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If you receive a notice from the IRS notifying you that your tax return has been selected to be audited, your first reaction might be to panic. But if you’re prepared, there’s little to be concerned about.
An audit doesn’t necessarily mean that you, or your accountant, have done anything wrong. It just means the IRS is taking a closer look at your return. There could be issues they want to clarify, or perhaps there’s a minor calculation error that needs to be addressed. Provided you’re organized, have prepared correctly, and cooperate with the audit, you’ll be well-positioned.
It’s vital you work with your CPA throughout the audit process, particularly if you’re employing advanced tax strategies or reporting significant income and deductions. In this short guide, we’ll walk you through the process of what to do if you receive an audit notice.
Relax, take a deep breath, and read on. With the right approach, an IRS audit is nothing to lose sleep over.
For an IRS Audit, Preparation is Key
When it comes to an IRS audit, failing to prepare is preparing to fail. Being caught unprepared is the worst thing that could happen: you’ll be scrambling to pull together your books and document your expenses.
If you don’t have a bookkeeping system in place, start one. Today. If you’re ever subject to an audit, it’s likely the IRS could be questioning your income, expenses, and deductions. With the technology available today, maintaining digital records of all this is straightforward. Make sure you keep receipts for all expenses exceeding $75.
This is particularly important for individuals using real estate tax strategies. If you have claimed real estate professional status, you must have spent 750 hours materially participating in a real property trade or business. Keep time logs to substantiate this fact: you may be required to share these with the IRS in the event of an audit.
If you’re employing a short term rental tax strategy, record-keeping is equally important. Make sure you have records to prove you satisfy the conditions for the short term rental loophole.
You must show that the average stay at your properties was seven days or less, or 30 days or less with the provision of substantial services. Using short term rental management software is a simple way to track this data.
You must also prove your material participation in the short term rental business. To learn more about material participation tests for short term rentals, read this article: Short Term Rental Tax Strategy. If you fail to keep records documenting the time you and other individuals have spent on the short term rental business, you may find yourself in a weakened position if you are audited.
A major part of the litmus test for an IRS audit is the speed with which you can produce this supplementary information. If you’re ever audited, having this information readily available, and not having to scramble to pull everything together, offers a major boost to your chances of success.
At Hall CPA, our accountants prepare each of our clients’ tax filings and records with the expectation they will be audited at some point in the future. Operating with this approach ensures that if an audit does occur, our clients are well-positioned to respond.
What’s Involved in the Audit Process?
The IRS audit process is well-defined. It’s important that you know exactly what to expect in the event that you are subject to an audit.
The first indication you’ll receive that you’re being audited is a notice in the mail. If you have your business mail sent to a PO Box, office, or other address, make sure you check it regularly. The notice will come either from the federal or state government and will specify the time frame you have to respond.
Once you receive the notice, your first step should be to contact your CPA straight away. Don’t delay here: contact your CPA the day you receive the notice. Share a copy of the notice with your CPA, and tell your CPA the code associated with the notice: this will usually have the format “CP-______”, and will be located in the top right corner of the notice. Finally, make sure you clearly communicate the response date to your CPA.
If your CPA doesn’t get back to you within a day or two, keep trying to contact them. Under no circumstances should you respond to the notice without the advice of a CPA. You may give up information you don’t want to share, and by the time you realize this, you may have put yourself in a weakened position and made things more difficult.
Once your CPA responds, they should be able to guide you through the next steps. Many audits are simple: you may just have to send supplemental information to the IRS to have the issue resolved. In other cases, the scope may be wider, and you might need to involve a tax attorney, a different CPA firm, or additional professional help. Your CPA will advise you on the best course of action.
Common Reasons for Audits
An audit can be triggered by all kinds of factors, and it’s important to understand them. This can help you identify not only why you’re the subject of an audit, but how you can minimize your chances of another audit in the future.
Oftentimes, it might be a tax mistake that triggers an audit. Common mistakes include mathematical errors, failure to report some portion of income, and taking unusually high deductions. However, it may not always be a mistake on your part that triggers an audit. Sometimes, the IRS just needs to query certain elements of your return.
If you’re a real estate investor, there are several reasons you may be audited. If you’re using real estate professional status, the IRS may be questioning whether you’re really a real estate professional. Or it could be an expense somewhere on your tax return, like a repair on Schedule E: having records of these transactions ensures you can justify this. Even more simply, it could be a simple mathematical error that needs to be corrected.
Sometimes, there is no discernible reason for the audit: it’s purely random. Filing an amended tax return increases the chances you’ll be audited. When you file an amended return, someone at the IRS manually reviews it, and sometimes, that can lead to questions. Outlying line items like a particularly large home office deduction can trigger an audit.
Generally, the riskier the tax strategies you use, the higher the chances you’ll be audited. Seeking real estate professional status and taking large deductions can offer significant tax savings, but if these strategies are not executed with the support of an experienced CPA, they can be risky.
Proactively hiring a CPA that’s experienced in real estate investments and associated tax strategies is a surefire way to ensure your taxes are filed correctly. Filing a detailed, accurate tax return is the best way to minimize your chances of an audit. Even in the event you are audited, working with a proven accounting firm ensures you have all of your bases covered.
At Hall CPA, our specialized accountants have deep expertise in developing effective tax strategies for real estate investors. We offer not only tax preparation services but also tax planning services that help you maximize profitability and achieve your financial goals.
To learn more about working with us, contact our team today.