Investment Expense

[Harvey Lucas]

In 2007 my client went to one of these get rich real estate seminar programs that have been popular over the years.

They offered instruction on short sales, flipping, foreclosures, tax sales, rent to own, etc, etc.

She paid $16,000 for the seminars, courses, cd's, ongoing support and the like.

She was very excited about it, jumped in with both feet and decided to "be in business" of this type of activity.

She already had one rental property that she acquired in 2005, she then acquired another in 2007.

She rented her rentals as rent to own, as such she was abe to get higher rent than if they were simply rentals.

She incurred all types of expenses as she dove into the activity, ie, licensing, office exp, promo gifts, travel, advertising for forclosures, auto reply phone system, list fee's, etc, etc, etc. roughly $10,000.

She referred to it as "a business", it has all the earmarks of "a business", however, to me it really smelled like "investment activity" or plain and simple sch E activity.

I was not comfortable putting all this expense on schedule C because we had no sch C income and it did not strike me as "a business" in the usual way.

She did sell one of the rentals in 2007 but that was clearly a 4797 transaction. She had a profit of $80,000 on the sale.

Her schedule E has 2 rentals for 2007, the one that sold in July of 07, and the other that she held full year.

Combined loss after expenses on the schedule E was -36,000.

Because she had a sale of a rental property in that year, the entire -36,000 loss is allowed as a deduction, ie, not limited to the -25,000 limit.

She has W2 gross income of 150,000.
She also owns the home she lives in.

I put the "investment expense", ie, 16,000 training and support, and the other expenses 10,000, ie, $26,000 on sch A as investment expense.

I am wondering now if this was correct?

Maybe it should have gone on sch E, or maybe even sch C.

She was "in the business" of searching for, finding, buying properties that she would, rent or sell. Usually we consider that to be investment or sch E rental activity.

Possibly I should have allocated all of these cost to the cost basis of the properties that she bought.

Any comments would be appreciated.

Sincerely,

Harvey Lucas

[BHoffman]

Hi Harvey - I would choose Sch A to deduct investment seminar expenses. IRS doesn't allow travel expenses to be included, do they?

I don't know about adding to basis, as the seminar expense probably can't be directly traced to the purchase of this or that particular property.

[Snaggletooth]

UPEs

Harvey, we recently had a discussion about Unreimbursed Personal Expense, where I learned a whole wheelbarrow full of stuff.

There is a provision to deduct on page 2 of the Schedule E some expense items which are not attributable to the property itself. This is for UPEs and is allowable. Investment expenses (Form 4952) which end up on Schedule A don't help as much as a direct deduction, and Form 4952 stuff is for investments that are more passive than operational.

My only problem with the $16,000 is it appears this should be treated as "start-up" and depreciated over 5 years. Especially since it looks like this woman is going to be successful. And if there become so many properties that the woman is going to be spending major time managing them, then a Schedule C will become appropriate.

[Gene V]

I wonder if the seminar would be deductible. See TTB page 8-8

Investment seminar. Cost of attending for one’s own investing
purposes is not deductible [IRC §274(h)(7)]. If the taxpayer is in the
trade or business of investing, the cost of attending is deductible.
See Classifying Investors and Traders, page 6-10,
to determine if a taxpayer is in the trade or
business of investing.

[Snaggletooth]

Trade-Off

Sounds like it is deductible only for an operation and not an investment.

In other words, deductible for a schedule C and maybe not for a schedule E.

Think about it if the woman is going to make big money. Saving the deductibility of $16,000 is not much compared to the self-employment taxes and loss of capital gains which would come with a proprietorship.

[Lion]

New Business

Training to get into a new business is NOT deductible. If she's buying foreclosures and selling property, then it's inventory and a business and Schedule C, not Shedule E rentals. Deduct the usual and necessary expenses to do business; sounds like a few of her expenses might be extraordinary, though. Sales of her inventory houses will be ordinary income.

[Kram BergGold]

You goofed

Clearly you need to amend. Investment seminars are not dedcutible on Schedule A.
I don't like Schedule E because I don't see the expense as being ordinary and necesary to renting out properties..
That leaves the seminar expense as a start up expense on Schedule C but to deduct real estate expenses on C you have to show that rentals are less than 7 days or B & B like or there is some other thing going on like flipping. She would then keep properties on E that she bought through normal channels and plans to keep for many years and properties bought through exotic channels that she plans to hold for short (not necesaarily short term) would be on Schedule C. Gains on these of course would then be taxed as ordinary income.

