If you’re a Real Estate Agent, you travel. You travel all the time - so much so that sometimes it seems that you spend more time in your car than you do at home. Tax-wise, the IRS does not consider driving in the vicinity of your primary market travel. Local driving gets deducted as an auto expense and is covered extensively in our Real Estate Agent Tax-Cut Library. Our article What Auto Use is Deductible? A Lot More if You Have a Home Office helps maximize your driving deduction, and our auto articles, starting with the Auto Deduction & The Standard Mileage Rate, are an excellent resource for deducting vehicle use.
Although auto use during IRS-qualified travel gets deducted in the same manner as other driving, what constitutes travel is quite different. This article explains four criteria required for trips to meet the IRS definition of deductible business travel. Other commentaries will expand on these criteria and discuss other aspects of travel, such as meals. We’ll also provide some planning tips that will help deduct significant portions of business vacations.
Travel – An Easy IRS Target: The first thing to understand about travel expenses is that the IRS highly scrutinizes them. Why? A large portion of deducted travel does not meet the IRS definition of business travel. As a result, the travel deduction is easy picking for denied deductions, increased tax due, interest, and penalties.
There are many reasons for the high rate of erroneous travel deductions. Rumor and misinformation are common culprits, especially when creative business minds see an opportunity to mix vacation fun with tax-savings. The complexity of tax rules regarding travel deductions, however, is the source of many of these rumors and misinformation. It’s hard to correct half-truths and wishful thinking when travel basics take up a three-section of our Real Estate Agent Tax-Cut Library. But, learning the facts is a worthwhile investment for owners who want to mix fun, business, and big tax-savings.
Business Travel vs. Local Travel: Deductible business travel is quite different from deducting local business driving (local driving is presented thoroughly in our Tax-Cut Library and discussed in our article series, starting with Auto Deduction Options: Standard Mileage Rate). Although auto use remains deductible during business travel, the rules governing what constitutes business travel differ significantly. A business trip must pass four tests to qualify as a deduction on Schedule C. This other will discuss these tests. Other articles detail different aspects of travel such as meals, substantiation, and tax-cutting planning tips.
The Four Travel Tests: As mentioned above, four requirements must be met for a trip to be deductible as business travel. They are:
- The Travel Must be Overnight and Away from Tax Home,
- The Travel Must Be Related to Your Current Business,
- The Travel Must Be Reasonable for Your Business and Industry,
- The Travel Must Occur for a Business Purpose.
These requirements seem fair, and they are. The first three tests are straight-forward: Travel must be overnight, related to business, and reasonable. The fourth test, however, the requirement that travel is PRIMARILY for business, causes tax-troubles for ill-informed vacationers who want to save some bucks. We’ll discuss avoiding these problems in a bit. But first, let’s flesh out the first three tests.
Test One - Overnight and Away from Tax Home: Business travel must require substantially more time than an ordinary workday. The travel destination must be far enough away from one’s tax-home to require sleep or rest before returning. Contrary to the test’s title, the trip does not need to last overnight to qualify. It must, however, be far enough away that rest or sleep is required before a safe return is possible.
The concept of a Tax-Home is essential to understanding the travel deduction. Your tax-home is not the same as the home where you live. It is the general area in which you do business. This definition does not create a challenge for agents residing in the geographic area where they sell real estate.
But, what about agents who generally sell in a city an hour or more away from their residence? For example, Alice lives in Marana, Arizona, but makes 85% of her sales in Phoenix 90 miles north. Marana is not her tax-home. Her tax-home is the general Phoenix area, where she conducts the majority of her business. Staying overnight in Phoenix to attend a conference is not deductible travel, even if she has to stay overnight. For Alice to receive a travel deduction, her destination must be far enough away from Pheonix (not Marana) to require substantial rest or sleep before returning.
Test Two – Related to Current Business: This test’s a no-brainer – of course, you can’t deduct travel for one business as an expense for another. The primary challenge posed by this test not deducting travel on the wrong return. It’s deducting travel costs when the owner is not formally in business.
