Claiming Rental Losses

Kiplinger: IRS Audit Red Flags

Normally, the passive loss rules prevent the deduction of rental real estate losses. But there are two important exceptions. If you actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. But this $25,000 allowance phases out as adjusted gross income exceeds $100,000 and disappears entirely once your AGI reaches $150,000. A second exception applies to real estate professionals who spend more than 50% of their working hours and 750 or more hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off losses without limitation. But the IRS is scrutinizing rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. The agency will check to see whether they worked the necessary hours, especially in cases of landlords whose day jobs are not in the real estate business.

(iStock)

More From Kiplinger:
The 19 Most-Overlooked Tax Deductions
QUIZ: Is It Deductible?
14 Extraordinary Tax Deductions

The opinions expressed are solely those of the author and do not necessarily reflect the views of Comcast.

More from this Slideshow

0 of 0

IRS Audit Red Fl... Ever wonder why some tax returns are eyeballed by the Internal Revenue Service while most are ignored? The IRS audits only slightly more than 1% of all individual tax returns annually. The agency doesn't have enough personnel and resources to examine each and every tax return filed during a year. So the odds are pretty low that your return will be picked for review. And, of course, the only reason filers should worry about an audit is if they are fudging on their taxes.

Here are 12 red flags that could increase your chances of drawing some unwanted attention:

(iStock)

More From Kiplinger:
The 19 Most-Overlooked Tax Deductions
QUIZ: Is It Deductible?
14 Extraordinary Tax Deductions

The opinions expressed are solely those of the author and do not necessarily reflect the views of Comcast.
Making Too Much ... Although the overall individual audit rate is about 1.11%, the odds increase dramatically for higher-income filers. 2011 IRS statistics show that people with incomes of $200,000 or higher had an audit rate of 3.93%, or one out of slightly more than every 25 returns. Report $1 million or more of income? There's a one-in-eight chance your return will be audited. The audit rate drops significantly for filers making less than $200,000: Only 1.02% of such returns were audited during 2011, and the vast majority of these exams were conducted by mail.

We're not saying you should try to make less money -- everyone wants to be a millionaire. Just understand that the more income shown on your return, the more likely it is that you'll be hearing from the IRS.

(iStock)

More From Kiplinger:
The 19 Most-Overlooked Tax Deductions
QUIZ: Is It Deductible?
14 Extraordinary Tax Deductions

The opinions expressed are solely those of the author and do not necessarily reflect the views of Comcast.
Failing to Repor... The IRS gets copies of all 1099s and W-2s you receive, so make sure you report all required income on your return. IRS computers are pretty good at matching the numbers on the forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill. If you receive a 1099 showing income that isn't yours or listing incorrect income, get the issuer to file a correct form with the IRS.

(iStock)

More From Kiplinger:
The 19 Most-Overlooked Tax Deductions
QUIZ: Is It Deductible?
14 Extraordinary Tax Deductions

The opinions expressed are solely those of the author and do not necessarily reflect the views of Comcast.
Taking Large Cha... We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag.

That's because IRS computers know what the average charitable donation is for folks at your income level. Also, if you don't get an appraisal for donations of valuable property, or if you fail to file Form 8283 for donations over $500, the chances of audit increase. And if you've donated a conservation easement to a charity, chances are good that you'll hear from the IRS. Be sure to keep all your supporting documents, including receipts for cash and property contributions made during the year, and abide by the documentation rules. And attach Form 8283 if required.

(iStock)

More From Kiplinger:
The 19 Most-Overlooked Tax Deductions
QUIZ: Is It Deductible?
14 Extraordinary Tax Deductions

The opinions expressed are solely those of the author and do not necessarily reflect the views of Comcast.
Claiming the Hom... Like Willie Sutton robbing banks (because that's where the money is), the IRS is drawn to returns that claim home office write-offs because it has found great success knocking down the deduction and driving up the amount of tax collected for the government. If you qualify, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance and other costs that are properly allocated to the home office. That's a great deal. However, to take this write-off, you must use the space exclusively and regularly as your principal place of business. That makes it difficult to successfully claim a guest bedroom or children's playroom as a home office, even if you also use the space to do your work. "Exclusive use" means that a specific area of the home is used only for trade or business, not also for the family to watch TV at night.

