Collection Expenses

In December, Jill, a successful author, sold copies of her new book to five local bookstores for $15,000 with 60 day payment terms. Since Jill prepares her tax return on an accrual basis, she recorded $15,000 of revenue on December 31st. Unfortunately, some of the book stores failed to pay her within 60 days. After 120 days of trying to collect on her own, Jill contacted her lawyer, who is known for being ruthless to people who wrong his clients. After $5,000 of legal fees jill was able to collect $9,000 of the $15,000 owed to her. When she prepares her tax return she can deduct the $5,000 of legal fees as a collection expense on line 17 of her Schedule C and another $6,000 ($15,000 revenue recognized less $9,000 collected) of bad debt expense on line 27a of her Schedule C.

Joshua, a freelance web developer invoiced his client $23,000 upon completing development of a website and mobile application. Unfortunately, the client was unable to pay Joshua since their sole investor chose not to provide any additional funding. Joshua paid a collection agency a flat fee of $1,000 to try and collect his receivable, however, the agency was unsuccessful. Despite not being able to recover amounts owed to him, Joshua will still be able to deduct the full $1,000 he spent attempting to recover his $23,000 outstanding receivable.

Susan is a real estate agent who is known for her ability to close the toughest deals. Last January after receiving a large commission check Susan loaned her friend Kate $30,000 payable on December 31st so Kate could renovate her kitchen. Fifteen months later Susan had spent $2,500 on legal fees but still hadn't collected a dime from her former friend so she informed her accountant she wanted to deduct the legal expenses on her Schedule C. Her accountant explained that while the loan was made for real estate purposes, it was not a business loan and therefore the collection expenses would not be considered a deductible business expense.

Elijah owns a long-term rental property which he rents to a tenant on an annual lease payable in monthly installments. Last year, Eli's tenant lost his job and did not pay any rent for two months prior to his eviction. Eli was determined to collect the outstanding rent so he lawyered up and sued his former tenant. After a month of litigation, Eli was able to recover the two months of unpaid rent and his attorneys fees. At the end of the year, Eli's accountant informed him he would be able to deduct all of his legal fees on his Schedule E, but that he would also have to recognize the two months of rent and reimbursed legal fees as part of his gross rental income.