3 Ways That Investors Set Themselves Up For An IRS Audit
Navigating the world of investing can be daunting, and on this tightrope walk there are many different things that will try to sway you too far one way or the other. Here are a couple of things that might help you stay on that rope and give you a little bit of safety moving forward in your investing process.
STR “Loophole”
Entering the real estate market at year-end can be enticing, especially with whispers of promising strategies circulating on social media or at networking events. However, the rush to capitalize on opportunities, particularly those aimed at tax reduction, can lead to missteps.
For instance, the process of acquiring, renovating, and putting a property into service as a Short-Term Rental (STR) requires time and planning. Yet, some individuals view it solely as a year-end tax strategy, attempting to expedite the process in a matter of weeks.
Rushed purchases and unrealistic timelines can result in properties sitting vacant as the year closes. Claiming tax deductions based on occupancy without substantiating rental activity may raise eyebrows with the IRS, who typically scrutinize such claims.
Rental day trading
Savvy investors have learned from a wealth of educational resources available on the subject. Aware of the necessity to substantiate STR activity, they resort to creative measures when acquiring properties late in the year.
However, even with the best intentions, time constraints often hinder their ability to secure rental income before year-end. Some resort to arrangements such as "stay swaps," where rental days are traded between property owners, without genuine occupancy.
Despite perceived ingenuity, such practices may clash with IRS regulations, potentially classifying unused rental days as personal use days, thus impacting tax treatment.
Real Estate loophole
Many real estate investors engage in various activities to actively manage their rental properties, from overseeing property managers to investing time and resources in market research and education.
However, the extent of their involvement may not meet the criteria for material participation, rendering resulting losses passive rather than active. While some knowingly take this risk, hoping to offset regular income with passive losses, increased IRS scrutiny and technological advancements may expose such practices in the future, potentially leading to repercussions.
When executed with careful planning and adherence to regulations, strategies such as late-year real estate investments and creative rental arrangements can be effective tools for investors seeking to optimize their financial positions. Properly timed acquisitions and diligent rental management can yield substantial tax benefits and long-term financial gains. However, when rushed or executed without thorough understanding and compliance with relevant laws, these strategies can quickly turn problematic. Therefore, while these strategies hold promise, it's crucial for investors to approach them with caution, ensuring meticulous execution and adherence to legal and ethical standards to mitigate risks and maximize rewards.
If you have any questions about how you can save yourself from IRS audits, please feel free to call or email me at (615) 844-3398 or Jim.Maddux@raymondjames.com.
Disclosure:
Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.
