Buying, selling and owning real estate can lead to immense wealth, it also inevitably leads to mountains of paperwork. Deeds, contracts to sell, property tax forms, income-tax forms for rental property – it adds up to a tidy pile. The IRS says you can shred most tax-related records after three years. With real estate, you usually hang on to the paperwork much longer.
Generally speaking, real estate transaction documents are held far beyond the IRS- mandated three year timeline. This is due to the immense importance and legal significance of these documents.
Buying a House
Whether you buy a house as a home or an investment, keep the closing statement as long as you own the property. Whether you pay capital gains tax when you sell depends on how much profit you make on the sale. The profit is the difference between your basis – roughly the purchase price – and the sales price. Having a record of the purchase will help prove your math if the IRS asks questions after the sale.
Making Capital Improvements
Keeping records of improvements such as a kitchen remodel, a new roof or a new deck is also important. On a rental property, you depreciate them along with the house, allowing you to write off loss of value from age on your taxes. On either investment or personal property, they affect the basis. A $10,000 kitchen remodel adds $10,000 to the basis, which lowers your capital gains when you sell.
Exploring Tax Records
A lot of expenses affect your tax bills, but not your basis. These include the amounts you pay for mortgage interest, mortgage insurance and property tax. If the home is an investment property, repair and maintenance costs are also a factor. You should keep tax records at least three years, which is the normal limit on how far back the IRS can look in an audit. If the agency accuses you of under-reporting income by 25 percent, it can go back six years. If you want to play it safe, keep records at least that long.
Selling Your Real Estate
Once you sell or otherwise dispose of a piece of real estate, you should still hang on to your records for three or six years in case the IRS decides to audit you. If for any reason you don't file a tax return for the year you sell, the IRS has no time limit on audits, so you're smart to retain your paperwork. Keep everything organized so you can find information when you need it: current records should also be kept separate from material from previous tax years, for instance.