While the average real estate investor can earn anywhere from $70,000 up to $124,000, the possibilities are virtually endless. And the more you earn, the higher your real estate tax obligations will be. Because of this, it's imperative you have a solid tax planning strategy to limit your tax liability. Fortunately, you don't have to do it alone.
You have an entire team of experienced real estate tax professionals at the MB Group who can help you create a strategy to optimize your taxes. But if you're intent on doing it yourself, make sure you keep a close watch on the following IRS audit triggers for real estate investors.
What Does It Mean to Be Audited by the IRS?
An IRS audit is an examination or review of an individual's or organization's financial information and accounts to make sure all information has been accurately submitted. Contrary to popular belief, an audit doesn't always mean there is a problem. The IRS uses many methods to determine which tax returns to audit, including:
- Randomly selecting tax returns where returns are simply audited randomly.
- Computer screening tax returns based on returns that deviate statistically from the “norms”
- Related examinations involve choosing returns to audit based on issues or transactions associated with other related tax returns, such as investors or business partners who are being audited.
How Far Can the IRS Go Back on Taxes for Real Estate Investors?
Whether you're a real estate investor or anyone else, generally the IRS will go back to cover the last three years. If they identify a significant error, they may add extra years. According to the Internal Revenue Service, auditors usually will not go back more than six years. In addition, the IRS attempts to audit tax returns as soon as they are filed.
What Are the Top IRS Audit Triggers for Real Estate Investors?
Now that we've discussed the basics for an IRS audit, let's look at a few of the most common IRS audit triggers for real estate investors.
You Have High Earnings
Simply put, the more you make, the higher the likelihood the IRS will audit you. As a result, higher earners must be very strategic and meticulous with recordkeeping and tax documentation.
The Numbers Don't Add Up
Without a doubt, one of the most important steps you can take to reduce the likelihood of an audit is to ensure your W-2's, 1099 forms, and other sources of income match with what you report on your return. Failing to match all the numbers can automatically trigger the dreaded letter.
Complications with Tax-Deductibility of Commission Advances
If you took commission advances, it's imperative you properly file them and have the necessary financial records. Typically, the fee associated with the real estate commission advance is deductible, but make sure to work with your CPA or real estate tax accountant to verify.
You Made Substantially Less
If you report significantly less income this year than you did the previous year, the IRS may assume you're not reporting everything, which could trigger an audit. As always, make sure you have receipts for everything you're taking as a deduction.
You Work for Yourself
As a real estate investor, you're most likely self-employed, which may automatically make you more susceptible to an audit. Even if you have established your business as an LLC or corporation and pay yourself a salary, you may still fall into a higher risk category than someone who is getting a W-2 from a company. As with any case, make sure you are meticulous in your filing and recordkeeping, especially when it comes to your deductions.
You Claim the Home Office Deduction And/ or a Vehicle
If you use your vehicle or home for business for your business, it makes dollars and sense to incorporate these deductions into your real estate tax planning strategy. Make sure to communicate with your tax accountant on how much is allowable for vehicles and home offices. This is important because exceeding the thresholds can be an IRS audit trigger.
You Claim a Lot of Entertainment/Meal Deductions
You should be very strategic and meticulous when claiming deductions for entertainment and meals. For example, are you deducting the entire amount when you should only be deducting the client's portion? Are you spending amounts that are large compared to your gross taxable income? Each of these factors and more can be red flags for an IRS audit. Make sure you are aware of allowable amounts for entertainment and meal deductions.
Large Tax Deductions
When you submit your return, it's compared to others in your industry, previous returns, and other factors. If one or two of your real estate tax deductions — such as depreciation-related deductions — are exceptionally larger than the norm, it could trigger an IRS audit.
You Have an Especially Generous Heart
The IRS is always on the prowl for real estate investors and others who inflate their donations to charity. When reporting charitable donations, make sure you have the proof and documentation to support your donations.
You Only Have Neat Round Numbers
Neat, round numbers are not common. And if your return features only neat and round numbers, it could cause an auditor to hone in on your return.
Contact MB Group for Real Estate Investor Tax Planning Solutions
At the MB Group, we offer a full array of tax planning and filing solutions for real estate investors. Our experienced CPAs and tax accountants will work closely with you to minimize your tax liability and maximize your return.
Contact us today to learn more.