Our first tip of our last minute year end tax deductions series:  Prepay Expenses Using the IRS Safe Harbor

You just have to thank the IRS for its tax-deduction safe harbors. IRS regulations contain a safe-harbor rule that allows cash-basis taxpayers to prepay and deduct qualifying expenses up to 12 months in advance without challenge, adjustment, or change by the IRS.

Under this safe harbor, your 2020 prepayments cannot go into 2022. This makes sense, because you can prepay only 12 months of qualifying expenses under the safe-harbor rule.

For a cash-basis taxpayer, qualifying expenses include lease payments on business vehicles, rent payments on offices and machinery, and business and malpractice insurance premiums.

Example. You pay $3,000 a month in rent and would like a $36,000 deduction this year. So on Thursday, December 31, 2020, you mail a rent check for $36,000 to cover all of your 2021 rent. Your landlord does not receive the payment in the mail until Tuesday, January 5, 2021. Here are the results:

  • You deduct $36,000 in 2020 (the year you paid the money).
  • The landlord reports taxable income of $36,000 in 2021 (the year he received the money).

You get what you want—the deduction this year. The landlord gets what he wants—next year’s entire rent in advance, eliminating any collection problems while keeping the rent taxable in the year he expects it to be taxable.

One word of advice: Don’t surprise your landlord, if he had received the $36,000 of rent paid in advance in 2020, he would have had to pay taxes on the rent money in tax year 2020.

Be sure to check back tomorrow for tip #2!