Small Business Taxes & Management

Special Report

Recordkeping for Special Tax Items


Small Business Taxes & ManagementTM--Copyright 2021, A/N Group, Inc.




Ask a tax professionals how long do you need to keep returns and documentation and if your return is simple he or she will probably say keep the returns forever and the backup documentation for three years. That's probably all you need to know if you don't invest (outside of an IRA or 401(k)), don't have a house, etc. But if your situation is more complicated you're involved in a business, are an active investor, have rental properties, etc. In these cases you might have to save your documentation for far longer. Keep in mind that the discussion below applies generally to individual returns. There are some special


The Basics

The IRS can audit your return until three years from the date you filed the return or when the return was due, whichever is later. If the IRS finds a substantial understatement of income of more than 25 percent, the statute is extended to six years. In the case of fraud or a failure to file a return, there is no statue. There are some fine points, such as when the IRS extends the due date because of a federally declared disaster, but you file on time.

Tax returns should be kept forever. They don't take up much space and having it could be a life saver. Keep your W-2s also. You'll need to keep the documentation for mortgage interest (Form 1098, charitable contributions, medical, etc.) for the three-year period discussed above.

If you have a business and deducted, say, computer supplies, you generally need save the receipts for three years. But some other items require a much longer holding period. For example, you purchased a forklift and depreciated the item over five years. You'll have to save the documentation on the purchase and any improvements made to the item for three years after the item is disposed. Why? If the forklift is sold you'll have to recapture some or all of the depreciation and may even have a gain on the sale. Most states have similar rules, but check those for your home state. Some states do have different holding periods, particulary for employment taxes. And if you have an interest in a partnership, S corporation, rental property, etc. in another state and didn't file a return reporting the income (if required to do so), the statute of limitations doesn't expire.


Capital Gains and Losses

Capital losses can be carried forward indefinitely. You can use capital losses against ordinary income up to $3,000 per year or to offset capital gains. But if you invested $175,000 in Madison Gaming and sold out at $20,000 and you rarely generate much in the way of gains, it could take 20, 30 or more years to utilize the losses. Even if you're lucky, it could take longer than three years. You may have to show how those losses were generated and how they were utilized. That means showing the original purchase and sale information and copies of returns showing the utilization of those losses. You'll have to keep the documentation until three years after the loss is fully utilized.

If the purchase and sale occurred many years ago, the purchase and sale tickets may be your only documentation. Since 2011 brokerage firms have had to track your basis so saving the year-end statement showing the basis and sale proceeds may be suffient. The tax returns after the sale will show when and how the losses were utilized.

Gains have to tbe documented too. You may have shown a $50,000 gain on your tax return, but if you can't show your basis, the IRS can claim your basis was zero, and that can result in a much bigger gain. This one is simpler though. Since any audit of the gain is likely to be within three years, you'll have the sale documentation. The only thing you'll need is the purchase side. Again, keep in mind the 2011 new rules date.


Real Estate and Other Assets

This is another item with a long "tail". You could have bought that house 40 years ago and still own it. Or it could be the building you invested in back when your business was young. Coming up with documentation for the original purchase price might be easy, if you bought the building. But could be more difficult if you hired someone to construct it. And what about improvements over the years? The best idea is to keep a permanent file with all the documentation including closing costs, deeds, surveys, etc. It wouldn't hurt to scan the documentation and put the PDF files in a safe place.

What if you sold the home in the '90s and rolled over the gain into a house worth more? You deferred the gain on that sale so if you still owned the second home and sold it in 2021 your gain would be the current selling price less the original cost basis of 40 years ago. That's not something everyone knows and it could result in a much larger gain, especially considering the movement in house prices. A similar situation can happen in commercial or rental real estate. In commercial real estate it's called a like-kind exchange and those deferred gains can be carried forward indefinitely. Improvements to the property increase your basis and depreciation decreases it. To show depreciation you should keep all your tax returns. The more improvements and changes to the property, the more important the documentation.

While like-kind exchanges are no longer allowed for assets other than real estate, you could have bought equipment, and traded it in multiple times in prior years. A truck may have been traded in five, six, or more times over a 30-year span. Fortunately an IRS agent is unlikely to ask for original documentation on a pickup truck, he could certainly do so for large farm machinery or construction equipment. Again, you'll need cost basis, improvements, and depreciation over that time period.


Net Operating Losses

These are often used up relatively fast, but not always. Many businesses had huge losses last year and those losses can be used to offset future profits. For some taxpayers those losses may be around for some time. You can't just show the agent the tax return from the loss year. You'll have to have all the documentation to prove the loss including your accounting records (general ledger, etc.) and invoices and checks and bank statements proving each item.

In addition, you'll have to show how you utilized the loss over the years. Basically that means copies of the tax returns and schedules you used to arrive at the losses.


Business Credits

Business credits offset taxes, but if you have little or no income you probably have little or no taxes. If the credits can't be used currently, they can be carried forward. The rule here is much like for net operating losses, but you'll only need data on the amount of the credit and how it was utilized.


Installment Sales

An installment sale may be reported on a return for 5, 10, 20 years, or even longer. You'll need the orginal basis in the property, and improvements made, depreciation taken (from tax returns) and a copy of the sale document. After that you'll need the tax returns reporting the income over the years.


Passive Losses, At-Risk Limitation, Basis Limitation

Passive activities (e.g. rental real estate) can generate substantial losses over the years. You may not be able to take the losses until you have offsetting passive income or the property is disposed of. Other reasons for carry forward losses are the at-risk and basis limitations. The issues here are like those of a net operating losses. You may have to show how you arrived at the losses. For example, you bought the Madison Street property 20 years ago and have incurred losses each year. You'll need the documentation on the expenses and income for the property for those years. Fortunately, if you keep good records and enter data correctly, tax programs will track the losses by property or entity.


Start-up Expenses, Goodwill, etc.

Business start-up expenses (such as pre-opening advertising, employee training, stocking shelves, etc.) before opening must be capitalized (depending on total expenditures a taxpayer may deduct up to $5,000) and can be amortized over 180 months. The IRS could go back and ask for the schedule of how you calculated the initial expenses and the amortization over the years. The Service could also ask for the supporting documentation.

Goodwill, often associated with the purchase of a business or part of a business can't be deducted currently. It too must be amortized over 180 months. Fortunately the documentation here is often less complex.


Gifts, Partnerships, and S Corporations

If you leave those 100 acres of farmland to your nephew when you die, his basis will be the fair market value at the time of your death. To document his basis, all he needs is the appraisal at the time of your death. Give him the farmland and his basis will your original basis. If the gift is large enough (over $15,000 in 2021) you'll have to file a gift tax return.

Your basis in a partnership, LLC, or S corporation will be your original investment plus any loans plus any profits less any distributions or losses. (It's more complicated, but in many cases it could be that simple.) You should track your basis each year because on the sale of the S corporation, etc., that basis will be used to determine your gain or loss on the sale. Most tax preparation software contains schedules to assist you.


IRS Audits

The IRS audits your return and disallows some charitable contributions. It takes no action on the net operating loss (NOL) being carried forward. You're not out of the woods. If you use some of that NOL five years later, the IRS can challenge it at that time. Only if the IRS examines the NOL and leaves it unchanged or makes an adjustment can you rest easy. (Of course, you could still be challenged on the utilization of the NOL moving forward.)


Best Advice?

Talk to your tax adviser about recordkeeping, particularly on more important items. And the more complex your tax situation, the more competent your adviser should be.


Copyright 2021 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536

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--Last Update 07/16/21