I’ve had a lot of clients who were real estate investors and they all want to write off their travel expenses to visit a property or check a prospective property they may purchase.
Can you deduct travel expenses? For the most part (remember later that I said “most part”) you can deduct your costs of traveling, lodging, meals and incidentals. Let’s take a look at a thoroughly confusing topic and shine a little light into the fog.
I. Two types of investors:
Before I tell you how to deduct your real estate travel expenses, we need to categorize your business activity. You’re either a Real Estate Professional (REP) or you’re not. At least for tax purposes. Being an REP is definitely preferential for tax purposes, but qualifying is not easy. Here’s what you need to do:
- First, you need to spend more than 50% of your total time working in a real property trade or business.
- That total must be more than 750 total hours. No part timers allowed.
- Lastly, you must “materially participate” in each rental activity.
To have “materially participated” is a facts and circumstances kind of thing. Hiring a management company to manage your rental properties would absolutely disqualify you. Being the guy up on the ladder at 10pm painting the interior 2 days before the new tenant moves in would lead me to believe that you are materially participating.
Not many will qualify. The material participation rule is pretty easy. It’s the first qualification that gets most people. I’ve had clients with a dozen rentals who did all the work and more than likely spent 750 hours during the year, but they had a full time non-realty gig (2000 hours) so they failed the first test.
Here’s a couple of examples:
Melanie:
Melanie worked at a stained glass shop full time. Over the course of the year she worked 1,900 hours making stained glass windows. She also owned three rental properties and did all the work on them. She will not qualify unless she can prove that she worked at least 1,900 hours in real estate, materially participating in all aspects of managing her properties.
Steve:
Steve worked part time preparing taxes for H&R Block during the busy season. He works 980 hours. Like Melanie, he also owned three rental properties and did all the work on them. He worked 1,200 hours managing and maintaining his rental properties. Steve would qualify as a Real Estate Professional.
II. Which one do you want?:
I just made a big deal of the requirements to qualify as a Real Estate Professional, so that one is obviously the most preferential. As an REP you aren’t limited in how much loss you can take from your rental activities. As a non REP (regular taxpayer with rental property who doesn’t satisfy the tests above) you will be subject to Passive Activity Loss rules and limited to a maximum of $25,000 in losses annually. Your ability to deduct for real estate travel is tied directly to this classification.
Passive Activity Loss rules don’t make tons of sense in this example because a passive activity by definition means you aren’t materially participating. But most owners of rental property are in charge of getting renters, repairing things and are 100% responsible fore everything.
The biggest negative in my mind regarding the Passive rules is the loss amount available. There’s a maximum $25,000 available, but your income affects the ultimate deduction. The $25,000 available is reduced dollar for dollar once our income hits $125,000, with no deduction available once your income exceeds $150,000.
Maybe the most important benefit is not having to pony up for that lousy 3.8% Net Investment Income tax on investment income over $250k for a Married Filing Joint taxpayer. With real estate in many states selling for over $1,000,000, being classified as a Real Estate Professional has real benefits.
An example:
Nick and Dianne are not Real Estate Professionals. They sold a rental home and netted a $1,000,000 capital gain. They would pay an additional $28,500 in Net Investment Income tax due to the sale.
In this example, Nick is a Real Estate Professional. Nick is an REP and isn’t required to pay this tax.
What about the other guys?
Well, you get the previously mentioned $25,000 passive activity loss you can use.
As mentioned above, you still have a rather large potential deduction at your disposal. In regards to travel, the potential big deduction you will lose is the ability to write off travel to visit prospective purchases. Add the travel costs to basis once you purchase the property. If you don’t buy there is no deduction.
III. Eligibility Criteria for Deducting Travel Expenses:
What’s the relationship of the expense to your real estate activity? If there is a direct relationship, i.e. traveled to make repairs or meet with contractor to go over improvements? Fully deductible.
Where it gets sketchy is when you commingle work with vacation. Take a week and visit your rental in Lake Tahoe? Ski 5 of 7 days and work on the property the other 2? You must allocate the expense between business and personal enjoyment.
IV. Travel Expenses for Property Acquisition and Management:
If you are a Real Estate Professional, you get a travel and meals deduction for travel to visit prospective properties. Even if you don’t buy. Since you are in the “business” of real estate, checking on available properties out of your tax area is likely. It would be the same if you were in manufacturing and had to visit a prospective vendor of a raw material used in making your product. Its necessary to the success of your business.
If not an REP, then no deduction. In the eyes of the IRS, if you can’t qualify as a Real Estate Professional, you aren’t in the real estate “business”. It’s a passive activity, almost like its nothing more than an investment in Microsoft stock. Even though you’re doing all the work, they still categorize it as a Passive Activity and you have to abide by the passive rules.
V. Travel Expenses for Rental Property Visits:
Buy that condo on Maui or in the Bahamas. Deduct your travel expenses to inspect or work on your rental property will be deductible. But be careful with this. You actually have to work on the property to get any kind of deduction. Take a 2 week trip and work 1 week on your property? You can take 50% as a tax deduction.
VI. Track your information better:
If you’re a Real Estate Professional, you need to maintain a set of books. It’s your business. I’m a fan of QuickBooks Online since it’s relatively easy to learn and being online allows you (or anyone else who works on your books) to access from anywhere there’s WiFi.
Not maintaining good records can ultimately cost you.
I had a client many years ago who was ok, but not great at her recordkeeping. She would pay for a lot of expenses with cash and not put it in her books. Every year she would tell be she spent “a couple hundred” with cash for me to add to her return.
One year I bet her the cost of her return that if she just saved all her cash receipts for the year, it would be over $1,000 instead of the “couple hundred” she always told me.
The next year she brought her stuff in with an extra envelope full of cash receipts. She averaged over $500/mo. $6,000 in additional deduction that saved her around $2,400 in tax.
Do your books people.
VII. Make sure your tax person knows these rules:
Get someone who knows who can deduct travel expenses. Since real estate is one of the biggest industries in the US, the tax code is filled with rules specific to the industry. With a cost of entry low enough that almost 7% of taxpayers own residential rental property, it makes sense that this is a spot Congress can look at when forging policy (not to mention the fact that Real Estate is on of the four largest industries in the USA).
With the majority of people who own rental property not classified as a Real Estate Professional, you will need someone who knows the rules, and more importantly, knows how you specifically are classified as a taxpayer and how best to utilize those rules to your benefit.
Conclusion:
You want to deduct travel expenses? As a Real Estate Professional, the IRS sees you as primarily in the real estate industry.
As a Real Estate Professional, you will be able to deduct travel to and from anything related to your real estate world. This includes travel to see perspective properties to purchase. This deduction is not available for passive properties.
A real Estate Professionals primary focus is making money through buying, selling, renting and renovating real estate. Travel may be an integral part of business. Travel is a direct cost so it’s a deductible expense.
If you don’t qualify as a Real Estate Professional you will be limited to a max $25,000 loss in a tax year. Your rental activity is considered a passive activity for tax purposes.
Someone who has a passive activity however is limited to deducting travel for visits to already existing properties. If you have a property on Maui, you could conceivably visit every year to inspect and make any repairs or upgrades, and your trip would mostly be deductible. If you take a one week trip to visit your property and spend 4 days working on the property and 3 enjoying the island, you can deduct 4/7 of your travel.
On the other hand, if you are visit Maui with an intention of buying a property, but ultimately don’t? No deduction. Not even with t