Portfolio Expenses – Are They Deductible or Not?

The Tax Cuts and Jobs Act (TCJA) brought about many changes including the elimination of miscellaneous deductions subject to the 2% of adjusted gross income (AGI) limitation. Although these expenses were suspended starting back in 2018, we still find many fund managers and investors surprised to learn that expenses falling into this category are not deductible on their personal tax return. The law currently sunsets in 2025.

Investment funds, including private equity, venture capital and non-trader hedge funds, are typically not considered a trade or business for purposes of IRC 162. As a result, the expenses of investment funds are generally categorized as expenses under IRC 212 and are not deductible to individuals and most trusts. C Corporation investors are still able to take advantage of the deductions. Note this is not applicable to funds that qualify as having trader status.

Examples of some expenses that fall into the portfolio expenses category include:

• Accounting and legal fees
• Administrative fees
• Management fees

Starting in tax year 2023, the IRS introduced Box 13, Code AE, on Schedule K-1 to report these specific deductions. The IRS defines them as expenses “formerly deductible by individuals under section 67 subject to the 2% AGI floor.” In practice, we will often see these expenses reported in Box 13, Code ZZ, along with a footnote to Schedule K-1 noting them as IRC 212 expenses (i.e., no longer deductible). Prior to 2023, these expenses were reported in Box 13, Code W.

As a double nail in the coffin, tax basis in your partnership interest is decreased by your allocation of partnership expenses, but you ultimately receive no benefit of the expenses. These expenses were formerly reported on Form 1040, Schedule A, as itemized deductions which had to exceed certain limitations — while not necessarily getting the full benefit of the expenses, there was still some benefit.

As we wait to see if there will be an extension of the provisions enacted with TCJA before it expires, contact us to discuss questions related to the deductibility of fund expenses.

Authored by Meghan Matthews

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