Are Legal Expenses Tax Deductible for Real Estate Investors?

When it comes to legal expenses, what can and cannot be claimed as a tax deduction can be confusing. In fact, the answer really depends on the nature of the legal expense itself. Whether you’ve formed a series Limited Liability Company (LLC) or are using your self-directed 401(k) to make real estate investments, Royal Legal Solutions is here to help.

The Rules

The Internal Revenue Code (IRC) is the governing set of laws created to define what can and cannot be taxed. It is written by our US Congress and approved by the President. The IRC dictates that, with few exceptions, that you cannot deduct personal, living or family expenses on your income tax returns. (Itemized deductions are one of the exceptions.) The IRC does, however, allow the individual to deduct certain ordinary and necessary expenses that are paid throughout the tax year. These include:

• Expenses related to the production of taxable income;
• Expenses related to the management, conservation, or maintenance of a property that is owned for the purpose of generating an income; or
• Expenses that are incurred in association with the purpose, gathering or refund of any tax.

Legal Interpretations of These Rules

How the Internal Revenue Service (IRS) views the laws established in the IRC can often seem convoluted. However, case laws have helped to demonstrate the legal interpretation of these rules. While there are other ways in which these rules can be applied, below are a few that are best related to the real estate investor’s interest.

• Conduct of a Business – Legal fees that are paid by a taxpayer throughout the development of a trade or business transaction are typically deductible. However, they must be ordinary and necessary expenses as related to the business.
• Relating to Insurance Proceeds – Legal fees that are incurred in relation to an insurance claim related to a taxpayer’s business are deductible. However, personal legal fees related to a claim are typically not. Nevertheless, if the legal fees are related to a capital asset, such as a personal home, can be included under the home’s tax basis. This will result in an offset of taxable gains later.
• Producing a Taxable Income – Legal fees, such as those related to attorney and court costs, are deductible if they are generated during the production, or collection, of a taxable income. You must demonstrate that these are reasonably connected in order to claim them as a deduction.
• Bankruptcy – If your business has claimed bankruptcy, the related legal fees are deductible. Furthermore, if a personal bankruptcy occurs as a result of a business failure, associate legal fees will be partially deductible.
• Income-Generating Property – If you incur legal fees related to the management, conservation or maintenance of an income-generating property, these expenses are often deductible.
• Title of Property – When it comes to the legal expenses related to acquiring, perfecting, defending or clearing a property title, you cannot claim these as deductions. These capital expenditures, however, can be recovered through other means, such as depreciation, depletion or cost recovery.
• Damage Suits – If a damaging lawsuit is filed against your business, you can deduct the legal fees associated with defending yourself.

Expert Services

The professionals at Royal Legal Solutions understand how complicated tax laws can be. As part of our expert services, we can help to prepare any tax filings related to your business or investments. If you would like to learn more about how Royal Legal Solutions can help, take our Tax Discovery Quiz.