents usually operate as sole proprietors or as part of a closely-held LLC or corporation.  That means every dollar that an agent can save is a dollar that contributes to their personal bottom line.  Also, real estate agents are usually responsible for out of pocket expenses that may directly or indirectly improve their business—many of these expenses can be tax deductible.  Finally, not knowing the tax implications of their decisions can set agents back thousands of dollars…this can mean the difference between success or failure in the early years of establishing a successful business.

Let’s look at five ways real estate agents can maximize their deductions and making their business as tax-efficient as possible.  These are not five ‘quick tips,’ but they’re rules of thumb:

  1. Tax Tip #1:  Document every expenditure. 

    When you’re working for an employer, you might be required to document your expenditures.  However, when you’re spending OPM (other people’s money), you don’t really care as much about their money because it’s not yours.  When it’s your money, you’ll want to take care of every dollar to maximize your investment.  You want to document every expenditure, whether or not it’s tax deductible, if nothing more than make sure your books are organized.  Whether you’re audited by the IRS, looking for a loan or line of credit, or simply looking to become part of a larger real estate group, taking the time to document everything & keep a clean set of books will help enhance your professional reputation.  Which leads us to Number 2.

  1. Tax Tip #2:  Treat your business like it’s a business.

    Whether this is part-time work or your full-time career, being a real estate agent is a business, whether you think so or not.  The sooner you recognize this fact, the sooner you can learn how to run your business.  Part of running an effective business is finding the most cost-effective manner to reach your goals and objectives.  This doesn’t mean cutting corners or settling for less.  It simply means clearly identifying your goals, then working to ensure you’re maximizing the efficiency of your processes to get there.  Maximizing your efficiency means maximizing your tax-efficiency as well.

  1. Tax Tip #3:  Ask yourself, “Is this deductible?” every single time.

    Just get into the mindset that every expenditure could possibly be deductible.  Perhaps not.  But you should ask this question every time you spend money on something.    Obviously, taking a trip out of town for leisure doesn’t count as a deductible expense.  However, taking a trip out of town to check on an investment property you own is related to your business and can be eligible for tax deductions, even if you happen to take some leisure time in association with that trip.  However, the difference between legal tax avoidance and an illegal attempt to evade tax liability can be very subtle, so you should become familiar with the rules before you attempt to take deductions.

  1. Tax Tip #4:  Be familiar with the rules.

    The tax code is complicated.  It’s very difficult.  It’s huge.  However, the IRS expects you to be familiar with the rules that related to your personal situation.  Just like knowing the real estate business, you should know a little bit about how taxes play into your business.  It also wouldn’t hurt to be able to help your clients better understand how taxes play into their transactions.  Section 121 (the ability for taxpayers to exclude up to $250,000 or couples to exclude up to $500,000 of their home sale gain, provided they meet certain ownership and use requirements) should not be a foreign concept to you.  Neither should terms like depreciation, basis, or Section 1250 recapture.   You don’t have to be an expert, but you should be able to answer one or two questions on widely covered topics such as these before you have to punt to a tax professional.  You can always caveat by saying something like:

“I’m not a tax professional, but Section 121 of the Internal Revenue Code does allow you to …. provided you meet certain ownership and use requirements.  However, for your particular situation, you might want to talk to an accountant or other tax professional to make sure you’re taking the right steps.”

Which brings us to the last point:

  1. Tax Tip #5:  Hire an accountant or enrolled agent today.

    Would you rather spend your time and effort being the best real estate agent you can, or would you rather save a few hundred dollars and do your own taxes. Perhaps you can’t afford that few hundred dollars in the first year or two.  Here are a couple of reasons why that might be a very sound investment:

  • You might be saving a few hundred dollars and missing out on tax deductions or credits that could be worth much more.  There is an entire industry dedicated to helping people prepare their tax returns, and another industry dedicated to helping people and companies become more tax efficient.   Let these folks take the work off your hands, and so that you can run your business more efficiency.  If they find that missed deduction and save you a bunch of money, you’ve already recouped that investment.
  • You learn. Knowing more about taxes and how they can impact you will help you build a better business.
  • When you see a client whom you know needs tax help, it’s a lot easier to refer that person to a tax professional you’ve already hired.  Being able to say, “Let me introduce you to my accountant” is just another way to add value to those clients, in the same way you’d refer them to a contractor, mortgage broker, or any number of professionals you’re constantly referring clients to.

In future articles, I’ll go into more detail about expenses and their deductibility.  However, implementing these five steps is the best way for you to quickly develop your business as a real estate agent in the most tax-efficient manner.

As always, please feel free to follow this blog or contact me at:  forrest@westchasefinancialplanning.com, if you like this blog, have concerns or questions, or have a topic that you would like for me to address.  Until next time, take charge of your life!