Give yourself a tax break/Texas Realtor

July 2003

Give yourself a tax break

How to maximize your deductions and minimize your tax liability.

by Edward Lyon April 14 is the wrong time to try and reduce your taxable income. You need to maximize your deductions and implement tax-reducing strategies the rest of the year to make a significant difference in April.

The following information offers a few areas where real estate professionals can often find substantial deductions. As with any financial advice, consult your accountant or other qualified professional before implementing any of this advice.

Advertising

Advertising and farming costs you incur promoting your business are deductible business expenses. These include traditional print advertising, online ads, lead-generating hotlines, newsletters, and similar expenses.

You can also deduct the costs of sponsoring athletic teams, as long as you can show a clear connection between your sponsorship and your business. So plaster your name all over those Little League uniforms to qualify.

Mileage and vehicle maintenance

You know that travel for your business is deductible, but there are other legitimate ways to write off car and truck mileage. For 2003, traveling to manage your investments is deductible at 36 cents per mile up to your net investment income, and travel for volunteer work or other charitable causes is deductible at 14 cents per mile as a charitable gift.

While those deductions can come in handy, the bulk of your vehicle deductions probably arise from business-related travel. The following trips all qualify as deductible business miles:

If your home is your principal place of business, then every mile driven from your home on business is deductible.
If your home is not your place of business, your commute is not deductible. But only the trips from your home to your first business stop of the day and from your last business stop of the day to your home are defined as your commute. For example, if you leave home, drive to the post office, show six properties, meet clients for dinner, and drive home, your mileage between the post office and restaurant is deductible. However, if you have a regular business stop–one that you’ll make eight to 10 times in a six-month period–that will last less than a year, you can deduct the mileage to that stop. That enables you to get around the commute rule and deduct mileage to your listings.
If you travel outside your normal geographic area–or if you commute more than 50 miles a day for an assignment expected to last less than one year–your mileage is deductible.

Knowing what is deductible is the easy part; tracking your deductible mileage can be tricky. To facilitate this calculation, figure out the business use percentage (BUP) for your vehicle. The BUP provides an easy way to substantiate your mileage deductions for the IRS. If you can’t show them how you arrived at your deductions, you’ll not only have to pay extra tax, but the IRS can hit you with a civil fraud penalty equal to 75% of that extra tax.

Here are a few ways to calculate your BUP:

Brute-force method. As attractive as it sounds. Record every deductible business mile every day, all year. On December 31, divide the total number of miles you drove by your business miles to arrive at your BUP.
Ninety-day method. Record your deductible miles for a "typical" 90-day period, calculate your BUP for this period, and extrapolate it for the entire year.
Simplified method. Probably the easiest of the three for active real estate professionals. Record your mileage at the start and end of a 90-day period and assume that all miles are deductible. During this period, track any nondeductible miles. Calculate your BUP and extrapolate it for the entire year.

Once you’ve figured out your BUP, there are two ways to calculate your deduction. The mileage-allowance method is the simplest. You deduct the appropriate amount per mile (36 cents in 2003) plus the BUP of interest on your car loan, state and local personal-property tax on the vehicle, parking, and tolls.

The other way is the actual-expense method. With this, you deduct the BUP of all your auto expenses: gas, oil changes, tires, service and repairs, licensing and tags, insurance, parking, tolls, car washes, lease payments, and depreciation. You can even write off the cost of litigating and settling losses from accidents that occur while driving for business.

You must use the mileage-allowance method for the first year your vehicle is used for business. After that, you may switch to the actual-expense method, but not back. Select the method that gives you the biggest deduction, which probably will come from the actual-expense method, especially if you drive an SUV or luxury car.

Vehicle leases and depreciation

If you lease your car, you can deduct whatever part of your lease payment equals your business use of the car. For example, if you lease a car for $300 per month and use it 75% for business, you can deduct $225 per month.

However, there’s a catch. If you drive an "expensive" car–one with a market value of more than $15,500–the IRS limits your deduction to what they estimate you could have depreciated if you bought the car outright.

If you buy your car, you can’t deduct your payment, but you can depreciate it. This enables you to deduct your purchase over a period of time intended to approximate the car’s useful life.