[Harvey Lucas]

From the varied responses

I can see why I struggled with it so much in the first place.

I put it on Sch A investment exp because it was the most conservative approach, ie, limited by 2% of AGI.

However, we are scheduled for an IRS audit on this issue in May and now I have to seriously reconsider the matter and decide my presentation and approach to the auditor.

It seems to me that she was already "in the business of rentals", ie, she owned a rental property that she acquired in 2005.

The term "business" is a little ambiguous and can mean various things within the code.

When you own a rental property, many people would say you are "in the business" of owning a rental property.

And, even though it can be refered to as a business, for tax purposes I think we all agree that rental properties and associated activity goes on Sch E.

I know of people with dozens of rental properties, clearly in the "business of rental property", yet still it goes on sch E, ie, not subject to SE tax.

It would be an unusual exception to see someones rental property activity on sch C.

So, if she is already in the business of rental properties, and she goes to an educational/professional organization and pays a fee for advice and service to increase her skills and abilities to earn money in the rental property business, then it follows that her expense for doing so is an "ordinary and necesary business expense" and as such it should be deductible on the appropriate form associated with that activity, in this case sch E.

Certainly the $16,000 she paid was not for only one thing. It was for many services and onging support and advice all directly connected to the rental property business that she was already in, ie, managing rentals, getting tenants, evicting tenants, buying more properties, selling properties, etc, etc, etc.

She had a reasonable expectation that her payment for these services would increase her ability to earn income in an activity that she was already involved in, as such, it should be deductible.

I think this will be my argument and approach and I will prepare an amened return to present at audit and ask for a refund on this issue, ie, these expense should not be limited by the 2% of AGI factor on sch A.

Wish me luck, I will let you all know how it goes.

Harvey Lucas

[BHoffman]

Best of luck, Harvey. Don't know if this will help, but you might want to take a look at IRC 212:

http://www.taxalmanac.org/index.php/Internal_Revenue_Code:Sec._212._Expenses_for_production_of_income

And the related Treas Reg:

http://www.taxalmanac.org/index.php/Treasury_Regulations%2C_Subchapter_A%2C_Sec._1.212-1

This is what first came to mind when you initially described the situation. Lion brings up a good point however.

Have you found any tax court cases where this particular investment seminar provider has been deducted and the court found in favor of the IRS? Maybe a google search of the investment seminar provider?

Please keep us informed?

Thanks,
B

[Harvey Lucas]

Trade or Business Defined?

Regarding Code Section 162, regarding expenses deductible pertaining to taxpayers "trade or business"

Is there a good definition of what is a "trade or business" within the tax code, or regs, or IRS publications?

Thank You,

Harvey Lucas

[Kram BergGold]

Court case on point

This is from Mary Mellum's email letter.


Mr. Woody started a business in May 2004 “buying, remodeling, and renting property.” In October 2004 he paid over $20,000 to take a course to acquire real estate investment skills. After the course he modified his business plan to include “flipping” and “wholesaling”. He received an SBA loan in November as well as an EIN. In December he opened a checking account in the business name and obtained a credit card. He made various offers to purchase properties but was out-bid on most.

In May 2004 a contract to purchase was cancelled after a home inspection revealed many defects and the seller was not willing to make the needed repairs. The first property actually purchased was on December 30, 2004. The property did not have a tenant in it at the time and Mr. Woody was unable to show it was held for rent in 2004.

During 2004 he incurred various expenses including car & truck expenses, supplies, meals & entertainment, computer & software, miscellaneous, and workshops & training totaling over $23,000 (the workshops came to $21,515).

Mr. Woody argued his investigations and research from February to April may have been before he commenced the real estate business, but the business started when he entered into a contract of sale in May (which he later cancelled). IRS argued Mr. Woody didn’t start the business until December 30, 2004 at the earliest and since all of the expenses were incurred prior to that date, they were not deductible.

Tax Court cited Glotov v Commissioner, “A taxpayer is not carrying on a trade or business under section 162(a) until the business is functioning as a going concern and performing the activities for which it was organized.” As such the expenses would be “start-up” or “pre-opening” expenses at best with the first day of business being December 30, 2004, at the earliest and quite possibly not until the property was held out for rental. Tax Court further stated the workshops and training qualified Mr. Woody for a new career, rather than maintaining or improving skills in an ongoing business, therefore they are not deductible.

Thomas J. Woody, TC Memo 2009-93

This case can be found at www.ustaxcourt.gov by clicking on the OPINIONS SEARCH tab and typing “Woody” in the Case Name box.