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IRS looks to cut rental tax losses

By Kay Bell ·
Thursday, March 10, 2011
Posted: 2 pm ET

The Internal Revenue Service needs to keep a closer eye on landlords. They apparently are not reporting all their income.

That's the word from the Treasury Inspector General for Tax Administration, or TIGTA, the federal office that keeps tabs on the IRS. TIGTA recently looked more closely at rental activity and its associated tax revenue because in August 2008, the Government Accountability Office reported that more than half of taxpayers with rental real estate activity in 2001 misreported their income and losses to the tune of $12.4 billion.

So what did TIGTA's follow-up find? That the IRS is indeed leaving lots of rental tax money uncollected.

If the IRS reviewed more returns that contained rental real estate claims, the U.S. Treasury would grow by $27.3 million over five years.

"Given the magnitude of underreporting in our voluntary system of tax compliance, even small improvements in the IRS’s examination of tax returns with rental real estate activity could increase taxpayer compliance and generate substantial additional revenue to the federal government, helping reduce the tax gap," said TIGTA Inspector General Russell George in the report's preface.

While the IRS questions whether that much rental income money is going uncollected, it doesn't dispute that there's room for improvement here.

The tax agency agrees with TIGTA recommendations, including the one calling for the its Small Business/Self-Employed Division director of examination ("examination" is what the IRS calls audits) to conduct an analysis to determine which tax returns with rental real estate activity need a closer look.

If that analysis does find tax returns with questionable rental real estate activity, the IRS will increase its audits of such returns.

When will these additional audits happen? TIGTA recommends they start by July 15, 2013. The IRS says it will "monitor this corrective action as part of our internal management system of controls." Essentially, that means the IRS will get to it when it has sufficient resources.

But this tax year, the agency will begin implementing another TIGTA suggestion regarding rental real estate income reporting.

The Tax Reform Act of 1986 created passive activity loss, or PAL, rules that limit deductions for rental real estate activity losses. To reduce some of the revenue loss in these claims, the IRS plans to revise the 2011 tax year instructions for Form 8582, Passive Activity Loss Limitations. The change will mean that taxpayers with prior year unallowed passive activity losses must submit the form with their tax return.

The IRS also plans, per TIGTA's recommendation, to require this 2011 tax year that real estate professionals report the net amount of income earned or lost.

The bottom line for folks with rental property is to make sure you know and follow the tax rules. The IRS is expecting to get more money from this sector and it's going to start auditing returns it believes will help it reach that goal.

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taxservice2u CA
April 01, 2011 at 1:06 am

Beth, I don't think you need an EIN/TIN from your tennant. Tax law has no notion of non-profit for individual landlords. You say you charge for taxes and insurance, consider also charging for (and deducting) depreciation, separately on both the structure and any improvements, to help fund the future replacement of any ageing items (roof, water heater, repainting, plumbing, windows, fence etc.) Yes, consider having a professional do your return. In addition to the time you will save, lenders often want to look at the applicant's tax return, which might have more credibility if signed by a CPA preparer.

March 18, 2011 at 9:56 am

this is my first tax return to have rental property, it was for 1/2 the year and after spending multiple hours reading the tax laws and trying to do it correctly with Turbo Tax, I think I will do better to have a professional do my taxes next year.
What is the difference in taxes if it is "not for profit" ( I charge what my house costs me including taxes and insurance)and is that the same thing as passive vs active participation?
Another thing I was surprised about was that I needed an EIN (employer? or employee?)or soc.sec# for the person who is paying me rent for my house. Is that standard procedure?
What do you recommend for me to get more informed and better educated on being a landlord?
thanks, beth in texas

March 17, 2011 at 4:16 pm

One has to laugh at the IRS's claim that they could bring in $27 million more with additional audits of landlords. In the scheme of a $14 trillion deficit, this amount is nothing. The IRS has wasted many times that sum on attempting to implement new computer systems that still don't work decades after the efforts and the public expenditures began.

Commercial landlords are generally 1099 recipients for tenant-paid rents. . .nothing to hide there and those sums are substantial. That only leaves individual, residential landlords to pursue because no 1099s are generated by their tenants.

A "voluntary tax compliance system?" Please, we have no such tax system in this country. One hundred thousand plus IRS employees are in the business of extracting as much money as possible through intimidation, threats, levys and the full force of the Federal Government. And they have tens of thousands of pages of tax code to fall back on when they run out of ideas.

CPA Miami
March 11, 2011 at 10:33 am

Great article! In an attempt to raise revenues, its clear the IRS is specifically targeting new groups of taxpayers which now includes "landlords" and other real estate professionals. This is further illustrated in the new 1099-MISC reporting requirements targeting landlords. Considering IRS examinations for 2008 have just begun, taxpayers are well advised to implement more conservative reporting procedures for 2010 and succeeding tax years.