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:
- 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.
- 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.
- 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: email@example.com.