If you drive your car more than 50% of the time for business, you qualify for Modified Accelerated Cost Recovery System (MACRS) depreciation: 20% the first year, 32% the second, 19.2% the third, 11.52% the fourth and fifth, and 5.76% the sixth. (Limits for those subject to the alternative minimum tax are 10% the first year, 20% the second through fifth, and 10% the sixth.) There are, however, special limits as to how much you can depreciate each year: $3,060 the first year, $5,000 the second, $3,050 the third, $1,775 the fourth and fifth, and $1,152 thereafter.

The Jobs and Growth Tax Relief Reconciliation Act of 2003 offers a 50% temporary "bonus depreciation" for new-equipment purchases used more than half the time for business made between May 6, 2003, and Dec. 31, 2004. This temporarily increases the 30% bonus for new-equipment purchases enacted in 2002.

For passenger cars, this change in the bonus deduction increases the maximum first-year depreciation from $7,660 to $10,710. SUVs with a gross vehicle weight, loaded, of 6,000 pounds or more don’t count as passenger cars and aren’t limited to the annual depreciation ceilings.

Phones

Buying a cell phone or pager for business is a deductible expense. Your phone bills–both land lines and cellular–are also deductible when you’re using the phone for a deductible purpose. Business phone lines and long-distance calls from your business or personal phone are deductible under these rules:

The cost of installing and maintaining an extra line for work is a deductible business expense. You can also deduct the cost of call-waiting and call-forwarding features you add to your personal line for business purposes.
Long-distance calls for work are deductible.
Calls you make to manage your investments are deductible as an investment expense.
Calls you make for medical care are a deductible medical expense.
Calls you make to manage rental property are a deductible rental expense.

Computers

The computers and peripherals you buy to manage your business are deductible according to how you use them. If you use your computer more than half the time for business, you can depreciate it over five years or claim first-year expensing. First-year expensing limits are high enough ($100,000 for property put in service in 2003, 2004, and 2005) that you should be able to deduct the full purchase price the year you buy the system–the simplest way to write off your system. However, if first-year expensing isn’t available, you can depreciate it according to the MACRS "200% double declining rate."

For example, assume you buy a $2,500 system that’s used 60% of the time for business, 20% for managing investments, and 20% for zapping aliens. You can claim first-year expensing of $2,000 (80% of the total price), which enables you to deduct the highest possible amount that year. If first-year expensing isn’t available, you can depreciate $400 (20% of the purchase price multiplied by the 80% deductible use).

Conventions, continuing education, and seminars

You can deduct as a business expense courses you take to maintain your licenses or advanced designations. Also, you may deduct the costs of marketing and sales seminars, sales coaching, and similar programs you attend to boost sales. However, you cannot deduct classes taken to prepare yourself for a new trade, which means pre-licensing classes, and licensing expenses are not deductible.

Conventions in North America or the Caribbean that you attend for business are deductible; this includes registration, materials, activities, and the like.

Credit cards

Credit-card interest and account fees you pay for your business are a deductible expense. Be sure to use a separate account only for business charges.

Normally, you can’t deduct expenses until you’ve paid them. However, if you use a third-party credit card (like VISA, MasterCard, American Express), as opposed to a store-specific credit card, you can deduct the expense the year you incur the charge. This strategy can be useful when accelerating deductions to capture tax savings, as well as bunching deductions for maximum value.

Dues

Dues you pay to chambers of commerce and civic organizations are deductible business expenses, as are portions of your NAR, TAR, and local-association dues.

Eighty percent of your $87 annual TAR membership fee ($70) is tax deductible. You can also deduct $51 of your $64 NAR member dues—approximately 80%—as well as the entire $20 special assessment for the NAR Public Awareness Campaign.

The full amount of dues you paid is not tax deductible because the Tax Reform Act of 1993 made any funds used for lobbying state or federal governments nondeductible. Check with your local board to determine how much, if any, of your local dues you can deduct.

If you reasonably expect to gain some business benefit from your membership, dues you pay to charitable, religious, or educational organizations are also a deductible business expense. Personal dues you pay to these organizations are a deductible charitable gift.

Home office

These are some of the most misunderstood deductions available. Most taxpayers assume home-office deductions throw up a red flag and invite IRS attention. But throwing up a red flag doesn’t guarantee you’ll be audited, and audits don’t always result in additional taxes.

