Saturday, February 08, 2003

Reader Question #2: Deductions for interest on real estate loans.

Arthur writes: The scenario: I buy an investment property, specifically an apartment building, for mostly cash with some partners. I refinance the property later. Is there a different in interest deductibility among the different loan options available to me - refinanced, home equity, line of credit, etc.?

Arthur, Schedule E makes no distinction between the types of loans you can get on your property. A refinancing is the same as an original mortgage, and so is a home equity (second mortgage), lump sum or line of credit. Your financial institution sends you a 1098 form showing you the interest paid, and you should add these together on Line 12 of Schedule E. If you have private financing (e.g. a land contract, or another financing arrangement that involves the property as collateral), report that separately on Line 13. Indeed, you aren't limited to secured debt. Interest on credit purchases, including credit card interest, is deductible on both Schedule E and C, even though this was eliminated for personal deduction years and years ago. (Probably wisely, because the last thing the government should be doing is encouraging personal debt. Business debt, though, is considered investment and should be encouraged.) If you can't pay off a contractor, but you keep up with payments including interest, that is all deductible.

Back to your question, though: certain types of interest aren't deductible. Interest on taxes due, for example, or interest paid with funds from the original borrower, and interest that is required to be capitalized (e.g. for products you produce, which doesn't apply to real estate you own rather than build).In general, then, there is no tax advantage or penalty for choosing a particular loan option, in terms of this deduction. There may well be tax effects in terms of depreciation or asset allocation, so keep those in mind.

Friday, February 07, 2003

Kudos, incoming! I've been nominated as blog of the day at ShredNow.
Reader Question #1: Deducting conference and research expenses.

Seth writes: I've been a freelance writer who's dutifully reported that income on Schedule C. But 2002 was the first year I've had substantial expenses, making taxes a bit more tricky. (Not that I'm complaining!) I've kept solid records and a boxful of sorted receipts, and generally everything is pretty clear. But two types of expenses I'm uncertain where to deduct on Schedule C. 1) Not travel to and from, but the expense of entering a business-related convention or seminar; and 2) The cost of research materials. Are these "Other Expenses" that I declare in Part V of Schedule C, and if so, how would I label them? Or perhaps there's another form I'm overlooking?

Seth: You're on the right track. Conference and seminar expenses, if clearly related to your business activity, are deductible on Schedule C. It's probably best to list the fees under Line 48. The travel, meals, and entertainment expenses are all subject to the 50% limitation, however, and must be listed separately on Line 24. Caution, though: if you're attending a conference for professional development, there is a possibility the IRS would consider that an Employee Business Expense that you should deduct on Schedule A, where it would be subject to the 2% (of your total income) limitation. With a freelance writer, the distinction here would be unclear. If you could demonstrate that the conference led directly to a writing gig, that would be best.

Research materials are subject to the same balancing act. Those related specifically to articles you write, companies you work for, or other business you develop, can justifiably be listed on Schedule C, where they offset income dollar for dollar. Those with a less certain relationship to the business would be Schedule A material -- even if you're likely to be able to get away with it. In the end, though, consider that unless it's a very substantial amount, it won't affect your taxes much either way. Schedule C is deliberately vague about defining many business expenses; the default is to consider them deductible. For more information on filling out the forms properly (but not so much information on your question), see Publication 535, Business Expenses {PDF}.

Thursday, February 06, 2003

Letters, we get letters: I am now getting reader questions by the bucketload! Well, if four questions would fill a bucket. (I'll print them out using 96-point type.) I will answer all reader mail questions in the blog, without revealing the questioner's name. Since some questions may require research, I will normally answer no more than one question daily.

Wednesday, February 05, 2003

Are you one of the few who've filed? Get your refund status, directly from the IRS. This is one of the handier best-kept-secrets in the field.

Tuesday, February 04, 2003

New recurring series: Nobody's sent me any questions by mail yet. Shoot away! Really! But until that happens, I realized I have a steady supply of interesting questions to answer -- based on my Google search engine referrers.

Our first question is reporting paypal income. Indeed, this fits in neatly with my future series on weblogs & taxes -- perhaps I'll get there next week or so. But for now it's an interesting question by itself. Paypal, of course, is not a source of income -- only a conduit, like a bank. If somebody sent you money by check, technically you are obligated to report it, but technically many people don't bother. For most taxpayers, income of this sort isn't really worth reporting (or worth enforcing, for the IRS). But at a certain point, it will become significant, and that's where banks and Paypal (which is really a bank, behind the web interface) can cause problems, because they have accurate records. If for any reason the IRS suspects you may be "living beyond your apparent means", they could launch an audit, and IRS does have the legal authority to subpoena records from financial institutions. If you haven't been reporting money received this way, for whatever purpose, you could be socked with severe penalties for leaving it off your taxes.