An agent’s business does not start until they are actively seeking properties for buyers and buyers for sellers – they must be appropriately licensed and serving the public before they are in business. Therefore, travel related to training or taking the real estate exam to become a licensed agent is not deductible. Once licensed and active in their first state; however, travel related to becoming licensed in another jurisdiction is deductible if it meets the other three tests. To learn more about the tax rules associated with becoming a licensed agent, please read our article Real Estate Agents, Are License Training and Exam Fees Deductible.
Travel before an agent is actively conducting business is also not deductible as travel. For example, Greg successfully passes his real estate exam but decides not to work under his sponsoring broker. Before undertaking any business, Greg travels to several different cities to interview with other brokers. The cost of these trips is not deductible as a travel expense. It may, however, be deductible as a Startup Expense (also discussed in the article mentioned above).
If, on the other hand, Greg is actively in business with one broker, travel to interview with brokers outside of his tax home is deductible.
Test Three – Reasonable for Your Business or Industry: Test three is subjective and, therefore, easily misapplied. Determining what travel is reasonable depends on facts and circumstances related to your business and target market. Reasonable expenses have two primary components, Ordinary and Necessary. Ordinary means the trip is typical for a similar business. Necessary means the travel is helpful and appropriate for your trade and industry. Neither definition draws a clear line that allows an owner to differentiate reasonable travel from unreasonable travel expenses.
The Reasonable Test also states that extravagant or lavish travel is not reasonable and, therefore, not deductible. Unfortunately, the IRS offers little guidance as to what constitutes extravagant or lavish travel. It does, however, assert that first-class plane tickets and upscale hotels are not automatically unreasonable.
As confusing as this requirement may seem, passing it is pretty simple – apply some common sense, i.e., the smirk test. The smirk test works like this: Jim deducts travel to a five-star, $500 per night, resort to attend an annual state-wide real estate convention held at the resort. That makes sense, right? It happens once per year in the state and provides a valuable learning and networking experience. Sure, it’s expensive, but your probably not fighting laugher.
Now, consider Gail? She rents the same $500 per night room for three nights. Why? To attend a one-day continuing education class held twenty minutes away at a Holiday Inn Express. I am smirking as I type this scenario. An IRS auditor will probably do the same thing as Gail explains the reasonableness of her $1,500 hotel deduction.
Test Four – Undertaken Primarily for Business: Test four is the one that lands most business owners in trouble. The trouble is most often triggered when an owner attempts to throw some business activity into a vacation rather than structuring the vacation around a legitimate business trip.
A trip is taken primarily for business when the main reason it occurs is conducting business. The chief travel motivator cannot be sightseeing, politics, recreation, or visiting friends and family. Proving business purpose is relatively easy when the owner travels alone, attends a business-related event, and returns immediately there-after. The challenge arrives when any of the following factors are present:
- The claimed business purpose of the trip is vague,
- When family or friends tag along,
- When time spent on activities are disproportionately non-business related, and
- When the timeline extends beyond the duration of business activity.
The Bottom Line: Travel must meet the primary purpose requirement and the other three tests to constitute a deduction. Structuring a trip that mixes business and pleasure and qualifies for a deduction requires knowledge and planning. Helping agents deduct such trips comprises a large portion of our Real Estate Agent Tax-Cut Library.
Take Away: Travel must pass four tests to be deductible as a business expense: 1) Be far enough away from a tax-home to require sleep or meaningful rest, 2) Related to the current business, 3) Its itinerary and cost must be reasonable. And, finally, 4) The primary purpose of the travel must be the conduct of business.
The primary-purpose test is the one most commonly failed because of owners mixing business and personal travel. The good news, however, is that some planning and recordkeeping can go a long way to construct deduction-maximizing, working vacations.
Summary and Invite: We hope this article has helped you understand the four requirements of deductible business travel better. If you’d like to learn more about cutting your highest cost: TAXES, check out our Real Estate Agent Tax-Cut Library. The Real Estate Agent Tax-Cut Library includes over eight hours of video broken into twenty-nine searchable volumes and covers every possible deduction a Real Estate Agent can take on their tax return. Our Broker Version will help your entire agency cut their taxes! We also invite you to browse our courses.