Understanding Audits

Just the mere mention of an IRS “audit” strikes fear in the heart of most Americans; in fact, many would be short sale investors are so overwhelmed by the prospect they completely avoid the topic altogether. Unfortunately, what you don’t (want to) know can still hurt you when it comes to taxes; after all, ignorance of the law is no excuse and you must still sign-off on all tax forms prior to the final submission. Understanding a little about audits can go a long way toward preventing problems in the first place.

1. The very first thing to understand about audits is that they are not as common as most people imagine….in fact, audit rates have steadily declined over the past decades. In 1963 over 5.5 percent of all Americans were audited. In 2008 only .80 of Americans were audited – less than 1 percent of taxpayers annually. Audit rates for landlords do not appear to be any higher than that of the average population according to “How to Beat the IRS at Its Own Game” by Amir Aczel and approximate that of most small business owners. Real estate dealers and investors also appear to garner roughly equivalent audit rates.

2. Automated Under-reporter Program. Although not widely known, the IRS compiles and compares payment data submitted by banks, financial institutions and property managers, repair co’s etc.. against rental receipts and mortgage interest payments claimed by landlords. When the amounts don’t match, it automatically triggers further investigation.

3. Avoid round numbers. Yes, they are easier but it raises a red flag that the amount in question could be “made up” rather than real.

4. State and federal returns should match. Sounds simple but it’s a common mistake likely to trigger additional scrutiny at one end or the other.

5. Don’t file early. Why give IRS additional time to decide whether or not to audit your return? Remember, they have three years to make up their mind…more than sufficient time!

6. Stay within market averages! The IRS makes good use of average market rates for each area and you should too. Avoid renting or selling to friends and family where it could be construed as a gift, barter or other irregularity in need of additional “attention” (ie, an audit).

7. Keep those receipts. Without a doubt, good record keeping is the first defense against an audit. When in doubt, make a note and include it with your tax return.
Bottom line: Don’t cheat on taxes but also don’t become so fearful of an audit that you miss available tax write-offs and deductions. Stay within the legal limits and use aggressive tax strategies to reduce taxes and maximize profits.

NorthWest Real Estate