Investor Tax Checklist

Checklist of Deductions for Investors

To encourage you to invest, Congress lets you deduct many of the expenses involved. Browse through this list to see what you may be able to deduct.

Expenses You Can Deduct

Legal fees: If you sought legal advice regarding your investments, you can deduct those fees. If the legal services you received covered more than just your investments, include only the portion of the fees that can be allocated to your investments.
Professional fees: These are similar to legal fees. For example, you can deduct fees you paid to your accountant in compensation to provide you with advice about the tax effects of certain investment transactions.
Fees for investment advice: You can deduct payments to a broker or an investment manager to manage your stocks and other investments.
Books and magazines regarding investments.
Safe deposit box fees, to the extent that you store your securities or other investment paperwork in the box.
Fees you pay directly to your IRA or Keogh custodian. If the fees are subtracted from your IRA or Keogh account, they’re not deductible.
Traveling costs related to your investments, such as trips to your broker’s or investment advisor’s office and trips to look after investment property. The costs must be reasonable, and you must be prepared to prove the reasons for your travel in case of an inquiry by the IRS.
One-half of the cost of your meals or entertaining costs in connection with your investments (like if you took your investment advisor to lunch to discuss investments).
Premiums you pay on insurance you take out to protect your investments.
Payments to clerical or office workers who help you manage your investment activities.
Rent you pay for an office you use to manage your investments.
Home computer costs if you use the computer to manage your investment activities. You generally must depreciate the computer using the straight-line method.
Cost of software you use to manage your investments. In certain circumstances you may need to depreciate the software.
Fees you pay to a broker, bank, trustee or agent to collect taxable bond interest or dividends. This doesn’t include brokers’ commissions on the purchase or sale of securities.
Investment expenses from a mutual fund that isn’t offered to the public. Funds offered to the public don’t pass investment expenses on to their investors.
Service charges you pay as part of a dividend reinvestment plan.

Where Do I Take These Deductions?

You deduct these expenses as miscellaneous expenses on Schedule A, line 22.

Altogether, these miscellaneous expenses (on Schedule A lines 20 through 22) must add up to more than 2% of your Adjusted Gross Income (AGI) before you can take the deduction. And even then you only get to deduct the amount above the 2% limit. That means you must have spent quite a bit, on various deductible expenses, before you can qualify for the deduction. But you should still keep track of your investment expenses, because they can add up quickly, and they may help reduce your taxable income.

Caution:When your investment portfolio includes both taxable and tax-exempt securities, you can deduct only those expenses that are related to the taxable securities.

Of course, you may not know exactly how much of these expenses relate directly to your taxable securities. If so you’ll need to calculate that amount.

Figure out your total investment expenses.
Determine the amount of income you have from taxable investments, as distinct from income coming from the tax-exempt investments.
Divide the income from taxable investments by the total income from your investment portfolio, to find the percentage of incoming coming from taxable securities.
Multiply the total investment expenses by that percentage (in decimal form) to calculate the portion of those expenses that relate to your taxable securities.

The result is your deduction.

Expenses You Cannot Deduct

Broker’s commissions that you pay for buying and selling securities. These affect your tax cost and the ultimate gain or loss on their eventual sale.
Fees charged by your bank for check writing.
Seminars on investments and investing strategies.
Expenses of attending a stockholders’ meeting, even if you own stock in the company and the meeting would be useful toward making further investments.
Any expenses you incur toward generating investment income that’s exempt from taxes (such as municipal bonds).

For More Info

See Chapter 3, Investment Expenses, in IRS Publication 550: Investment Income and Expenses.

If you decide that it's worthwhile to take the home office deduction, you need to determine exactly what to deduct, and how to calculate the deduction. Follow these steps:

1. Go through your records.

It is very important to keep receipts for all of your home office expenses. Keep them for such things as replacing the carpet in your office space and for office furniture and equipment. You can depreciate (deduct over a period of time) or perhaps claim a Section 179 deduction (write off immediately) these expenses as capital assets. Your records should also include repairs made to your home, and office equipment purchases.

If you operate a day care center in your home, you also need to record the hours you operate, and the number of weeks in the year that you are open for business.

