The Top 3 IRS Audit Areas Real Estate Investors Should Know About

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As income for real estate investors increases, so have IRS audits in these areas. While it is important to minimize our tax liabilities, it is just as important that we do so in the most strategic way to protect ourselves from unwanted correspondence from the IRS.

Today, I want to write about some of the top issues that the IRS is focusing their audit efforts on. These are some of the areas where IRS agents are being trained to specifically focus on in the coming years. It’s always good to know what these areas of interests are so that we can plan for and document accordingly in case of a potential audit.

A current IRS target area is meals and entertainment deductions. The IRS has realized that a lot of taxpayers overstate company meals and entertainment expenses on their tax returns. So here is the technical rule: A meal or entertainment expense can only be claimed if business occurs immediately before, during, or after the meal. Some of you may think, “How is the IRS going to prove that I didn’t discuss business during lunch?” Well, remember that the law states that the burden of proof is on the taxpayer. In other words, the IRS doesn’t have to prove anything. It’s up to you to prove that business occurred in order for you to take the expense.

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The Top 3 IRS Audit Areas Real Estate Investors Should Know About

Meals and Entertainment

A good way to provide the support is to obtain the business card of the individual you met with. You can further substantiate that by jotting down a couple words regarding what business was discussed. If your business is in an industry that involves a lot of entertaining and eating, make sure you have sufficient documentation to support that deduction.

Related: 3 Reasons You Should LOVE the Home Office Tax Deduction

Another good fact pattern to have is to create a company policy regarding meals and entertainment. State in the policy that the company will only reimburse these expenses if business occurred before, during, or after the meal. I have seen situations where the IRS looks very favorably upon companies who have these policies in place.

Large, Vague Expenses

Another area that IRS agents love to dig into is individuals or businesses with big, unexplained expenses. Examples of these expenses are commonly called “credit card expenses” or “general and administrative expenses” or simply “other expenses.” IRS auditors love digging into these expenses because these descriptions are very vague. One of the reasons the IRS has decided to focus on these vague deductions is because this is where taxpayers typically will throw in some questionable items.

This is not to say that we should not have any general and administrative or other expenses on our tax return. Instead, what we recommend is that you try to break it out and be as descriptive as possible. An example would be instead of showing $5,000 of other expenses, you might show $1,000 for telephone, $500 for magazine subscriptions, $3,500 in continuing education, and so on. Knowing that this is an area of focus for the IRS, we recommend that you revisit your accounting and bookkeeping system. If you currently have a large balance in vague accounts such as “Other Expenses,” take the time now to separate out those expenses so that you can be more descriptive when it comes time to file your tax returns.

Related Party Transactions

Another area the IRS is ramping up efforts to audit is related party transactions. This is a fairly complicated area of the tax law, so we won’t go into details on this. But examples of related party transactions would be: 1) making a business loan to your children, 2) selling a business to your brother, or maybe 3) having one of your entities pay the other entity for services or goods. Again, this is not to say that you should avoid this type of tax mitigation strategy because frankly, these are good strategies to shift income and transfer assets. So let’s not abandon these ideas; rather, if you have these types of related party transactions, be proactive in working with your tax advisor on how to correctly document these transactions.


Now that we know some of the important areas that the IRS has been targeting, we can be proactive in minimizing our risk. One of the best ways to audit-proof our tax return is to have sufficient documentation to support the positions taken. For example, if you are a real estate professional, make sure you have the documentation that indicates the amount of time spent on qualified activities. Similarly, if you are a business owner taking auto deductions, having a mileage book will help to overcome scrutiny from the IRS.

If you are like most people, you probably hate the idea of all this documentation and tracking. As mundane as these things may be, the documentation and support are your insurance to get out of paying the IRS in the event of an audit. My recommendation is to put some steps in place to help you systemize this process.

Related: Your Complete Guide to the Real Estate Professional Tax Loophole

Create a tracking process that is simple yet thorough to capture all relevant data. Once the process is in place, make sure to use it consistently. Don’t wait until the auditor comes knocking to create your documentation!

It is important to understand that audit flags do not necessarily lead to actual audits. Don’t hesitate to take deductions you are legally entitled to. Do spend the time to make sure that you have all your ducks lined up in case of an unwanted IRS visitor.

What do you do as an investor to decrease your audit risk? Have you run into issues in any of the above mentioned areas in your business?

Leave me a comment, and let’s discuss!

About Author

Amanda Han

Amanda Han of Keystone CPA is a tax strategist who specializes in creating cutting-edge tax saving strategies for real estate investors. As real estate investors herself, Amanda has an in-depth understanding of the various aspects of investing including taxation, self-directed investing, entity structuring, and money-raising.


  1. Daniel D.

    I’m not real good at keeping a mileage log.. do you have any suggestions to overcome? One thought I had was write down each time I visited a property or went to a store for a property on a scrap of paper that was handy and save those scraps.. does that qualify as sufficient documentation? I think i am over thinking it, but does a mileage log need to have all mileage info, personal and business, or just the miles I want to deduct? For example, if I have a Home Depot receipt and it was regarding the purchase of a can of paint for a property could I just scribble the miles I drove on the receipt.. would that be sufficient?

    • Sharon Tzib

      Daniel, the way I handle business mileage is a bit old-school, but it’s always worked for me. At the beginning of every month, I put a standard envelope in my vehicle. On the outside of the envelope, I write the month/year, and then I make 4 columns: Date, Start, End, Purpose. Whenever I have a business trip, before I leave, I enter the date, start mileage, and purpose. At the end of my day (or the beginning of the next, if I forget) I fill in the end mileage, and if I had more than one business purpose (i.e. multiple meetings), that as well.

      Amanda can correct me if I’m wrong, but if I happen to be on a business related trip, and I run some personal errands, I can still write off the mileage.

      If I happen to incur any car related expenses, like tolls or parking, I put them into the envelope for safe keeping. At the end of every month, I tally the mileage and expenses and write it on the outside of the envelope, seal, and store in my tax file for the year. Come tax time, I tally all 12 envelopes easily so I can provide the info to my CPA.

      Yes, this requires a bit of organization and you must form the habit, but once you get used to doing it, it is very easy and saves you a ton of time at tax season, and should you get audited, you’ll be well prepared.

  2. David R.

    Great article Amanda! We have taken the advice of our CPA and started a process after each business meal to write down name(s) and briefly describe what specific business related topics were discussed. We usually write this information down on the bottom of our receipt copies and while we are still at the restaurant, not a couple days or weeks later.

    Once a month we will scan those receipts onto an external hard drive. We do this because those receipts tend to fade over time. Come tax time, what good is a blank piece of paper to an auditor. We’ve set up this system not just for M&E expenses but all business expenses. They then get sorted into folders based on category of business expense.

    Thanks again for the tips! )

  3. Shaun Reilly

    For the M&E is there any threshold trigger on that?
    I assume that they want to curtail the people that claim every meal they ever eat is a business meal.
    If you are only at a few hundred dollars for the whole year will they care enough to dig into that (Assuming you don’t have other red flags)?
    I keep all the receipts and feel they are all legit, but would rather not have to go through and justify every $2-8 stop at Dunkin, BK or McDs for coffee, breakfast, or lunch when I’m meeting with someone at a property 30 miles from home at a mealtime.

  4. Andrey Y.

    Another useful and clear article. Thanks Amanda!

    Would anyone recommend using a CPA if you cant find one that specializes in RE and rental properties? Since we are putting in the legwork in keeping track anyway, I would hate if the CPA ended up less knowledable in this arena than the taxpayer.

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