According to Linda Winslow, attorney with Kingman Winslow, LLC, real estate brokers and investors are being audited increasingly more often in this challenging economy. She spoke to the Independent Brokers Association about this last week and I have provided my notes from that presentation here:
80 new IRS auditors have been hired in the Seattle area. Audits are being conducted on real estate brokers, agents, and investors. Investors are being audited where they have shown big losses.
S corporations are being audited in force for the first time ever to collect on self-employment taxes. Owner/brokers have not been paying themselves a salary, and the IRS is looking at total revenue and how much is owner's compensation.
Most of Winslow's clients are netting over $100k; IRS is looking for profitable years and to collect self-employment taxes. The IRS is looking for a case to justify that agents should be taxed exactly the same as sole proprietors, which would eliminate one of the big advantages of an S corp.
One client who made $150K one year was audited by the IRS, who is now trying to collect $15-20K in back taxes. The reality is that it would cost even more to fight this in court (although an appeal will be filed).
Taxpayer is not required to talk with IRS if the taxpayer is represented by legal counsel.
Auditor looks at every deposit to make sure that it matches your gross receipts for your tax return. Reimbursements need to be counted as income, along with off-setting expenses. Try to keep your deposits as accurate as possible.
Be sure to send 1099s to owners and others who need to be sent one.
In an IRS audit, the IRS has the burden of proof to show that you owe tax revenue. They do this by looking at bank statements and matching to your records.
The taxpayer's burden of proof is to show that expenses are deductible. Car expenses are problematic if there is no mileage log for travel. Save receipts with odometer readings if you are not keeping a mileage log.
You need to keep a mileage log, even if this is a corporate vehicle.
Home office is a good deduction for small business owners. IRS no longer audits for this. Take a picture of the home office, so the IRS does not have to make a visit. All business mileage from a home office is tax-deductible.
When a couple is in business together, there is no dividing line between the two.
There is an automatic 20% penalty on adjustments (which can be appealed).
Out of town travel is also a red flag for the IRS. Meeting with brokers does not justify a travel deduction.
The IRS auditor will ask for a copy of your tax return first, as they are not given a complete copy. It is a huge secret about how the IRS picks people for audit.
A desk audit comes from the IRS via a letter on a specific issue. If you do not respond, they can put a lien on the property. These are typically for schedule A items: high mortgage interest, high charitable contributions, etc.
$250K exclusion for single person's primary residence, depending that they have lived there for two of the last five years. There may be ways to avoid additional 23% capital gains taxes (especially if older seller has a lot of investment income, over $250K income).
Pretty easy to be a 1031 tax exchange facilitator. No professional requirements for this. Good idea to make sure they have a bond for the money they hold.
B&O taxes are calculated on gross income, including client funds that come into the corporation. Rental Housing Association is fighting this method of taxation.
IRS considers rental income to be part of what a real estate professional does. So there is no real distinction between business and personal rental investments.
It is a grey area for the IRS when someone who flips houses becomes a "dealer."
An unusual income year can trigger an audit.
Mortgage interest over $1M may not be deductible, and can trigger an audit. This applies to personal residences only.
Gifts up to $14K per year to children is tax-free....step transactions may affect deductibility. There are issues around shifting income to children. IRS will look at this.
Do not give your clients tax advice if you are not a tax professional!
For a copy of Winslow's book "Real Estate Agents Tax Guide: Deductions, Deductions, Deductions," contact her at firstname.lastname@example.org