Is Investing in Someone Else's Business Tax Deductible?
A business has two ways to raise capital, either by borrowing money or selling an ownership stake. That gives you two options for investing in a company: by lending cash or by buying into the business. Neither approach gives you a tax write-off, however, unless your investment turns into a loss for you.
Buying stock is one way to take an ownership share of a business. After you buy the stock, it won't usually affect your taxes until you sell. If you turn a profit on the sale, you pay capital gains tax; if you sell at a loss, you can deduct up to $3,000 from your other income. Should you suffer a bigger loss, you can carry the extra over to next year and write it off then.
Another way to buy into a business is to form a partnership. For example, if your friend has a great business idea but limited money, you could put up 50 percent of the capital -- or 70 percent, or 30 -- and split the profits. You report partnership income and expenses on Schedule C. If the expenses outweigh the income in a given year, you report a loss on Schedule C and then deduct the loss from your other income on Form 1040.
If you personally lend money to a business start-up -- that is, you lend the money; your company does not -- it counts as a personal debt. You get to claim the debt as a tax write-off after you've tried and failed to collect the money, or when it's obvious you'll never get it back. You report bad debts as a short-term capital loss on Schedule D. Attach a detailed explanation of the debt and what went wrong when you file your return.
The costs of managing and tracking investments are often deductible if you itemize. For example, investment advice from your broker or legal fees you incur researching the partnership are valid write-offs. If you use your computer to make investments, you can depreciate the machine. Investment expenses are a 2 percent deduction, like unreimbursed employee expenses. Add up all your expenses in this class and subtract 2 percent of your adjusted gross income. Whatever's left is your write-off.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.