The Internal Revenue Service (IRS) receives millions of income tax returns every year. Since it is impossible to review each one, the IRS has identified “red flags” that signal them to give a tax return a second look.
Unfortunately, landlords and property owners are subject to additional scrutiny. The IRS reviews their forms more meticulously than employers, independent contractors, and so on. Hence, those who’ve entered the real estate industry need to be extremely careful during tax season. It may be tempting to save a couple of hundred dollars, but if you get caught — well, you’ll be in serious trouble.
As they say, the IRS is always watching. Don’t get carried away with your deductible expenses, otherwise, you may find the dreaded audit notice in your mail.
In this article, we’ll go over the top red flags of the IRS for landlords, property owners, and property managers.
Top IRS Red Flags for Landlords
Being a landlord or property owner means you can take advantage of several tax deductions, however, the moment you claim these benefits, you’ll be under the strict scrutiny of the IRS.
In general, if you make a mistake in your tax return, you can simply inform the IRS. However, if it seems like you’re purposefully evading your taxes, the IRS will likely subject your rental business to an audit. Here are the common red flags that the IRS looks out for:
#1 Errors in Your IRS Forms
Landlords, property owners, and property managers need to file Form 1099 if they hired an independent contractor (e.g. gardener, plumber, contractor) to perform rental-related duties within the year unless the contractor is part of a corporation. On the other hand Form W-2 reflects the wages that the landlord paid to their employees, including the taxes withheld.
It’s important to ensure that the numbers in Form 1099 and Form W-2 match, otherwise, the IRS will take a closer look at your returns. In addition, make sure that you file the right forms. As a landlord, you will need to file your returns using Schedule E, which is for passive income.
Plus, according to the IRS, errors in paper returns are more common than errors in electronic returns. Hence, you may want to consider filing your returns online than filling out a form manually. Minor errors such as a misspelled name or incorrect Social Security Number (SSN) may trigger the IRS to audit you.
#2 Charitable Donations
Charitable donations can be written off from your taxes, but be careful — donations that are disproportionate to your income level are considered red flags. For example, if you make $300,000 annually, the IRS expects you to be able to donate 3-4% of that amount and nothing more. If you claim a charitable deduction that is much higher, the IRS may become suspicious.
However, if you truly made a donation, be sure to keep detailed records to support your claim. This includes receipts, documents, and other specifics.
#3 Excessive Travel Deductions
As a landlord, you can deduct out-of-town travel expenses from your taxes. These include parking fees, gasoline, meals, lodging, and so on. However, this doesn’t mean that you should splurge on five-star accommodation and Michelin-star dining. Excessive write-offs will trigger the IRS to audit you.
It’s important to prove that the purpose of your travel was for business. You can’t write off the expenses if, say, you mixed business with leisure. For instance, if your rental is in Miami Beach but you planned on going on vacation while checking on your property, you can’t deduct the costs of your hotel, gasoline, etc. from your taxes.
#4 Non-Filing of Income
Another red flag is failing to report your income accurately. The IRS will notice if the income you declared this year is significantly lower than the income you declared in previous years. While it is possible that your business simply isn’t doing well, it could also mean that you’re intentionally hiding your real income.
If your income is legitimate, there’s no need to worry. If the IRS subjects you to an audit, you simply need to provide them with proof. However, if you meant to make it seem like you made less money, you may be facing a lot of penalties.
Remember, even if it wasn’t intentional, if you fail to amend your tax returns as soon as possible, the IRS will audit you. That’s why it’s important to hire a single-family property management company that has accountants who can ensure that your forms are error-free.
#5 Filing Late
The IRS doesn’t take excuses from anybody. Everyone has to file their taxes on time. Just because being a landlord is more complicated than being an employee does not mean the IRS will go easy on you. The IRS still requires every taxpayer to file (and pay) their taxes on schedule.
If you file your taxes late, the IRS will be skeptical. What made you file your taxes late? Is there something in your form that needs a second look? It’s best to avoid attracting their attention.
Tax Tips for Landlords and Property Owners
If you own an investment property, you need to maintain proper and thorough documentation of your income and expenses. If you’re preparing your tax returns on your own, consider understanding the U.S. tax law beforehand. Doing this will ensure that you file everything that needs to be filed.
For many landlords, hiring a Certified Public Accountant (CPA) is a worthwhile investment. They will be able to assist you in preparing your tax returns, ensuring that there are no discrepancies in your forms.
The Bottom Line
IRS audits are no joke. Even if you accidentally reported inaccurate information, you will still have to face penalties. That’s why it’s worthwhile to hire a CPA or property management company that can help you prepare and present the proper records in the event of an IRS audit.
Luxury Property Care’s in-house accountants help property owners mitigate the risks of an audit by complying with tax requirements. We constantly update ourselves with tax laws to ensure that our clients stay on the IRS’ good side.