2. Determine your indirect expenses

Indirect expenses include your utility bills, mortgage interest or rent, real estate taxes, repairs, trash removal, and maintenance. To calculate the deduction for indirect expenses, you need to divide your office's square footage by your home's square footage to get a percentage. You apply this percentage to your indirect expenses.

3. Determine your direct expenses

Direct expenses are completely business-related, such as the purchase of a computer, or the installation of bookshelves in your office. Direct expenses are not subject to the business use percentage.

If you have one phone line in your home, the monthly charge for that phone line is not deductible, but long-distance business calls from that line are considered to be a direct expense. If you put a second line in your house that you use regularly and exclusively for the business, you can deduct the expenses for that line as a direct expense.

4. Calculate your home's depreciation

If you own your home, you also need to know your home's purchase price and the cost of all of the improvements you've done, the value of the land, and the fair market value of your home. This information is necessary to determine the basis. You apply your home office percentage to the basis to determine the depreciation.

5. Categorize your expenses

After you've gathered all the bills and receipts for your business expenses, use the list that follows to categorize them, then total each category so you can enter the expenses in the appropriate places on your tax return.

Suggested Expense Categories:

Advertising
Bad debts
Car and truck expenses
Commissions and fees
Depletion
Depreciation
Employee benefit Programs
Insurance (other than health)
Interest (mortgage, equipment, business credit cards, loans)
Legal and professional services
Office expenses
Pension and profit-sharing plans
Rent or lease (vehicles, machinery, equipment, office space)
Repairs and maintenance
Supplies (not used in creating objects which are sold)
Taxes and licenses
Travel, meals and entertainment
Utilities
Wages

If organizing all of this information seems overwhelming to you, consider getting Quicken TurboTax for Home & Business. It contains a lot of information to help you understand and maximize your home office deductions. As with most tax considerations, you may also want to seek the advice of a tax professional before making the decision to have a home office, or to take the home office deduction.

You could save money if you do — but perhaps not as much as you hope.

Here are some pros and cons to ponder, when deciding whether to take the home office deduction.

Some reasons in favor of taking the home office deduction:

Reducing self-employment taxes
Getting a deduction for rent
Deducting part of your home expenses

Some reasons to be cautious:

If your home office is tiny
Paying taxes on the home office share of any gain when you sell your house
The home office deduction cannot trigger a net loss

Reducing Self-Employment Taxes

If you own your home, you can deduct your home mortgage interest and taxes as itemized deductions in most cases. Claiming a home office effectively shifts some deductions from regular itemized deductions into business deductions. When you are self-employed, the deductions reduce your net business profit and your self-employment income, meaning that you’ll pay lower self-employment taxes.

Getting a Deduction for Rent

If you rent your home, you can deduct the portion of your rent that’s attributable to the business use of your home. This deduction means that at least part of your otherwise nondeductible rent is a deductible expense.

Deducting Part of Your Home Expenses

With a home office you can deduct a portion of many expenses that aren’t normally deductible, such as utilities, trash and snow removal, and depreciation. You can also deduct a portion of repair, maintenance, and homeowner’s insurance costs. When you are self-employed, deducting these expenses lowers your profit, income taxes, and the self-employment tax.

If Your Home Office is Tiny

Taking the home office deduction will most likely save you money, but how much? If you use a very small percentage of your home as an office, such as 10%, you need to use that percentage to compute your deduction for utilities, trash removal, mortgage interest, real estate taxes, and rent. The deduction, then, may not amount to as much as you anticipated.

Paying Taxes on the Home Office Share When You Sell Your Home

When you sell your home, the home office may be considered business property, and that portion of your gain on the sale may be taxed, because business property does not qualify for exclusion from income tax, as a personal residence gain. This situation can occur if you use your home for business in the year of the sale, or if you don’t meet the “two-year test” (in which 100% of the residence was used as your main home for an aggregate of 730 days in the last five years). If this applies to you, you must treat the sale of your home as two transactions: one as the sale of business property and the other as the sale of your personal residence. The sale of business property is a taxable transaction that you must report, and unfortunately, any gain that results isn’t eligible for the $250,000 home sale gain exclusion.

If you own your home, any depreciation taken after May 6, 1997 must be “recaptured” at the time you sell your residence for a profit, which means that the depreciation must be taxed at a special 25% rate. The rest of any gain that you have from the sale of the business portion of your home will generally be taxed at 20% (assuming you owned the home for more than a year).

