In these tough times for real estate sales, many real estate agents are earning little or no income. However, they still have to spend money to be an agent including paying for association fees, desk fees, vehicle/mileage expenses, and office supplies. Can an agent who earns little or no money from real estate still deduct these expenses from his or her income taxes?
As 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 IRS. The fact that an agent earns little or no income in a given year doesn’t mean he or she isn't running a business. Not all real estate agents make money every year, particularly in this economic climate. This is especially true for agents who haven't been in the business for a long time. 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. Also, 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.
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 ten 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 starting 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 “3 of 5” test to qualify as a business.
For more information on this and other tax issues for real estate agents and brokers, refer to The Real Estate Agent's Tax Deduction Guide, by Stephen Fishman (Nolo).