As we approach April 15, 2011, our call volume dramatically increases. Individuals desperately seeking to reduce their 2010 tax liability inundate my firm with deduction related questions. Ironically, like asset protection planning that begins upon notice of a lawsuit, tax planning for 2010 should have begun over a year ago; but alas, such is the individual born with the lifetime subscription to Procrastinators Monthly and unwilling to cancel it.
Amidst the fervor to reconstruct last year’s income and expenses into a cogent spreadsheet that in the immortal words of Judge Learned Hand our 10th Supreme Court Justice – "Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands." However, before donning your Don Quixote armor by taking pen to paper and slashing your income with all manner of possible deductions keep in mind that all deductions must be ordinary, necessary, and reasonable.
Ordinary Expenses: Are expenses that are typical in your trade or business that are needed to run your business. Ordinary expenses must also be necessary in order to deduct them from your business taxes.
Necessary Expenses: Costs for things helpful and appropriate in running your trade or business. Necessary expenses are not tax deductible unless they are also ordinary expenses.
Example of a Reasonable, “Ordinary and Necessary” Business Expense: Costs associated with looking for real estate e.g., internet subscriptions, software, computer, cell phones, mileage deduction (it is often more advantageous to take a reimbursement for mileage as opposed to deducting your vehicle through your business), mailers, advertising, or other promotional literature being distributed. Consider deducting purchases of educational courses, books and materials, or other products related to real estate investing. If you have incorporated yourself and have monthly or quarterly meetings at your house with other investors, your corporation should be renting your house from you and you may be able to exclude the income you receive under IRC Sec 280(a).
Generally speaking, deductions abound if you think about it long enough and can associate the expense with your business.
Word of note: The IRS recently released a report indicating their intent to perform more examinations of individual tax returns that report losses from rental real estate activity. The increased scrutiny was triggered by a 2008 report that found at least 53% of individual taxpayers with rental real estate activity for tax year 2001 misreported their rental real estate activity. The report appears to direct the IRS focus on those taxpayers claiming real estate professional status. Thus, similar to documenting expenses, documenting your time devoted to real estate related activities is extremely important given the IRS’s intent to look more closely at real estate activities. The Treasury Inspector’s Audit Report is located at http://www.treasury.gov/tigta/auditreports/2011reports/201130005fr.pdf.