The Home Office Deduction Cannot Trigger a Net Loss

Finally, you can’t claim the home office deduction in the current year if it creates or increases a net loss for your business. The only exception to this rule is when you’re deducting expenses that would otherwise be deductible on Schedule A as itemized deductions, such as mortgage interest and real estate taxes attributed to the business portion of your home.

However, you can carry forward the Home Office Deduction to future years until you have enough income to take the deduction

Effective in 1999, it became much easier to qualify for the home office deduction. Both homeowners and renters can now qualify, but there are still a number of rules you have to follow in order to claim the deduction and save money on your taxes. Our articles discuss the rules for taking the home office deduction first, then discuss whether taking the home office deduction will actually save you money, and, if so, how to calculate it.

If you own and operate a business from your home, these articles are for you. If you are not self-employed but work at home as an employee for a company, the rules are even more stringent: investigate them carefully before taking a home office deduction.

Rules for Taking the Home Office Deduction

You have to pass several tough tests to qualify for the home office deduction. 1. You Must Use Your Home Office Both Regularly and Exclusively. You must use a certain area of your home both regularly and exclusively for business. In most circumstances, the area should be a separate room in your home. However, a common area in your home that is not in a separate room can also qualify—as long as you use it exclusively for business. If you have a desk located in a family room, for example, mixing your business correspondence with your personal mail could cause the deduction to be disallowed. The IRS takes this point very seriously. They once disallowed a home office deduction because they saw a dog’s bowl under the desk in a picture brought in by the taxpayer. If you have an additional business with another location, you can’t perform any work for that business in your home office. For example, if you’re a teacher with a real estate business that you run from your home office, grading papers in your home office would invalidate your use of the home office for the real estate business. This may sound extreme, but it is just one of many true-to-life reasons why the IRS disallows home office deductions in audits. Example: In a Tax Court case in 2001, a psychologist was not permitted to take a deduction for a home office in her small apartment because the size was so small that no part of it could be used exclusively for business. She did not meet with patients there but rather used rented office space for that purpose. The only business activities she performed in her apartment were scheduling private-practice appointments by phone and storing records and reading material. And exclusive use means that your children cannot use your office computer to do research for school, or to play computer games. You can only shade this exclusivity if: You run a daycare center, and let the kids use the computer for games and applications You use part of your home to store inventory or product samples for wholesale or retail sales. Regular use does not necessarily mean that you must use the office daily or even weekly—just that you use it on a continuing basis. Occasional or incidental use does not qualify, even if you use the office exclusively for business. Can you prove regular use? Do you have a log of phone calls made from the office? Do you have invoices on a computer that show you used the office? Keep all records that can prove you use the office on a regular basis. 2. Your Home Office Must be Your Principal Place of Business. To qualify as the principal place of business, your home office must be where you perform the most important part of your work, or you must use the office for administrative or management activities of a trade or business, and you can’t perform a substantial portion of these administrative or management activities at any another location, such as another office off-site. Administrative and management activities include, but are not limited to Billing customers Keeping books and records Setting appointments Calling in orders Ordering supplies Writing reports You may perform some of these activities at another location, but your home office must be the place where you perform “substantial” administrative or management activities. Example: In a 2001 Circuit Court case, a violinist who regularly worked with recording studios and orchestras used her living room as a home office, in which she spent hours every day practicing. The court held that practicing was in fact necessary to her career and noted that she had no other office or practice location. It was also noted that to maintain her skills, the musician spent more time practicing than she did performing and recording. Therefore, a home office deduction was allowed for her practice space as it was considered her principal place of business. For More Info See IRS Publication 587, Business Use of Your Home.

Highbaugh Tax

Send mail to tami@ariesgraphicdesign.com with questions or comments about this web site.
Copyright © 2006 Highbaugh Tax
Last modified: 01/06/08

Highbaugh Tax

Send mail to tami@ariesgraphicdesign.com with questions or comments about this web site. Copyright © 2006 Highbaugh Tax Last modified: 01/06/08

Send mail to tami@ariesgraphicdesign.com with questions or comments about this web site.
Copyright © 2006 Highbaugh Tax
Last modified: 01/06/08