Editor’s note: Please welcome Stephen Fishman, a tax expert, attorney and author, who will address tax issues relevant to real estate professionals in a weekly Inman News column.
Q: I started working as a part-time real estate agent last year. Even though I worked with several clients during the year, I did not close on any houses and thus earned no income. However, I still spent money to be an agent, including association fees, desk fees, vehicle/mileage expenses, and the purchase of office supplies. Can I deduct these expenses from my income taxes?
A: Yes. So long as your real estate activity qualifies as a business for tax purposes, you may deduct all of your reasonable and necessary expenses from your income taxes.
This is so even if your real estate business earned little or no income, and thus incurred a loss for the year — that is, your expenses exceeded your income. You can deduct your business loss from other income you have for the year such as investment income, employee income, and your spouse’s income if you’re married and file a joint return.
This assumes you work as an independent contractor, which most real estate agents do.
The key question, then, is whether your work as a real estate agent qualifies as a business in the eyes of the Internal Revenue Service. The fact that you earned no income doesn’t mean you weren’t running a business.
Not all real estate agents make money every year, particularly in this economic climate. Moreover, it is very common for new businesses to show losses during their first few years.
Thus, despite what you may have heard, you don’t have to show a profit every year, or every couple of years, to qualify as a business.
No matter how much — or how little — money you earn, your real estate activity qualifies a business if you engage in it regularly and continuously during the year, primarily to earn a profit. It makes no difference whether you work full time or part time, so long as you work regularly and continuously.
However, if your primary purpose is something other than making a profit — for example, to incur deductible expenses — the IRS may find that your activity is a hobby rather than a business. If this happens, you won’t be able to deduct your losses from your other income.
To show the IRS that you’re serious about making money from your real estate work, you need to work at it regularly and continuously. You can’t get a real estate license, sit back and do nothing, and then claim you had a profit motive. This won’t pass the "smell" test. You should be actively working to obtain listings and/or close sales.
Starting right now, you should keep track of the time you spend working as an agent. Although there is no minimum amount of time you must work, you’ll have a hard time convincing the IRS that you want to make money if you work less than five or 10 hours a week. Keep a log showing how much time you spend working as an agent.
Your log doesn’t have to be fancy — you can just mark down your hours and a summary of your activities each day on your calendar or appointment book.
Other things you can do to show you are in business include: keep good books and other business records; invest time and money in training to sharpen your skills and get new ones; obtain a separate checking account for your business; and formulate a business plan.
Hopefully, you’ll start earning a profit in future years. If your venture earns a profit in any three of five consecutive years, the IRS will presume that it’s a business.
Any legitimate profit — no matter how small — qualifies; you don’t have to earn a particular amount or percentage. Thus, if you earn a profit from your real estate activity in any three of the next four years, it will automatically qualify as a business. However, you don’t have to pass this "three of five" test to qualify as a business.
Stephen Fishman is a tax expert, attorney and author who has published 18 books, including "Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants," "Deduct It," "Working as an Independent Contractor," and "Working with Independent Contractors." He welcomes your questions for this weekly column.