Preparing For An IRS Audit Of Your Real Estate Business

If you own a real estate business, it is important to be prepared for an IRS (Internal Revenue Services) audit. The IRS conducts audits to ensure that taxpayers are complying with tax laws and reporting their income accurately. An audit can be a stressful and time-consuming process, but with proper preparation, you can minimize the potential for errors and reduce your risk of penalties and fines.

KEY TAKEAWAYS:

The IRS Audit Technique Guide (ATG) is used to guide auditors in the audit process for specific industries or issues.
If selected for an audit, the auditor will examine your books, records, and other documents to identify any issues of noncompliance and determine whether adjustments need to be made to your tax return.
The auditor may meet with you to discuss any issues identified, and if an agreement is reached, the auditor will prepare a report outlining the adjustments to be made to your tax returns.
Auditors may request various records to support your reported income, deductions, and credits, so it is crucial to maintain accurate and complete records to avoid penalties and fines.
NEVER MAIL ORIGINAL RECORDS. SEND COPIES ONLY.

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The IRS Audit Technique Guide (ATG) is a document that provides guidance to IRS auditors regarding auditing specific industries or issues. It serves the purpose of educating auditors about the unique characteristics of a particular industry or issue, while also equipping them with information on the types of documents and records they should examine during an audit.

IMPORTANT:ATG is not a set of rules or regulations that businesses must follow. Instead, it is a tool used by auditors to help them understand a particular industry or issues and to guide them in their audit process. You can watch this short Video to know more about these guides.

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What Steps Will The Auditor Take?

It is important to keep in mind that every audit is unique, and the steps and procedures involved can vary depending on the specific circumstances and complexity of the real estate business under audit. The following steps are taken during an IRS audit of a real estate business:

A auditor will notify you if you have been selected for an audit. It is important for you to review your situation and understand all your income streams and activities, such as W-2s, Schedule C, and Schedule E.
The auditor will conduct fieldwork by examining your books, records, and other documents. They will request all documentation related to your timekeeping and closely examine your logs. The auditor will identify any issues of noncompliance and determine whether adjustments need to be made to your tax return.
The auditor may meet with you to discuss any issues identified and provide an opportunity for you to respond. If an agreement is reached, the auditor will prepare a report outlining the adjustments to be made to your tax returns.
They will give you determination. Most determinations go against the taxpayer. If you disagree with the auditor's findings, you may have the right to appeal against the decision through various administrative and legal channels.

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Indicators That Taxpayer Did Not Materially Participate

The Real Estate Professional (REP) status undergoes audits more frequently compared to others. Material Participation serves as the foundation of REP status. Here are several indicators that may suggest a lack of material participation in an activity:

The taxpayer did not spend a significant amount of time on the activity.
The taxpayer did not have the relevant skills or expertise to effectively manage the activity.
The taxpayer did not have any prior experience in the activity.
The taxpayer did not make the key management decisions for the activity.
The taxpayer did not keep adequate records or have a business plan for the activity.
The taxpayer relied heavily on a hired manager or advisor to manage the activity.
The activity consistently incurred losses, and the taxpayer did not take steps to improve profitability or change the management approach.
The taxpayer did not actively seek out new business opportunities or customers for the activity.
The taxpayer did not make any personal visits to the business location or worksite.
The taxpayer did not participate in the activity regularly, continuously, and substantially.

These factors should not be used as definitive evidence of non-material participation. The IRS will consider all facts and circumstances when determining whether you are materially participating in any activity.

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Examples of Records The IRS Might Request

Auditors may request a variety of records to support your reported income, deductions, and credits. Some of examples of records that might be required are:

Bank statements and canceled checks (This is to prove the payment of the invoice)‍
Invoices and receipts for business expenses (This is to prove the payment of the invoice)‍
Employment tax records, including payroll and FormW-2s.
Records of asset purchases, sales, and depreciation.
Capital gains and losses records. This includes the date of investment and sale.
Home purchase and improvement records, including closing statements and receipts for home improvements
Charitable contribution records, including receipts and acknowledgments from the charity
Rental property records, including lease agreements and rental income and expense records
Health care and insurance records, including Forms 1095 and 1099-H‍
Education-related records, including Forms 1098-T and 1098-E

It is important for you to maintain accurate and complete records to support your tax returns, as failing to produce requested records during an audit can result in penalties and fines.

NEVER MAIL ORIGINAL RECORDS. SEND COPIES ONLY.

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Conclusion

Having an in-depth understanding of the IRS audit process and familiarizing yourself with he steps undertaken by auditors is important. It is crucial to maintain accurate and complete records to substantiate your tax returns and ensure compliance with legal requirements. Failure to do so may result in penalties and fines. By adopting a prepared and proactive approach, you can mitigate potential risks and minimize the impact of an IRS audit on your real estate business.

Investor Friendly CPA® offers the services of skilled professionals who can provide complementary consultation to assist you in preparing your tax returns and conducting audits for your real estate business in an efficient manner.