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01/24/09: How Long Do I Have To Keep Financial Records

Housing Counsel

By Benny L. Kass

(Last in a Series)

“The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the Smallest possible amount of hissing”

Jean Baptiste Colbert (1619-83)

Your income tax return is due Wednesday, April 15, 2009. While many of us procrastinate and wait til the very last minute, now is a good time to start organizing your financial records from last year. It is also a good time to make sure you keep the books and records that you will need in the future and that the IRS requires you to hang on to.

You probably already received form 1098 from your lender indicating the amount of mortgage interest you paid in 2008. Take a few minutes to confirm that this information is correct. Computers and lenders can – and do – make mistakes.

Did you make any significant improvements to your home last year? If so, while this information may not be relevant for your 2008 tax return, it will definitely be important when you go to sell your house.

The IRS calculates gain by deducting the purchase price from the selling price. Let’s take this example. You paid $300,000 for your home several years ago, and expect to sell it this year for $800,000. You are married and file a joint tax return, so you are home free. You can exclude up-to-$500,000 of your gain.

But if you are single, you can only exclude up to $250,000 of that $500,000 profit you will make. Here is where improvements come into play. If over the years, you have made a number of changes to your house – a new room, updated your kitchen or your bathroom – all of the costs associated with these improvements will increase your tax basis. So in our example, if you can prove that you added $100,000 to your house, your adjusted tax basis is now $400,000 (instead of $300,000), and your profit has dropped down to $400,000 ($800,000 -$400,000). Now, you will only have to pay capital gains tax on the difference above the $250,000 exclusion – namely $150,000.

The current capital gains tax rate is 15 percent to the federal government (although it may be increased under the new administration). The improvements to your house will save you $15,000 in federal tax, as well as savings for any applicable state or local tax you may have to pay.

While not absolutely critical, it certainly helps if you have proof of your improvements. Keep copies of any construction/renovation contracts, invoices you paid for supplies and materials, and copies of cancelled checks (or at least your bank statements if your bank does not send you copies of your checks). There is an old case involving the singer-playwright George M. Cohan. Apparently he was too busy to deal with his financial situation. When audited by the IRS, he attempted to explain all of his expenses – which the IRS rejected. However, when the matter went to court, the judge allowed some of his claims, stating -in effect – the fact that a person does not have documents and records does not mean that he does not exist.

You certainly exist, but it would make more sense to keep all of your records in case you are ever audited.

The Internal Revenue Service periodically issues tax tips, which are very helpful. One such tip is entitled “What Tax Records to Keep”. According to the IRS, there is no special manner in which records are to be kept. “Generally speaking, however, you should keep any and all documents that may have an impact on your federal tax return”. Included in the suggested IRS list are ” bills, credit cards and other records, invoices, mileage logs, cancelled, imaged or substitute checks or any other proof of payment,” and any other records to support deductions or credits you claim on your return. (IRS TT-2009-08, January 14, 2009).

Notwithstanding Mr. Cohan, keeping records is not optional. According to IRS regulations, taxpayers are required to ” keep such permanent books of account or records, including inventories, as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return of such tax or information” And furthermore, these records must be retained for as long as they may be – or may become — “material” for any federal tax purpose. (IRS Regulation 1.6001-1).

What does “material” mean? Generally, the IRS can audit and challenge your tax return for the later of three years after your was due or filed, or two years after the tax is paid. However, there are many exceptions. For example, if it is determined that you have underpaid your tax in excess of 25 percent, then the IRS has six years in which to take action against you. Additionally, criminal prosecutions involving such matters as fraud, failure to file a tax return in any one year, or filing a false statement also extends the statute for six years.

Many homeowners prepare their own tax returns, and use a computer program for assistance. Others will use a tax preparer or accountant. But, as the IRS recently warned, “you are legally responsible for what’s on your tax returns, even if they are prepared by someone else” (Tax Tip 2009-07).

For more information about your financial records, check out IRS Publication 552, entitled “Recordkeeping for Individuals”, which is available on line ( Alternatively, you can contact the IRS directly by telephone: 1-800-TAXFORM ((800 829-3676), to order forms, instructions and publications. Between now and April 15th, the Martin Luther King public library (and many branch libraries) should have some information to assist you in preparing your 2008 income tax return.