Protect Your Profits: Common IRS Audit Triggers for REIs

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A few weeks ago, when the IRS (Internal Revenue Service) fired 7,000 workers, we head-hunted one of the auditors we were dealing with on behalf of a client.

With her extensive experience as an 'ex-IRS Auditor,' Holly brings a unique and insightful perspective into what triggers an audit.

Here's a quick take on what was happening before the mass purging of government employees and what is likely happening with the new landscape of more AI (Artificial Intelligence) and fewer boots on the ground in the tax collection world. With the reduction in the IRS workforce, the agency is increasingly relying on AI and automated systems to identify potential audit triggers, making it more important than ever for investors to be aware of these triggers.

1. High-Income Investors: The algorithm is designed to detect significant earnings. High earners, with their numerous opportunities for additional deductions, also have more chances to make errors in their reporting, making them more susceptible to audits.

2. Unreported Income: Here again, an investor has more opportunities to "miss" some income. Holly says, "You have no idea how much data an auditor has in about eighteen keystrokes." The IRS doesn't 'miss' very much.

3. Excessive Deductions: Holly says, "One of the first high-level reviews of a tax return is looking for numbers too high or too low for the investor's reported income. For instance, if an investor with a reported income of $100,000 claims $80,000 in deductions, this might raise a red flag. Similarly, if the same investor claims only $5,000 in deductions, this could also trigger an audit."

4. Self-Employment Income: "Hallucinations about how little a Single Member LLC doing $4MM yet only pays $85K to the owner." What is reasonable compensation?

5. Cash-Intensive Businesses: Businesses that rely heavily on cash transactions are more likely to be audited. There is a paper trail if the money goes into a bank account. If someone pays $10K a year in auto insurance on a reported $150K income, cash is walking out the door in someone's pocket and driving away in an Italian sports car.

6. Foreign Accounts: Some salesperson sold you a tax-dodge in the Caymans. Those numbers are, "not going to add up."

7. Earned Income Tax Credit (EITC): Here's another deal where salespeople (who are not Tax Strategists) run a 'mill' processing EITC credits for commission and no concern for business qualifications. Lots of fraud in this area, "so this is a big payday for an IRS auditor."

There you have it, straight from the IRS Auditor's mouth.

Remember, even if you're diligent in avoiding the triggers mentioned above, there's no foolproof way to prevent a tax controversy. Sometimes, it's just a matter of chance.

The above considerations will get you ahead of the auditing game if the IRS decides to review your tax affairs. And these are the things that we will cover in future blog posts.

Warmly, Janet, the Tax Wizard