A qualifying home office is any space you use "regularly and exclusively" as your "principal place of business." "Regularly and exclusively" means you use the space only for business and not for personal activities. If you claim the deduction for space you use as an employee, you must show that your employer requires you to maintain the home office for the employer’s convenience. It doesn’t have to be an entire room, and it can be used for more than one business. If you and your spouse both use the office, both of you have to qualify to take the deduction.

Your office generally qualifies as your "principal place of business" if you use it to meet clients (keep a guest book to verify this); your office is a separate structure, not attached to your home; you use it to conduct administrative and managerial activities and have no other fixed place to do so; or you use it to manage six or more rental properties.

To claim the deduction, first figure what percent of your home you use as the office. You can simply divide by the number of rooms, if they’re roughly equal, or you can calculate how much of your home’s square footage you use. You can then deduct that percentage of rent, mortgage interest, property tax, utility bills, repairs, insurance, plus incidental home expenses like trash pickup, lawn maintenance, and security. You can also depreciate the percentage of your home’s purchase price covering the office space.

The Taxpayer Relief Act of 1997 added a wrinkle to the home-office deduction. If you claim part of your house for business use, you convert that space from residential to commercial property. That means it may not qualify for the $250,000 exclusion when you sell the house. If you claim depreciation in any three of the five years before you sell, you’ll lose the exclusion on that part of the house and owe a 25% recapture tax on the amounts you have depreciated.

Meals and entertainment

Meals and entertainment you enjoy in the course of your business are deductible if they’re directly related to conducting business or they take place directly before or after substantial discussion related to business. The law allows you to deduct 50% of most meal and entertainment costs.

When was the last time you ate out and didn’t discuss business? Even if you’re just asking for referrals, you should consider it a business occasion. If you have lunch with your brother and have gotten clients from him in the past, is this a legitimate business occasion? You bet.

Be aggressive with meal and entertainment deductions, as long as you can substantiate them under these rules:

Business meals must take place in surroundings conducive to business.
Use a day planner or similar log to record your business appointments and prove your deductions. Include the place of the meeting, the cost of the meal, the business purpose, the names of those in attendance, and the business relationship between you and your guests.
Entertainment expenses are deductible if they are "associated" with business meals, meaning they take place directly before or after business discussion.
You must have receipts for expenses exceeding $75. Credit-card statements are fine if you record the business purpose of the expense in your business log.
If you’re not traveling together on business, you can’t deduct your spouse’s meals–unless your guest brings her spouse, then it’s allowable under the "closely connected" rule.
You can’t deduct dues you pay to lunch clubs, country clubs, and other clubs. However, you can deduct meals and entertainment (greens fees, for example) at those clubs.
You can deduct home entertainment costs for small gatherings just as if you’re entertaining outside the home. The same record and receipt rules apply.
For groups of 12 or more at your home, you must show an additional business purpose beyond "discussions," such as showing samples or displaying products. For example, don’t just celebrate your birthday; celebrate your 10th anniversary in the real estate business and display brochures and marketing materials in your entry way.
You can’t deduct season tickets to the theater or sporting events as one expense. However, you can deduct them for individual events, as long as they qualify and they meet the rest of the "associated" rules.

There are some types of meals that are 100% deductible:

Meals you can exclude from your employee’s income as a de minimis fringe benefit
Meals you provide to the general public to advertise or promote goodwill
Meals you furnish to your employees on your own business premises for your convenience–if there are insufficient eating facilities close by and employees can’t get meals in a reasonable amount of time

Be aggressive and keep good records

Tax planning gives you more control over your income and cash flow. You can’t control the economy, interest rates, or other external forces on your business; however, you can make sure you take advantage of every deduction the law allows. By implementing a strategy now to minimize your taxable income, you’ll be much happier in April 2004.

Edward Lyon, J.D., author of Instant Tax Relief for Real Estate Professionals, is a former legislative analyst for U.S. Reps. Jack Kemp and Dick Cheney and a graduate of the University of Cincinnati College of Law. He has created tax-planning systems for entrepreneurs, investors, and families, and delivered seminars across the country. Learn more about his tax-saving techniques at http://taxrelief.swlearning.com.

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