Which financial fees are tax deductible?
Ines Zemelman, EAAug-25-2016
Legal and financial fees are expenses we don’t choose to pay. Those payments are necessary expenses; therefore it seems logical to deduct them on your tax return. However, only certain types of financial and legal fees are deductible.
1. Legal fees related to producing or collecting taxable income or getting tax advice
This includes tax preparation fees, foreign financial accounts reporting (FBAR), consulting fees, lawyer fees if suing your employer for wrongful termination. These expenses are so called “miscellaneous itemized expenses”.
2. Buying / selling a house
When you buy real property, broker fees, commissions, and legal expenses are added to the purchase price for future calculation of cost basis. You cannot deduct them at the time when you purchase the house.
When the house is sold, you can add sale-related legal and professional fees to the previous cost basis that included purchases-related fees. All legal and professional fees related to house purchase/sale are itemized on HUD-1 settlement statement.
If the house was not used for rental activity, then deductions are factored into the calculation of capital gain or loss on the Home Sale worksheet. Those expenses cannot be claimed elsewhere as a separate deduction item. Resulting capital gain is taxable, subject to the Main Home capital gain exclusion of $250K per person. Resulting capital loss is non-deductible.
If house was rented or used in business, then ir will be reported as sale of business property. Resulting gain or loss flows to your personal tax return.
3. Renting apartment
If you rent an apartment and pay broker or legal fees to prove your financial standing - none of those expenses can be deducted.
If you have a dispute with your landlord and pay legal fees to represent you in housing court and protect from eviction - those fees are non-deductible as well (for you).
The landlord can deduct legal expenses incurred on his side because for him this apartment is an income-producing property. Whether you are right and your landlord is wrong - it does not change the tax aspect of expense deduction.
4. Bank fees (general account / overdraft)
- Personal bank account - bank fees are non-deductible.
- Business account - bank fees are deductible on the schedule of business expenses (Schedule C).
Special case - personal account dedicated for handling rental activity. Bank fees imposed to that account will be deducted as a part of rental expenses. For that reason, it is a good practice to have a separate bank account for all rental activities to keep track of the deductible expenses - for yourself and for the IRS.
5. Pension / insurance fees
Management fees paid from an IRA account may not be listed as separate expenses in an attempt to get an additional tax deduction.
Only expenses paid from a taxable account can be listed as a miscellaneous expense.
If expenses are incurred by a non-qualified foreign pension plan and you are obligated to report account income on your annual U.S.taxable return, you can deduct expenses from the amount of income produced by the fund and include the net amount after deduction to the personal taxable income.
6. Deductible investment expenses
Investment interest expense is the interest on money you borrow to purchase taxable investments. For example, you can deduct the interest on a margin loan you use to purchase stock, but not if you use the margin loan to buy a car or tax-exempt municipal bonds.
Other deductible investment expenses are
- Fees for investment counsel and advice, including subscriptions to financial publications
- Software or online services used to manage your investments
- Safe deposit box rent, if used the box to store certificates or investment-related documents
- Transportation to your broker’s or investment adviser’s office
- Attorney, accounting or clerical costs necessary to produce or collect taxable income
- Charges for automatic investment services and dividend reinvestment plans
7. Non-deductible investment expenses
- Trading commissions—these are "capitalized" to increase your cost basis and/or reduce your taxable sales proceeds
- Costs of traveling to attend a shareholder’s meeting
- Investment advisory fees related to tax-exempt income—you generally need to prorate these fees based on the portion of tax-exempt investment income versus total taxable investment income
- Borrowing costs associated with life insurance
8. Credit card (annual fees / interest)
Credit card interest, annual fees and late payment penalties are non-deductible for personal credit cards.
Credit card interest, transaction fees and annual fees are deductible for business credit cards. Penalties are non-deductible for business cards too.
9. Loans and credit lines
Interest on personal loans taken from a bank or from a private person are non-deductible.
Interest on personal car loans is non-deductible.
However, home equity loan secured by your main home or a second home qualifies for the interest deduction. You can deduct it in addition to the mortgage interest deduction on Schedule A of your personal tax return.
Interest paid on business loans is deductible on Schedule C as a business expense.
10. Miscellaneous fees
Miscellaneous fees may be tax deductible if they are directly or indirectly related to the income production. If you are unemployed and sign up for a paid job search portal, registration fee for that service can be deducted as job search expense and itemized on Schedule A.
Mandatory fees to take courses in education institution leading to degree are counted as qualified education expenses and can be deducted as part of education expenses deduction.
Fees paid for registration of your child in a nursery may be added to child care expenses if you otherwise qualify for the child care credit.
Same type of fees may be allowed or not allowed for deduction depending on the circumstances. The IRS does not allow deduction of HOA fees, because they are considered an assessment by a private entity. However, If the home is a rental property, HOA fees are deductible.
There is a simple rule of thumb that determines qualification for the tax deduction - whether the fee/expense is related to income production or not. It is illustrated by two types of legal fees described above: attorney fees to protect yourself from wrongful employment termination are deductible while attorney fees to protect yourself from eviction are not deductible.
The IRS made one exception where legal fees unrelated to income production qualify for deduction. Court cost and attorney fees related to and for the principal purpose of the legal adoption of an eligible child are tax deductible.