GRAY area alert: deducting real estate education

[Michael Plaks]

This question is very common and sounds very straightforward: as an investor, can I deduct my real estate education?

Warning: you will not get clear answers from this post. Instead, you will likely get confused. Welcome to the Taxation Gray Area club! Now allow me to show you why this is such a controversial issue.

1. Two types of deductions: "before" and "after."

The tax code has two very different treatments for business expenses. Let's say that you paid $20k to some marketing firm to create and distribute your promotional videos. If it happens after your business has already started, then the entire $20k is deductible as "ordinary and necessary" business expense under Section 162 of the tax code. (Yes, these section numbers are important.) 

However, if it happened before your business started, then it is called start-up expenses under Section 195 of the tax code. And the result is very different: $5k is deductible right away, and the remaining $15k is slowly deductible ("amortized"): $1k per year over the next 15 years. Not nearly as helpful as $20k right away.

2. When did the business start?

Maddeningly, this question remains very controversial and somewhat subjective. We have a lot of court cases to analyze, and unfortunately they are clear as mud. One court case says that you don't have a business until you buy your first property. Another court case says that you might operate a business even when you have no sales and no gross receipts. Huh? Exactly.

Accountants more or less have a consensus that for landlords, your business starts when your first property is ready and available for rent. For wholesalers, your business starts when you start making offers. As you can see, even these two formulas leave room for interpretation.

3. Can we deduct education in full after the business started?

Usually yes, but there is a "but." To be deductible, education needs to be specifically connected to the business you operate. If you have just one long-term tenant in your house hack duplex, and you're taking a $30,000 guru course on making money from assisted living or storage facilities or on running a syndication - it is probably not deductible under Section 162. 

In fact, even if the training course is related to property management, claiming that you needed to spend $30k on education while collecting merely $15k in rent per year is a flimsy position. 

4. So, if I have not done any deals, the education is a start-up expense, right?

Not so fast. Section 162 prohibits deducting of educational expenses if they qualify you for a new trade or business. Basically, they do not want lawyers to deduct the cost of law school and doctors to deduct their medical school - which sort of makes sense. 

Similarly, my colleagues often argue that real estate education is not deductible when you have not started investing. In their support, they point to the 2009 Woody Tax Court case which concluded that Mr. Woody's $21k real estate education would not be deductible. However, I don't necessarily agree with citing this case. The Court did say that this expense was not deductible, but it specified that it was not deductible under Section 162. The Court did NOT explicitly indicate whether or not it would qualify as Section 195 start-up costs. And the hints that the Court inserted in their decision could be interpreted both ways.

I'm not aware of another court case where this question was addressed conclusively. If you know of such a case, please chime in. Without such a precedent, I believe that eligibility of real estate education for Section 195 start-up costs remains controversial, aka gray area.

5. Is it education or something else?

More gray area! When you sign up for BPCON - is it education or networking? When part of your training cost is software that you will be using for your deals - is it education or an asset that will be placed in service once you start using it? When you hire a business coach - is it education or consulting?

So what do we do?

Remember I promised you no clear answers? I kept my promise. And if I did a half-decent job with this post, I hopefully convinced you that finding an answer for your specific situation is not a DIY project. Ask an experienced real estate accountant. And don't be shocked if you ask two of us, and we give you two different answers. This is the very definition of gray area.

PS. And here're some earlier relevant Bigger Pockets discussions if you want to get even more confused:
https://www.biggerpockets.com/forums/51/topics/484779-deduct...
https://www.biggerpockets.com/forums/519/topics/1105587-how-...
https://www.biggerpockets.com/forums/51/topics/1164415-ne-re...

[Jason Watson]

Yeah, the whole real estate investor seminar stuff is always funny to me. I doubt any of my to investor clients took a class. They were a) smart and b) knew money and c) poked around on the world wide webs a bit. I'm sure I've offended someone...

Nonetheless, there is a piece that might be missing from the post. Education does not need to be connected to your work per se, but rather improve your current work skills (or be required as part of your job with CEs for attorneys, accountants, etc.).

Here is the verbiage direct from the IRS. Before I click the ol' paste button, there are as many tax court cases allowing and disallowing MBA deductions for business owners. Even with identical facts. All depends on the court you get, and if they are having a bad day or not.

I do like the Section 195 and Section 162 intersection that you illustrate. Ok, here we go-

You can deduct the costs of qualifying work-related education as

business expenses. This is education that meets at least one of the
following two tests:

• The education is required by your employer or the law to keep your
  present salary, status or job. The required education must serve a bona
  fide business purpose of your employer.
• The education maintains or improves skills needed in your present work.

However, even if the education meets one or both of the above tests, it is not qualifying work-related education if it:

• Is needed to meet the minimum educational requirements of your present trade or business or
• Is part of a program of study that will qualify you for a new trade or business.

You can deduct the costs of qualifying work-related education as a
business expense even if the education could lead to a degree.