This article will focus on rental real estate losses. However, please keep in mind my general advice on taking tax losses is that the U.S. Tax Code is very stingy on allowing loses. So whenever you believe you are entitled to take a loss, be it a capital loss, a supplemental income loss – like a rental loss, a partnership loss, or a net business loss, my rule of thumb is to check the law, check it again, and check it a third time, just to make sure that the loss is allowed. Why? Because the Tax Code is very stingy on allowing losses.
A statute of limitations (SOL) is a law which sets a certain date, after which a party is barred from enforcing their rights. For example, generally, in New York, a person has three years from the date of injury to sue the party that injured them.
Thus, a SOL is basically a clock, an hourglass if you will, that will eventually run out of sand with the passage of time. When the sand is gone, the ability to file the law suit, or make the arrest, or assess the tax is gone.
First and foremost, the IRS is suspicious right off the bat about losses generally because losses are used to offset or absorb other taxable income, thereby reducing the loss takers overall tax liability. For a rough example, let’s say every dollar of loss reported on a tax return, takes a quarter out of the IRS’ pocket.
For this reason, (and other legal reasons) taxpayers need to be very, very cautious about taking losses on their income tax returns. The Tax Code is very stingy about individual losses. For example, are you taking flow through losses from a partnership or S–corporation? Do you have a basis? Is your investment at risk? Is your loss from a passive activity?
If you are a sole proprietor writing off your business expenses on a schedule C you should be aware that certain expenses claimed by sole props are especially vulnerable to IRS audits.
Because the IRS has limited resources to audit (or verify) that taxpayers are putting correct information on their returns, and thus, paying the correct amount of tax (and not cheating) the government targets certain types of filers more than others.
Specifically, the schedule C (and schedule E) filers are a favorite target. There are many reasons for this but the IRS can rely on two.
Every year many hundreds of thousands of businesses close because of financial downturns. Many of the owners of these businesses were clued in enough to “limit” their personal liability by choosing a corporate or limited liability company structure.
However, what they were not clued in about was that the payroll tax (or NY State sales tax) liabilities would follow them post the death of their business. An awful specter that can rise from the grave of a dead company (or a dying company) is the IRS’ responsible person assessment, or the so-called Trust Fund Recovery Penalty (TFRP).
Q: If I owe the IRS back taxes, will they file a lien against my house?
A: Generally, yes. It depends on how much you owe, how many tax years are involved and certain other variables. Also, a federal tax lien attaches to all property, houses, cars, bank accounts, paychecks, 401k accounts, etc…
Q: If the IRS filed a lien against me, can I still sell my house?
A: Yes, either the sale proceeds will pay off the lien, or the IRS will remove the lien if the proper application is made and sufficient proceeds paid to the IRS.
Many small business owners set up their businesses for federal tax purposes as a sole proprietorship – the so-called dba, by filing a “doing business as” form, which is called an assumed name business certificate in many counties. These budding entrepreneurs then go about running their new business hoping to find jobs and make money, while leaving the tax stuff to an accountant they talk to once a year.
This type of business structure has some small advantages such as low cost to establish and less forms to fill out and file annually. However, the exposure to a tax audit, in my view, far out-weighs these slim savings.