The most frequently asked question in personal finance is how long you should keep your tax returns.
Did you know that the average American spends over 13 hours a year on federal tax returns? This figure nearly doubles for small business owners to 24 hours.
Once you’ve filed your taxes for the year, it is always a relief. What do you do after filing your taxes? How long do you need to keep your tax records and returns?
Three years is usually a good period of time for most people. However, it can be longer in some situations. It can also be a good thing to keep records for longer than required, for reasons other than tax.
Find out how long to keep your tax documents in your specific situation. You may be surprised by the answer!
Table of Contents
What is the Limitation Period?
IRS: How long to keep tax returns
Unique Requirements for Property Owners
How long should I keep my tax returns as a small business owner?
What If I have claimed investment losses or bad debt write-offs?
How long to keep state tax returns
Summary of How long to keep tax returns
What is the Limitation Period?
Let’s begin with some definitions. The IRS uses some confusing terminology when it comes to determining how long you should keep your tax returns.
The IRS defines the period of limitation as “the time you have to amend your tax return in order to claim a refund or credit, or else the IRS will assess an additional tax.”
Keep all your tax documents for the applicable period of limitation. We’ll go into more detail about this below.
The period of limitation begins when the tax return is filed. Tax returns filed before the due date are treated as if they were filed on that day.
If you had to file your taxes on April 15, but did so in February, then the clock will still start on April 15. If you filed your taxes on September 15th and got an extension, the limitations period would begin on that date.
IRS: How long to keep tax returns
The IRS recommends storing the tax return for as long as possible. That is something I completely agree with. There’s no need to throw away your tax returns, especially in this digital age where everything is stored on a computer or cloud.
Tax returns from the past can be used to prepare future tax returns, and calculate amended tax returns when necessary. If you have rental property, as I do you can depreciate that over a period of 27.5 years.
When I do my taxes, it is much easier when I have my past tax returns to use as a reference.
Many other documents, including W-2 forms and 1099s as well as charitable receipts, mileage logs and more, can also be used to support your tax return. How long do you need to keep these documents?
The IRS website has the latest information on the limitations period and the application of the rules.
The Limitation Period for Income Tax Returns
If you do not fall into the situations (4),(5) and(6) below, keep records for three years.
If you claim a refund or credit after filing your tax return, you should keep records for at least 3 years.
If you are filing a claim to recover a loss due to worthless securities, or a bad debt deduction, keep records for seven years.
If you fail to report income, or if it exceeds 25% of your gross income on your tax return, you must keep records for six years.
If you don’t file a tax return, keep records for as long as possible.
If you have filed a fraudulent tax return, keep all records for as long as possible.
Keep records of employment tax for at least four years after the tax is due or paid, whichever comes later.
Most people will keep their tax records for three to seven year. Remember that the limitation period begins either at the date you filed your tax return, or the date the tax was due. You can keep your records for up to seven years if you wish to be safe and not have to read the fine print or figure out how it will apply to you.
If you’d like to go a bit deeper, we will discuss some specific scenarios in the next section.
It is interesting to note that the IRS recommends keeping records indefinitely, if you don’t file a tax return or if it was fraudulent. The readers of this article should not be in this category, but I want to make it clear that there is no time limit on the IRS’s ability to pursue you for filing a false income tax return.
Please don’t!
Unique Requirements for Property Owners
The first exception to the rule is keeping records of tax on property (such as a personal home, car, or rental property).
IRS says you must keep all records of property until the expiration of the limitation period for the year you sold the property.
If the limitation period is three years, then you must keep all records of property for at least that long. This would include any documents that support your depreciation calculations, amortization or depletion deductions.
If you purchased a home 20 years ago, and you sold it this year you will need to retain any documents related to the property to support deductions on your tax returns for another three years. You would need to keep loan documents and closing statements from the time you bought the property.
The 1031 exchange is another thing to think about, especially if your investment is in real estate. If you use a 1031 tax exchange to defer taxes, by selling an investment property and purchasing another, you must keep records of the property for at least three years after the sale.
The cost basis of an old property is used to determine the cost base of a new one. You will need to keep a record of all your previous transactions in order for you prove the gain or loss that was made on the sale.
I will keep all records of property forever as a rule. You can easily digitize your property records. This is useful for other reasons than just preparing your taxes. For example, you could use them to apply for a refinance or cash out loan.
As a real-estate investor, I have learned that it is important to maintain good records of rental accounting and bookkeeping throughout the year. This makes tax time much easier because I don’t have to scramble for months of receipts or expense records.
You need good software to prepare your taxes? Consider these options:
TurboTax
Liberty Tax
TaxSlayer
How long should I keep my tax returns as a small business owner?
There are special considerations if you have a small company, a side gig or freelance job, or a large portion of your income comes from 1099s, under-the-table work, etc.
It’s easy (and not intentionally) to forget about reporting income if you get a lot 1099s. The IRS has six years to audit your account if you haven’t reported at least 25%.
To be on the safe side, business owners should keep 1099s for at least six years and any other records of income and expenses.
It also applies to people who have a W-2 but receive significant income from side jobs or other sources. This is not for you if you are using apps to earn an extra $20 or so. If you have a side business as a financial analyst and it is generating a good amount of income, then I strongly recommend that you follow the guidelines provided in this section.
What If I have claimed investment losses or bad debt write-offs?
You may lose a lot of money on your investments, whether it’s a business, a stock or a loan to a deadbeat uncle.
You can use this loss as a deduction for your income on your tax returns. According to the IRS, if you file a claim for a loss due to a bad debt or an investment that is worthless, it will trigger a seven-year limitation period. You’ll need to retain your tax records at least for seven years to be prepared in the event of an IRS audit.
How long to keep state tax returns
If you follow the IRS guidelines on how long to retain federal tax returns, it is likely that your state tax records will be safe as well.
Check your state’s requirements. It may take some states longer to audit state tax returns than it does for the IRS to audit federal tax returns.
In California, for example, you have a four-year period to audit your state tax return. You should keep all your records at least for four years if you live in California.
Summary of How long to keep tax returns
Tax preparation and filing is never enjoyable, but worrying about the length of time you should keep your records and tax returns can be even more stressful. The IRS has provided some guidelines and rules to help you.
There is no perfect solution. To be on the safe side, you should keep all documents related to taxes for at least seven years. If you are employed by a corporation and have a W-2, but no significant property investments or losses, three years should be enough.
This is a brief summary to round things off:
Keep tax records at least three years after the date of filing.
It’s better to keep your tax records at least for six years if you have a small company or multiple sources of income.
Keep your tax records at least for seven years if you are claiming a loss on an investment or bad debt.
Keep all tax and purchase records for your property for at least 3 years after you sell it.
This article was originally published on Wealth of Geeks. It has been republished by permission.
