You can view the corresponding infographic on IRS Audit triggers by clicking here.
Audit—it’s a scary word for every tax-paying citizen, but, fear not! Audits are relatively infrequent, and there are specific IRS audit triggers you can avoid to greatly reduce the chance of that dreaded IRS letter in the mail. Here, on behalf of The Real Estate CPA, I detail the most common tax mistakes that can trigger an audit.
Before I list the IRS audit triggers you will want to avoid, just remember: audits aren’t very common. In 2016, only .7% of tax returns were audited. It’s also important to note that the vast majority of those audited make $500,000 or more, although the likelihood of being audited begins increasing once you hit $200,000. However, even then, your odds of being audited while making between $200,000-$499,999 is only a hair over one percent. Once you reach $500,000, the odds only increase to 3.62%. This doesn’t mean you should feel free to get careless with your tax returns, though: if you are one of the unlucky ones, the audit process can be time-consuming, expensive and extremely stressful. Here are a few common tax mistakes to watch out for as you file your taxes this year.
Mistake #1: Paper Filing and Mathematical Errors
According to the IRS, the error rate for paper returns is a whopping 21%—but, for electronic returns, the error rate is a measly one percent. If you needed an excuse to go green and file online, this is a great one. Errors can come from anywhere: a misspelled name, an incorrect Social Security number, an incomplete line item—however, some very common tax mistakes are basic mathematical errors. In 2014, the IRS found 2.3 million simple mathematical errors. Most of these errors are avoided by filing online, however, always check all of your work! It only takes a minute and will prevent the IRS from reviewing the rest of your return with a fine-toothed comb. Even something as small as rounding a number to the nearest whole number can trigger concern in the eyes of an auditor, so ensure your math is as accurate as possible.
Mistake #2: Failing to Report Income
Do you have an interest-earning savings account? Have you picked up a side-gig this year? If so, you probably received a 1099 Form, which details your earnings for the year. Even if the amount seems small in the grand scheme of things, it is income, and it needs to be reported to the IRS. Failure to report all of the income you make increases your chances of being audited in a big way.
Mistake #3: Taking High Charitable Deductions
Donating to reputable charities is not only a wonderful way to give back to the community, but it is also a great way to take a tax deduction. This deduction, however, should not simply be eyeballed—you need receipts and documentation proving that you donated the amount you claim you did. The IRS has expectations for how much people donate based on their income level, and they weigh each filer’s charitable deduction against the expectations for those in the income group. Those who make between $75,000-$500,000 a year are expected to generally donate roughly 3-4% of their income. If you fall within this income level, and you claim a charitable deduction greater than this, the IRS is likely to be skeptical. Even if you are a prolific philanthropist, make sure you keep detailed records showing the specifics of your charitable contributions—they will be vital if you are audited.
Mistake #4: Taking Excessive Deductions in Your Schedule C
Every real estate investor needs to understand their Schedule C—it lets those who are self-employed summarize their earnings and losses, including the deduction of any eligible business expenses. Deducting business expenses is one of the wonderful benefits of investing in real estate but be very careful—deducting too freely can be an IRS audit trigger. Before taking a deduction, ask yourself: is this deduction business related, and do I have the documentation to justify it? If the answer to either is no, skip it!
An example of a common deduction for many real estate investors is the home office deduction. While this deduction is a great one for those who work from home, the IRS knows it is ripe for exploitation. Generally speaking, if you are claiming more than 20% of the square footage of your house as office space, the IRS will be much more likely to audit you.
Mistake #5: Forgoing the Use of a Qualified Real Estate CPA
Sure, you could do your taxes on your own—but do you really want to? Hiring a CPA who specializes in real estate investment is a surefire way to ensure your taxes are done accurately, completely and with special attention given to the loads of deductions real estate investors have available to them. Accurate, complete and properly deducted taxes mean far less of a chanced of being audited—and who doesn’t want that? Give us a call at The Real Estate CPA today to see how we can help.