My rule of thumb would be this: if it's more $1000 for the year, be honest and put it down.

Now the question is how to report it. The easiest way to handle this income is as a business, using Schedule C -- or for many purposes, Schedule C-EZ. The beauty of this is that as a business, you can deduct ordinary and necessary expenses -- in other words, the stuff you spent to make the money you got. You're only taxed, that is, on profit. (This isn't the same thing as an accounting profit, though. It's possible to make an accounting profit while reporting no taxable income.) Were you an eBay seller? Deduct the shipping costs. Deduct the long-distance phone call to the buyer. Deduct the auction fees. As long as you can justify these with receipts or printed records, you'll be fine. Deducting things like your internet access, though, might seem like a brilliant move at first blush -- but are probably things that will get you flagged for review. Your eBay usage was probably only a tiny percentage of your online costs for the year. If you think you can justify 1% of $240, well ...

Will the IRS accept your deductions? The key question, for them, is whether you conduct your business as a business, that is, with a view toward making more money than it costs. Did you keep records? Did you have a DBA (doing business as) designation, or a business license? If you just screwed around and happened to make money, you might be engaging in a hobby -- and the IRS is suspicious of hobbies that are used to offset income, especially if you get a Schedule C with a loss. In the end, if you make serious money this way, you probably should consider getting serious about handling it.

Next: Well, probably not. But I did get "asked" how to deduct suv costs via MSN search. That's going to be the legacy of this stink made about the "SUV deduction" -- many more people trying to get it, now that they know it can be done. Call me a cynic ...

Woohoo! A banner day for my textads. My Pyrad on the front page of Blogger is sending about one person here every 90 seconds. What's funny is that due to deficiencies in the Pyrads interface (paging Evan), I thought it had already dumped my 12,500 impressions off a week ago Sunday. I thought it was strange I received not a single click, but wrote it off to an audience mismatch. I guess that was wrong, though, because the ads are clearly running now and working.

Update: scratch that. Still no evidence of my Pyrads; but I am a Blog of Note, which is why I'm getting referrers from the front page. Hmm.

Compared with my Metafilter Textad, which still has several days to run and is sending an even stream of daily surfers in the single digits, I guess this works. Ideally there's synergy between the two. I still haven't gotten many direct blog referrals.

And I have to be happy that I made the Daypop Top 40, even if it only seems to be through automated citations. Every bit of exposure helps! Now if someone could tell me when the affiliate income starts to kick in, I'll be a really happy man. I'm actually having a bit of a Suze Orman month, where just trying to pull together some scrape-by money, I'm having more money tossed my way. That's good, but it isn't a living yet. Click my ads, O readers! Blogroll me!

CNBC's columnist Schnepper sings the virtues of the earned income credit -- and its drawbacks. It's a hidden treasure for low-income taxpayers, but many don't know how to file the forms to get it. If your income is low, and you're working -- that is, earning income, rather than drawing some kind of investment or benefit income -- and especially if you have dependents, it's very likely you could not only completely zero out your taxes, but get free money back from the IRS. Such a deal! Schnepper suggests Congress was addle-brained in creating it with such complexity, but I suspect they're just as happy having put it out there -- and hoping as few taxpayers as possible actually take advantage of it. (It's the sort of tax cut that means never having to say you're sorry about the deficit.)

The big problem, of course, is errors in the filing: you have to get the dependent status just right, and kids eligible for the credit aren't necessarily the same as the dependents you can claim. Having a pro do your taxes can make this work, but of course that costs you part of your credit. On the gripping hand, that's free money you're paying him out of, so it's your call. (I actually do several of these a day.)

Then there's the advance earned income credit -- money that comes right into your pocket via your paycheck. As I've noted before, not all taxpayers who qualify will want their employer to know.

But the tail end is that getting your EIC application wrong can mean disqualification from the program, in addition to severe penalties. Schnepper may be wrong about the demographics, though; it seems there are plenty of people on the street who understand the benefits of being able to claim dependents, and shoot for getting a fraudulent credit, even if they've been turned down before.

Sunday, February 02, 2003

Hidden Paycheck is an interesting idea. Most employers have benefits available to employees that they don't know about. This company will help them produce a "paycheck" that shows the value of those benefits to the employee. One can see how this would increase employee satisfaction, but it might also increase employee usage of those benefits, which are often of the passive variety, ultimately leading to higher benefits costs to the employer. This might not, then, be a service they would be interested in following up on; why advertise something that will cost you money? Still, it's interesting.