Wednesday, August 4, 2010

Q&A: Business Expenses and Tax Deductions

Question: A friend of mine recently told me that he deducts most of his meals with his family because he is self-employed and his wife helps him out with his business. Thus, any of these meals are deductible because they discuss some business while eating. Is this true?

Joe B, Phoenix, AZ

Answer: No, this is definitely not true and is certainly not recommended. In order to deduct your business meals, you must make sure that your business discussion is both “substantial” and “bona fide.” Your friend would fail both of these tests. First, while there are no rules telling you how much time during the meal you must discuss business matters (i.e. it does not need to be a majority of the time), you must be sure that the business discussion is the primary purpose of having the meal. This does not mean that you cannot have a relationship with the person being entertained, but you had better have a valid business relationship with the person before you try to claim any tax deductions. In addition, the IRS would most certainly argue successfully that the primary purpose of your meal was not business related. When you entertain family members, you may be able to show a legitimate business purpose, although this will certainly be more difficult than someone who was not related to you. You should be sure to remember these rules, as it is up to you to prove that you are entitled to deduct the entertainment expenses as legitimate business expenses.

Tuesday, August 3, 2010

Q&A: Rental Property and Tax

Question: I have a rental property that I have been renting out since 2006. I plan on moving into the home next year and want to sell it in a few years. What are my tax consequences of this plan?

Nancy S, Nashville, TN

Answer: There are no tax prohibitions to moving into a rental property and subsequently obtaining the tax benefits of the capital gain exclusion under Section 121 of the Internal Revenue Code. When you sell the rental property, you will need to pay taxes on the amount of depreciation that was claimed while it was a rental property. The tax rate of this “depreciation recapture” is 25%. In addition, any gain that you have on then property (after depreciation) for any period of time after 2008 that it was a rental property is not excludable. For instance, if you rented out the property in 2009 and 2010 and the property increased in value by $20,000 during these 2 years, the $20,000 would be taxable as a gain and not excludable. The good news here, especially if you convert from a rental to a personal residence in 2010, is that it is likely that the property did not go much (if at all) in these 2 years due to the current real estate conditions. As long as you live in the home at least two years as your personal residence after converting it from a rental property, you will be eligible for a capital gains exclusion of $250,000 (single) or $500,000 (married filing a joint tax return).

Monday, August 2, 2010

Q&A: Assistance Dogs and Tax Deductions

Question: I have a dog that I use for medical reasons. Are the costs of this dog tax deductible?

Sarah Y, Vancouver, WA

Answer: Yes. The IRS has ruled that any service dogs used for medical purposes are tax deductible. These animals have been used for a long time to assist blind and deaf citizens.

Now, the IRS has extended this to include those with mental disabilities, including depression and post-traumatic stress disorder. In order to back up this tax deduction, make sure that you have something in writing from your medical professional so that you can prove that the dog is a medical necessity rather than a strictly personal expense. Please also remember that any medical expenses are limited to amounts over and above 7.5% of your income and you must itemize tax deductions in order to claim this deduction at all. It could also be reimbursed under a medical reimbursement plan with a business.