In general terms, expenses incurred for the purpose of earning income from a business or a rental property are deductible in the year they are incurred if they are unconditional. Basically, this means that during the year, or as of the end of the year, you are legally obligated to pay the expense, even though it is not due and not paid until a future year. The key point is there must be no condition that requires to be fulfilled before your legal obligation to pay is absolute.
Examples
- Jack hires a contractor to repair his building used in his business. The repairs are completed in year 1 and the contractor bills Jack at the end of year 1. The repairs are satisfactory to Jack and he is allowed to pay the bill within the first 6 months in year 2.
Since there appears to be no condition to Jack’s legal obligation to pay, he should be able to deduct the repair expense in year 1 even if he pays it in year 2.
- Assume instead that the repairs require certification by an architect or engineer. Part of Jack’s expense (say, 10%) is not payable until the certification, which occurs in year 2. In this case, the 10% portion of the expense is conditional upon the certification, so that portion is deductible in year 2. The remaining portion should be deductible in year 1.
This letter summarizes recent tax developments and tax planning opportunities from a third-party affiliate; however, we recommend that you consult with an expert before embarking on any of the suggestions contained in this blog post, which are appropriate to your own specific requirements. Please feel free to get in touch with Lee & Sharpe to discuss anything detailed above, we would be pleased to help.
