Try to stay tidy
Financial records that are neat, complete, and well-organized speed up the tax return filing process and can help you avoid mistakes. If the Internal Revenue Service has issues about your form, keeping your paperwork organized after you've submitted it will be helpful. Avoid throwing everything into a filing cabinet or shoebox.
"The biggest blunder is not being organized about what records ought to be kept,” says Neal Stern, CPA, a member of the National CPA Financial Literacy Commission of the American Institute of CPAs. “There are people who somehow believe that they should keep all of their paperwork, but they don't think through what the important paperwork is that should be kept or how it should be kept or how it should be organized."
Both those who store excessive amounts of financial paperwork and those who don't keep any files frequently struggle to locate necessary documents. “They end up having drawers full of old papers,” Stern says. “It's not much better than not having the paperwork if you can't figure out what you have and where it is.”
What to keep
You must keep any documentation that supports the amounts you included on your individual tax return. The W-2 and 1099 forms you receive from your employers, for instance, as well as any 1099-B or 1099-INT tax paperwork from banks, brokerages, and other financial institutions, should all be kept.
Keep your 1099-G form, which details the amount you received in unemployment benefits if you lost your job last year and got them from the government. The government is allowed a tax exemption of up to $10,200 of unemployment income ($20,400 for married couples filing jointly) earned in the 2020 tax year; however, this exemption vanishes for the 2021 tax year, so you will be required to pay federal income taxes on the full amount.
Keep receipts for the following if you're itemizing your deductions: credit card and other receipts, invoices, mileage records, and canceled cheques. You'll need confirmation slips (or brokerage statements), which detail the prices you paid for the investments and the proceeds you received when you sold them, if you've acquired or sold mutual fund shares, stocks, or other assets. After you sell all of your investments, keep a copy of them for at least three more years.
Similar to this, you'll need records to show what you paid and how much money you made from selling your house. Additionally, if you've sold a rental property, you'll need to keep thorough records of the sums you spent over time on the property as well as the amount you deducted for depreciation. Schedule E, the document you complete annually to report rental revenue, should be kept for as long as you hold the property.
How long to keep it
It's possible that you've heard that seven years is the ideal time to keep tax data, including returns. According to Steven Packer, CPA, of Duane Morris' Tax Accounting Group, the actual timing of keeping records isn't that straightforward.
"In most cases, tax records don't have to be kept for seven years because there's a three-year statute of limitations,” Packer explains. “So assuming there's no fraud or nothing else wrong, the IRS cannot look at your tax returns beyond that three-year statute.”
You must maintain your tax returns and documents for a period longer than three years if your tax return falls under any of the significant exceptions to the statute of limitations. The statue of limitations, for instance, is six years if you grossly understated your income. The percentage of your gross revenue that constitutes a major underestimate is 25%. If you report a gross income of $50,000 but your actual income was $100,000, you have greatly overstated your income.
If you have materially exaggerated the cost of property to reduce your taxable gain, the six-year rule still applies to you. The IRS has six years to initiate legal action against you if, for example, you sold a piece of property for $150,000 and stated that you paid $125,000 rather than the actual $50,000. Additionally, the statute of limitations is six years if you failed to report revenue from an offshore account that totaled more than $5,000.
If you submit a claim for a loss from worthless securities or bad-debt deduction, keep documents for seven years. There is no time restriction on when the IRS can press charges against you if you failed to file a return or if you filed a fraudulent return.
Property records can be forever
You must pay capital gains tax on the profit you make when you sell a property for a profit. You frequently need to keep your records for as long as you own your investment in order to calculate your capital gain. To determine the cost basis for the property, which is the actual cost adjusted upward or downward by other considerations, such as significant changes to the structure, you will require those records.
Due to the fact that the majority of people can avoid paying capital gains tax on their primary dwelling, determining the cost basis of property you live in is rather straightforward. If you sell your primary house, you can deduct up to $250,000 in gains from taxes when filing an individual return, and up to $500,000 if you file jointly. To be eligible for the exclusion, you had to reside in your residence for at least two of the previous five years. Even so, you must keep your transactional records for at least three years after selling the house.
If your sale doesn't fit the aforementioned requirements, you must maintain track of significant upgrades for at least three years following the sale. What improvements you can add to your cost basis to lower your capital gains tax is detailed in IRS Publication 523, "Selling Your Home." In the case of rental property, the same is true.
Although they only have to do so for stock transactions since 2011 and mutual fund transactions since 2012, the majority of brokerages will calculate your cost basis for stocks, bonds, and mutual funds. However, it's a good idea to maintain all of your transaction records in case your broker changes. Your broker is not required to keep your records on file forever. Keep track of any inherited property's value at the time of the owner's passing as this will serve as your tax basis.
If it gives you peace of mind and you can handle the clutter, there is nothing wrong with keeping your records longer than what is required by law. You might think about renting out some distant computer storage space in the cloud to store some of your documents.
The documents should be converted to electronic files and kept in the cloud, even if many people still preserve paper records. Having two sets is a good idea in case one is damaged. Finally, keep in mind that your state may have different regulations on record-keeping; consult your accountant or the state tax office.
