Lost $30K in Investment Venture, Now What?

Dear Tax Talk,

I had to back out of an investment property venture where I was going to purchase a condo for investment and rental. I lost my $19,000 deposit but had to settle with the builder's attorney, who I paid another $6,500 in legal fees. My attorney cost me another $4,500. I want to deduct the $6,500 and $4,500 under the miscellaneous deduction subject to the 2% limit on Schedule A. Can I do that? I believe the $19,000 can go on Schedule D.

Thank you,

-- David

Dear David, My advice on the investment property venture differs slightly from your position. It is clear that if you entered into the preconstruction contract for investment purposes, the loss of the $19,000 deposit is deductible. Since it is not an asset used in a trade or business or subject to the deprecation allowance or inventory, the deposit would be considered a capital asset and the loss should be reported on Schedule D.

Generally, investment expenses are treated as miscellaneous itemized deductions on Schedule A (Form 1040). To be deductible, investment expenses must be ordinary and necessary expenses paid or incurred to 1) produce or collect income or 2) to manage property held for producing income.

The expenses must be directly related to the income or income-producing property, and the income must be taxable to you. Since the attorney fees were necessary to protect your interest in the property, which would have produced taxable rental income, they would be considered ordinary and necessary expenses.

The deduction for most income-producing expenses is subject to a 2% limit that also applies to certain other miscellaneous itemized deductions. However, in some cases, attorney or accounting fees are part of the basis of property.

If you incur attorney fees in connection with defending your right to an investment asset, then the fees paid are added to the basis of the asset and deducted accordingly. Hence, the attorney fees would be added to your deposit and written off when you deduct the loss on Schedule D.

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