Don't be afraid to take the home office deduction if you're entitled to it. Risk of audit should not keep you from taking legitimate deductions. If you have it and can prove it, then use it.

(iStock)

More From Kiplinger:
The 19 Most-Overlooked Tax Deductions
QUIZ: Is It Deductible?
14 Extraordinary Tax Deductions

The opinions expressed are solely those of the author and do not necessarily reflect the views of Comcast.
Claiming Rental ... Normally, the passive loss rules prevent the deduction of rental real estate losses. But there are two important exceptions. If you actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. But this $25,000 allowance phases out as adjusted gross income exceeds $100,000 and disappears entirely once your AGI reaches $150,000. A second exception applies to real estate professionals who spend more than 50% of their working hours and 750 or more hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off losses without limitation. But the IRS is scrutinizing rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. The agency will check to see whether they worked the necessary hours, especially in cases of landlords whose day jobs are not in the real estate business.

(iStock)

More From Kiplinger:
The 19 Most-Overlooked Tax Deductions
QUIZ: Is It Deductible?
14 Extraordinary Tax Deductions

The opinions expressed are solely those of the author and do not necessarily reflect the views of Comcast.
Deducting Busine... Schedule C is a treasure trove of tax deductions for self-employeds. But it's also a gold mine for IRS agents, who know from experience that self-employeds sometimes claim excessive deductions. History shows that most underreporting of income and overstating of deductions are done by those who are self-employed. And the IRS looks at both higher-grossing sole proprietorships and smaller ones.

Big deductions for meals, travel and entertainment are always ripe for audit. A large write-off here will set off alarm bells, especially if the amount seems too high for the business. Agents are on the lookout for personal meals or claims that don't satisfy the strict substantiation rules. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, the place, the people attending, the business purpose and the nature of the discussion or meeting. Also, you must keep receipts for expenditures over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast.

(iStock)

More From Kiplinger:
The 19 Most-Overlooked Tax Deductions
QUIZ: Is It Deductible?
14 Extraordinary Tax Deductions

The opinions expressed are solely those of the author and do not necessarily reflect the views of Comcast.
Claiming 100% Bu... Another area ripe for IRS review is use of a business vehicle. When you depreciate a car, you have to list on Form 4562 what percentage of its use during the year was for business. Claiming 100% business use of an automobile is red meat for IRS agents. They know that it's extremely rare for an individual to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use. IRS agents are trained to focus on this issue and will scrutinize your records. Make sure you keep detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy recordkeeping makes it easy for the revenue agent to disallow your deduction. As a reminder, if you use the IRS' standard mileage rate, you can't also claim actual expenses for maintenance, insurance and other out-of-pocket costs. The IRS has seen such shenanigans and is on the lookout for more.

(iStock)

More From Kiplinger:
The 19 Most-Overlooked Tax Deductions
QUIZ: Is It Deductible?
14 Extraordinary Tax Deductions

The opinions expressed are solely those of the author and do not necessarily reflect the views of Comcast.
Writing off a Lo... Your chances of "winning" the audit lottery increase if you have wage income and file a Schedule C with large losses. And if the loss-generating activity sounds like a hobby -- horse breeding, car racing and such -- the IRS pays even more attention. Agents are specially trained to sniff out those who improperly deduct hobby losses. Large Schedule C losses are always audit bait, but reporting losses from activities in which it looks like you're having a good time all but guarantees IRS scrutiny.

You must report any income you earn from a hobby, and you can deduct expenses up to the level of that income. But the law bans writing off losses from a hobby. For you to claim a loss, your activity must be entered into and conducted with the reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes that you're in business to make a profit, unless IRS establishes otherwise. If you're audited, the IRS is going to make you prove you have a legitimate business and not a hobby. So make sure you run your activity in a businesslike manner and can provide supporting documents for all expenses.

(iStock)

More From Kiplinger:
The 19 Most-Overlooked Tax Deductions
QUIZ: Is It Deductible?
14 Extraordinary Tax Deductions

The opinions expressed are solely those of the author and do not necessarily reflect the views of Comcast.
See the Full Lis... Click here to see the full list of IRS Audit Red Flags.