Treasury Inspector General Says IRS Should Increase Audits of Tax Returns with Real Estate Rental Losses

In a report dated December 20, 2010, the Treasury Inspector General for Tax Administration (TIG) concluded that 53% of individual taxpayers misreported their rental real estate (RRE) activity.  An estimated $12.4 billion was under reported.  The TIG recommended that the IRS analyze tax returns with RRE losses to determine which returns to include in Compliance Initiative Programs (specialized audits), revise the Form 8582 instructions to require all taxpayers with suspended RRE passive losses to include the form in each year's tax return, and to record which taxpayers claim to be real estate professionals who are exempted from the passive loss limitations.

The IRS is already gathering some additional information on RRE activities by requiring addresses of each property be reported on 2010 tax returns, indicating the type of property (e.g. residential, commercial, etc.), and reporting the number of days rented at fair value or used personally.  In addition, the Small Business Jobs Act of 2010 requires owners of RRE activities to file Form 1099s for all service providers to whom more than $600 is paid, beginning in 2011.

Clearly the government sees some abuses by taxpayers in the tax reporting of RRE activities.  It is important that taxpayers have good records and documentation of income and expenses for each activity, and that they comply with the passive activity loss regulations.  Such records and compliance may be audited more frequently in the future based upon the TIG's recommendations.