Investment Management Expense Tax Deductions

The IRS makes a distinction between what may be deducted by an active business and what may be deducted by an investor, and clearly favors the former. Nevertheless, you may still be pleasantly surprised by the items that may be legitimately deducted in connection with investments.

 

What kind of investment management expenses are deductible on a tax return?

For example, can you deduct subscriptions to the wall street journal and other magazines? Generally, there are there ways to take these expenses are above the line deductions. This is better than have expenses are deductible only as itemized deductions and thus are subject to the 2% floor on miscellaneous itemized deductions. The following are deductible investment expenses:

  • travel to broker’s offices and investment sites;
  • bank fees and safe deposit rental;
  • fees for IRAs;
  • mortgage pool service fees;
  • custodian fees for investments; and
  • subscriptions to investment related publications.

 

How to deduct your investment-related expenses as business expenses

In order to deduct your investment-related expenses as business expenses, you must be engaged in a trade or business. Most of the time, an individual investor is not engaged in a trade or business because he manages his own securities investments. It does not matter about the amount of the investments or the extent of the work required. Someone could devote 40 hours a week to managing their investments and it might not qualify for the investment management expense tax deduction.

 

Investment Management Expense Tax Deductions

However, if a taxpayer can show that his investment activities rise to the level of carrying on a trade or business he might be able to get the deduction because he may be considered a trader. A trader is considered to be  engaged in a trade or business, rather than an investor, who is not conducting any business and just managing their investments.. A trader is entitled to deduct his investment-related expenses as business expenses and this will occur above the line.

In addition to deducting some of these investment management expenses, a trader is also entitled to deduct home office expenses if the home office is used exclusively on a regular basis as his principal place of business. An investor, as described above, is entitled to home office deductions since his investment activities are not a trade or business.

 

Active Trader Test for Deductions

The IRS gives much scrutiny to this area and it is an area of intense audit focus. There is a two-part test that must be satisfied in order for a taxpayer to be considered a trader. A taxpayer’s investment activities are considered a trade or business when both of the following are true:

  1. The taxpayer’s trading is substantial (sporadic trading won’t be a trade or business), and
  2. The taxpayer seeks to catch the swings in the daily market movements, and to profit from these short-term changes, rather than to profit from long-term holding of investments.

Thus, the fact that a taxpayer’s investment activities are regular, extensive, and continuous is clearly not enough for determining that a taxpayer is a trader. Individuals who manage their securities portfolio at home will not be entitled to deduct the home office expense unless they are active “traders”. This requires that they are interested primarily in the short-term profits derived from active trading of securities, rather than the long term gains realized from holding for dividends or long-term capital appreciation. Investors are denied home office deductions because their investment activities are not a trade or business. No deduction is allowed, for example, if a taxpayer, who is not in the trade or business of making investments, uses a portion of his residence (even though exclusively and on a regular basis) to read financial periodicals and reports, clip bond coupons and perform similar activities. That activity is not a trade or business.

 

What does the IRS Consider an Active Trader?

In order to be considered a trader, a taxpayer must show that he buys and sell securities with reasonable frequency in an effort to profit on a short-term basis. For example, a day-trader would probably be able to deduct investment management expenses.