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Record Retention Guidance for Individual Taxpayers

08.29.14

"What documents should I keep?” and “For how long?" are two of the most common questions we hear from our individual tax clients. Our typical response begins with, "That depends." While individual facts and circumstances make it impossible to provide bright line guidance, there are rules that dictate your responsibilities as an individual income taxpayer to retain the information necessary to support your tax returns.

The federal and state tax codes contain Statutes of Limitations provisions that determine how long you need to retain information reported on, or necessary for the preparation of, your tax return. Once the applicable statute of limitations expires, the IRS (Internal Revenue Service) or state tax authority can no longer make adjustments to your tax returns for that year and you can no longer file an amended tax return. The basic Statutes of Limitations include:

  • The IRS can review or audit your tax return and assess additional taxes for three years after it is filed or the due date (including extensions, if requested) if later. Some states have a longer statute of limitations. In California, the statute of limitations is four years.
  • The statute of limitations for federal and California purposes is extended to six years if your income is understated by more than 25% of the gross income reported on your tax return and the understated amount is not disclosed in the return or in a statement attached to the return.
  • If you claimed a loss for a worthless security or a bad debt deduction, the statute of limitations for filing an amended tax return is seven years.
  • If you did not file a tax return, or if the tax return filed is false or fraudulent, the statute of limitations is unlimited. We recommend that you maintain copies of your tax returns, Forms W-2, and proof of mailing indefinitely so that you have evidence of your timely filing.

For certain items on your tax return, you may be required to keep records for many years. For example, for every capital asset reported on your tax return, you are required to maintain records to support the cost basis of the asset so that you can properly report the gain or loss upon sale or other disposition. This includes:

  • For stocks and other publicly-traded securities, your cost basis is the purchase price plus any reinvested dividends or mutual fund distributions. Fortunately, most brokerage firms track this information for you. For non-publicly-traded securities, you may need to track this information yourself.
  • The recordkeeping requirements to determine the cost basis for so-called "pass-through entities" (partnerships, S corporations, hedge funds, etc.) can be onerous. For these assets, in most situations, you will be on your own to maintain records tracking your initial investment, all subsequent investments, all distributions, and all items reported on Schedules K-1 for the duration of your investment.
  • Documentation to be maintained for real estate assets include escrow statements for purchases, refinancings, and sales and records of expenditures for permanent improvements (e.g., invoices, payments, photos, building permits, and plans). If the property was ever rented or partially used as a home office, records to substantiate the business expenses, including depreciation, should be maintained until the end of the statute of limitations for the year in which the real estate is sold or otherwise disposed of. Special rules may apply if you purchased your current primary residence prior to May 7, 1997.

You may have attributes on your individual tax return that can cause the statute of limitations to extend beyond the normal period. For net capital losses in a given year, you are limited to a $3,000 capital loss in that year. The balance of the capital loss is carried forward indefinitely to be used against net capital gains in future years. In this situation, the statute of limitations for the year in which the net capital loss is incurred is measured from the year in which the capital loss carryforward is fully utilized. For example, if you have a $100,000 net capital loss in 2008 and you fully utilize the capital loss carryforward in 2013, the federal statute of limitations on your 2008 tax return expires in 2017 (to the extent of the carryforward loss).

Other individual tax attributes that can act to extend the statute of limitations include:

  • Net operating loss carryforwards
  • Passive activity loss and/or credit carryforwards
  • Carryforwards of itemized deductions (e.g., charitable contributions or investment interest expense)
  • Foreign tax credit carryforwards
  • Installment sales of assets
  • Nondeductible retirement plan contributions

This discussion is general in nature and is not intended to cover all individual tax situations. You may have non-tax reasons (e.g., insurance or creditors) to retain some records longer than indicated here. For more information on this topic, please contact your BPM Advisor, call (415) 421-5757, or email bpm@bpmcpa.com. BPM is here to advise how these rules apply to your particular circumstances and to recommend an appropriate record retention plan.

BPM is here to assist you
BPM is one of the largest California-based accounting and consulting firms, ranking in the top 50 in the country. It has served the San Francisco Bay Area's emerging and mid-cap businesses, as well as high net-worth individuals, since 1986. Our Private Client Services group assists high net-worth families, executives, and business owners seeking integrated tax strategies. By understanding your needs and goals, we are able to craft intelligent, personalized tax roadmaps that minimize your risks and maximize your peace of mind. For more information or to learn how we can help, contact Sandy Murray, CPA at (415) 288-6223 or Rich McDonnell, CPA at (650) 855-6880, or visit us at our website.