Recordkeeping Retention

Published on Friday, November 30, 2018

Recordkeeping Retention

You may be in the garage looking at boxes of tax records and wondering if you can finally shred some of them.  Although we often recommend six years, the answer is, it depends!

So, how long do you have to keep your individual tax returns?  The usual answer from the IRS is at least three years after the filing date, but there might be extenuating circumstances.  Also, keep in mind the three-year limit only applies from the date the IRS has the document in its possession.  It’s good to note that the IRS can go back as far as six years to access additional tax for omission of more than 25 percent of the amount that was due and there is no time limit if fraud is involved.

What are some examples of why I might need to keep tax returns more than the three years noted above, you ask? 

• If you have a capital loss carry forward, you should keep the tax return on which the original loss was reported.  Also, keep the documentation that supports the original loss.  You will need to keep these documents up to four years after the loss has been used up.
• If you sold rental real estate via a 1031 exchange, keep the tax returns and supporting documents until four years after the disposition of the final property in the exchange sequence.
• If you have passive loss carry forwards, tax credit carry forwards, net operating loss carry forwards, or any other types of carry forward, you need to retain the tax return where the carry forward originated.
• When you sell a house where the basis for gain purposes can be increased by the cost of home improvements.  Home improvements and similar expenses that can reduce a taxable gain should be documented and will be needed if you are ever audited.
• If you sold your previous home before May 7, 1997, and deferred tax on the gain from that (rolled into the basis of your new home).  You should keep that tax return indefinitely, the escrow closing papers, and a copy of IRS Form 2119, which establishes the basis of your new home.
• IRA contribution statements Form 5498, Form 1099-R, and IRS Form 8606, should be kept until you take the last distribution from your IRA.

The IRS does not require you to keep your records in a particular way.  Keep them in a manner that allows you and the IRS to determine your correct tax. For easy retrieval, consider keeping them by year and type of income or expense.

One easy solution to shredding the box of old returns would be to keep an electronic record.  The IRS requires the same of paper files and electronic, they must be complete.  This means that anything that was used to prepare the return must be scanned in the file with the original tax return.  The file must include complete and accurate records of your data that is accessible to the IRS.  If not, you may be subject to penalties for non-compliance, unless you continue to maintain your original hard copy.  Retention of these files follow the same guidelines as the paper copy.

Although the bulky files can be annoying, remember that keeping this documentation is the way that you prove your income and expenses.  Good record keeping becomes invaluable if you are ever audited.

Michelle Britain
Firm Administrator