If you’re a landlord or property investor, you need to ensure that you safe-keep rental-related documents. Not only does this help you make better financial decisions for your rental business, but it also protects you in case you end up on the Internal Revenue Service’s (IRS) radar.
In this article, we detail the types of documents you need to keep, as well as explain why you need to practice record-keeping in the first place.
Why should you keep property tax records?
#1 IRS Audits
The IRS requires everyone to file their taxes every year. With that, they also require everyone, including property investors such as yourself, to safe-keep tax-related documents. This is because your income tax return may be flagged by the IRS, which means you’ll have to go through the grueling process of an IRS tax audit.
Remember, the smallest mistakes can result in an audit. Even if your errors were unintentional, you still need to prove that you never intended to commit tax fraud. To do this, you will need to present pertinent documentation. If you don’t have these documents, you’ll have a difficult time proving the correctness of your income tax return.
#2 Litigation with Past Tenants
Another reason why you should keep property tax records is that a former tenant might take you to court. The American Bar Association (ABA) recommends keeping records that prove your landlord-tenant relationship for seven years. This includes lease agreements, tenant applications, rejection letters, and so on.
Although this is a rare situation, it’s still best to be prepared. Keeping tenant-related documents protects you in case a former tenant files a lawsuit against you. Since many tenant-related disputes revolve around the Fair Housing Act (FHA), you or your property manager should keep these pertinent documents in a safe place.
What property tax records should you keep?
You’ll end up on the IRS’ radar if your income tax return shows that…
- You made a lot of money in the past year.
- Your deductions are disproportionate to your income.
- You are running a small business.
- You made significantly large charitable donations.
- You claimed rental losses.
- You claimed deductions for meals, travel, and leisure.
- You claimed business use on a vehicle.
- You claimed the deduction for home office use.
- …and so on.
Even if your income tax return is entirely true, the IRS may still be skeptical. When that happens, don’t worry — you simply need to disprove their suspicions. To do that, you need to provide them with pertinent documents, which we’ll list below:
#1 Permanent Records
Permanent records are rental-related records that you need to keep indefinitely. This is because they will be relevant to you in the long run. These include:
- Tenant lease agreements
- Legal documents, e.g. inspection reports and court appearances
- Permits, e.g. building permits
- Documents related to property improvements
- Documents related to your company or corporation
- Insurance policies
- Past tax returns
- Property titles and deeds
- Loan documents, e.g. mortgages
#2 Short-Term Records
Short-term records are relevant for five to seven years. You’ll want to keep them in case the IRS audits you or in case your former tenant sues you. In general, short-term records are those that reflect your income or expense for the tax year. These include:
- Advertising/marketing costs
- Legal fees for lawyers, accountants, realtors, etc.
- Office expenses, e.g. internet and second phone lines
- Proof of rent received
- Proof of security deposit retained
- Proof of travel, e.g. tickets and number of miles
- Work orders for repairs and maintenance
- Utility payments
- Payments made to independent contractors
Have you hired your own employees?
If you have employees such as a resident manager, you need to keep records such as employment tax returns, payroll tax records, etc. for four years. The IRS’ Employer’s Tax Guide details the documents that you should keep. You should also contact your state’s tax agency as your state may have specific requirements for landlords that have hired their own staff.
How long should you keep property tax records?
The IRS suggests safekeeping your property tax records for around three years after filing your taxes, however, you should consider storing documents for far longer. This is because the IRS can run an audit up to seven years after you file your taxes, should they be suspicious that you incorrectly reported your income. Although the audit deadline is technically three years, the IRS has the authority to extend it. Hence, it would be helpful to store your property tax records or documents in case you need them in the future.
In the event that you are audited, you will be asked to show your financial records. This includes insurance receipts, rental payments, bank statements, and much more. If you’ve enlisted the services of a property management company, they typically retain audit reports indefinitely.
When can you throw your tax records away?
You technically shouldn’t throw your tax records away. Instead, partner with a property management company that can scan them for you. By keeping digital copies, you can ensure that you’ll always have the data to back you up in case the IRS conducts an audit. Your property manager will probably keep these key documents on a hard drive or using online file hosting services such as DropBox.
You should also consider using property management software such as AppFolio. It’s what professional property managers use to keep track of payments, work orders, and much more. Use it alongside other spreadsheet apps to cross-check your records.
Ideally, you should keep physical or hard copies of your insurance policy for three years, even if you are no longer insured by that insurer. Warranty sales receipts should also be kept for as long as the warranty is valid. Similarly, sales receipts for repairs and improvements should be kept until you sell the property.
No landlord wants to be audited by the IRS, but in the event that it does happen, at least you’ll be prepared. Through proper record-keeping, you can prove to the IRS that your income is exactly as it should be.
If you need assistance during tax season, enlist the services of our property managers. Luxury Property Care is a team of real estate professionals that specialize in residential and commercial property management. When you work with us, you can reap the benefits of being backed by our in-house attorneys and accountants.