How to Survive an IRS Audit about Your Real Estate Investment

A special guide for Real Estate Investors

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There are 3 types of Audit:

  • The written inquiry. Here they just will send you a letter asking for some documentation for some expense you deducted. This is the easiest. Provided you have the information. Remember you don’t need receipts for minor expenses below $25.
  • The in person audit of certain items. See below for advice.
  • The in depth compliance audit. If you are “lucky” enough to be selected for one of these, you might as well just change your name and flee the country. Well, not really, but you’ll be tempted. This audit might be conducted in your office or home and can require you to prove EVERY miserable thing on your tax return. Sample. “You’ve claimed for 2 children. Prove they’re your children.” Then you have to produce their birth certificates just to prove that these 2 smiling individuals at your feet are actually yours and not from “Rent a Kid”.

The in Person Audit of Certain Items:

  1. The best advice is to send your CPA with a LIMITED power of attorney to cover only the items on the IRS notice to you.
  2. The auditor will probably start by verifying who is appearing for the tax payer and if they have proper authority.
  3. Then they will check social security numbers and addresses.
  4. If you have a job they will confirm your employer and that of your spouse, if you have one.
  5. They’ll ask if you have filed all the returns you should have. Maybe you should have filed a 1099 for your babysitter or maid.
  6. They’ll usually ask if you’ve been audited before.
  7. They’ll ask if you’ve reported all income. Like gambling income.
  8. Bartering is a taxable event they like to question. Example. You said to your dentist that you’ll fix his car if he’ll fill your teeth. Even if no money changes hands the dentist and you are both taxable on the value of the services provided.
  9. They ask about safe deposit boxes, obviously to find out if you have any cash hidden away. We recommend that you have any safe deposit box in a company name anyway, as if it’s in your name, access will be frozen on your death. And make sure that someone trustworthy besides yourself has the right to access it.
  10. If you have a company and employees they’ll ask if the withholding has been done right.
  11. Have you given some sort of compensation to relatives in a non-cash form.
  12. Tenants are an interesting problem here. Let’s say you own a rather nasty house in bad condition. Your tenants agree to take it “as-is” and do the work themselves in return for a reduced rent or security deposit. It’s arguable that the rent credit is taxable as income to them. Not only that. They are now employees of you. So if they cut off an arm with a chain saw while working on the house, guess who gets a workmen’s compensation claim?
  13. Be VERY careful here. Perhaps you would be better protected if your lease said something like, “The house is in terrible condition and the tenant acknowledges that the rent they are paying reflects that condition.”… “Tenant agrees to employ suitable licensed contractors to make the following repairs at his own expense.” Then it would hopefully be their fault if they chop their arms off.
  14. By having your CPA appear instead of you, with a limited power of attorney, the IRS are prevented from going on a fishing expedition.

Disclaimer. We are not tax experts or CPAs. The above is meant to be informative and useful, but as always, check with your professional advisor.