How to Prove Tax Deductions as an Investor: A Guide to Tracking Receipts

How to Prove Tax Deductions as an Investor: A Guide to Tracking Receipts

5 min read
Amanda Han

Amanda Han has been a CPA specializing in tax strategies for real estate, self-directed investing, and individual tax planning for over 18 years. She’s been investing in real estate herself for over 10 years with a focus on long-term hold residential and multifamily assets across multiple states.

Experience
As both a tax strategist and real estate investor, Amanda combines her passion of real estate investing with her expertise in tax. Her goal is to help investors with strategies designed to supercharge their wealth-building using entity structuring, self-directed investing, and income offset opportunities to keep more of what they make.

Her highly rated book Tax Strategies for the Savvy Real Estate Investor is amongst Amazon’s bestseller list. Amanda is also a frequent contributor, speaker, and educator to some of the nation’s top investment and self-directed IRA companies.

Amanda and her husband Matt MacFarland have a passion for animals and founded Animals for Armed Forces, a non-profit organization that has helped to place over 1,800 shelter pets with forever homes.

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Her cutting-edge tax strategies have been featured in prominent publications, including Money Magazine, Realtor.com, and AllBusiness.com. Amanda was a speaker at “Talks at Google” that features influential thinkers and creators. Amanda has also appeared in CNBC’s Smart Money Talk Radio, as well as BiggerPockets podcasts.

She is a 40 under 40 honoree by CPA Practice Advisor, showcased amongst the best and brightest talent in the accounting profession. Her firm Keystone CPA, Inc. was awarded a two-time winner of the Top CPA of Orange County Award by OC Metro Magazine.

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She is certified by the CA State Board of Accountancy and is a member of the prestigious American Institute of Certified Public Accountants (AICPA) with clients across the nation.

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Last week I sat down with a new client, Jesse, for some tax planning. He recently purchased his first few rental properties, and like many new investors, he wasn’t exactly sure how to document his expenses, what receipts to save, or how detailed his records needed to be. Like with all good questions, the answer once again is everyone’s favorite: “It depends.” The IRS is not always clear about what they want as proof for each deduction, and every auditor has a different definition or leniency with what they want to see. One thing to keep in mind at the end of the day is that the auditor does not have to prove anything — you do.

This may come as a shock to some of you, but in the eyes of the IRS, the taxpayer is actually guilty until proven innocent. As such, the burden of proof weighs on the taxpayer and not the IRS. With that in mind, here are some tips that Jesse and I went over that you may find helpful.

Keep Receipts

Hanging onto receipts is important when it comes time to do bookkeeping or if you need to check back on records. Digging through bank statements at year end to see what repairs were for your rentals can be tedious and sometimes not very helpful at all. For example, if you shop at Costco and purchase some printing paper for your home office, if you do not have the receipt, your bank statement will likely only show $50 paid to Costco. It will be up to the receipt to help prove that the $50 was spent on printing paper and not on baby wipes.

This is why receipts are important to hang onto.

Related: The Tax Court Case That Proves You Can Qualify as a Real Estate Professional With Only One Rental

I explained to Jesse that the IRS has a rule that if a receipt is over $75, then you need to keep it. The bank statement alone generally will not be enough proof for the deduction, as the receipt will have more information than a single line item on the statement. Invoices, receipts, and bills over $75 should all be saved to show proof for repairs, gardening, utilities, and even business meals. The larger the expense, the more likely it is that the auditor will look into it. If you are on a trip to visit properties out of state or away for a conference, then be sure to save your hotel receipts no matter how much it costs. Travel expenses are scrutinized even more so you will need to show receipts for each place that you stay.

Use a Logbook

Jesse’s first follow up question was one that I get often: “Can I throw away everything for expenses under $75?” Not necessarily. Although you aren’t required to have the receipt in an audit, that expense might help you claim another one. For example, if you fly cross country to visit your rental properties and the only receipts you have are for the flight and the hotel, how will you be able to prove that you were there for business? Logbooks are a great way to keep track of small expenses as well as meetings. If you don’t want to keep a notebook with you at all times, there are also a bunch of phone apps out there for logging expenses and mileage.

Just because an expense is under $75 doesn’t mean that you can toss the receipt. At least jot down the restaurant, date, and who you were with in your logbook so that you can look back later if necessary. In fact, to help prevent you from having to memorize what you need to keep receipts for, the simplest thing to do may be to get into the habit of just keeping all investing and business-related receipts.

Auto expenses are another instance in which a logbook, journal, or app is necessary. As I mentioned before, the larger the deduction, the more likely that it will be scrutinized, and auto expenses in some cases can be very high. Recreating your mileage at the end of the year is also much less reliable than logging miles after each trip. Recently a client of ours was selected for audit, and her auto deduction was one of the areas that the auditor chose to focus on. She had to go search through bank statements, calendars, and appointment books to attempt to recreate the deductions that she had not kept track of. The mileage that she deducted had been an estimate, and once it came to the audit, it was almost impossible to trace back to the amount listed on her tax return. In the end, the taxpayer had to recreate all of her travel logs and ended up paying a settlement amount to the IRS. Instead of going through the trouble to recreate your logs years and years later, it is important to log your mileage each time you go on a business trip or run a business-related errand.

If you are a real estate professional, then you should also be logging your hours. To qualify you must spend more time in real estate than your job(s) and meet the 750 hour minimum. You also must keep track of these hours, as your “real estate professional” status could also be questioned during an audit. In your logbook or datebook, write the date, duration, and a description of the activity. Meeting with property managers, traveling to your properties, and attending real estate conferences generally count toward the 750 hours that you need, so keep track of each activity in addition to your receipts and mileage.

Related: Smart Steps All Investors Should Take NOW for a Minimized Tax Bill Come April

When Can I Get Rid of Them?

Don’t just hang onto the receipt until you can enter the expense into QuickBooks and then toss it. Keep a box or file folder in your office, snap a picture with your phone, and keep it filed on your Google Drive or use one of the many phone apps that keep track of receipts. Another question that I’m often asked is how long receipts and tax documents should be kept. There is no hard or fast rule, but at least four years is an accepted time period, as that is the IRS’s statute of limitations. For example, for most taxpayers, the only years currently open for audit are 2012-2014. The year of 2011 and prior years are closed, unless the taxpayer has certain circumstances that allow those years to stay open or re-open. If you do not file your tax returns or are still behind on tax payment for prior years, then the IRS can reach back much further into earlier years. For receipts or other documents that relate to an investment property or assets you still own, we typically recommend you keep those until four years from the date that you dispose of those properties/assets.

Some auditors want to see practically every receipt, while others just want to glance through a few. Since you never know what they will ask for, it’s crucial to have organized proof of each business transaction. Although you may never be selected for audit, you don’t want to end up missing out on your deductions just because you threw away the proof.

What organizational system do you use to store your receipts? Any questions about documenting deductions?

Let me know with a comment!