One of the IRS’s major taxation groups is individuals with rental income. Small scale rental business is huge in the U.S. and definitely has a significant impact on the taxes collected every year. For this reason, the IRS and other tax authorities keep scrutinizing and reevaluating rental business to ensure that all landlords pay their full dues to Uncle Sam. Some of the recent developments in these areas of rental income are given below:
The Tax Reform Act of 1986
The Tax Reform Act of 1986 was introduced to try and curb the excessive misuse of tax provisions to avoid paying taxes for rental property income. There were many rental properties that made losses continually and used the losses against future revenues. The Act introduced the Passive Activity Loss (PAL) that was losses made from such activity like rental property. The Act placed a limit on the deductions on the amount of loss from rental income. However, as part of the implementation of this ACT of 1986, the IRS has made adjustments to the Form 8582, Passive Activity Loss Limitations, that captures the Reform Act. The adjustments to this form will take effect in the 2011 tax returns and will require individuals with rental losses even from prior years to submit the form with loss details.
Government Accountability Office Report on Rental Income
As part of the efforts taken by tax and government revenue authorities to address diligence in tax collection from rental properties, a review was undertaken by the Government Accountability Office in 2008 on tax returns done by individuals with rental property. The review report revealed that misreporting of rental income in 2001 lead to uncollected taxes of about $12.4 billion. According to the report, more than 50% of all individuals with rental property provided incorrect information that did not adhere to the guidelines of the IRS. The report by the Government Accountability Office drew more attention to incomes from rentals as an area of focus towards reducing the tax gap.
TIGTA Recommendations on Rental Income Tax Scrutiny
Following this report by the Government Accountability Office, the Treasury Inspector General for Tax Administration, an office charged with reviewing the effectiveness of the IRS, took on its own review of the tax on rental income and indeed found that the IRS was not that effective in collecting taxes related to rental income. In its report, TIGTA projected that the IRS would increase taxes by $27.3 million in the next 5 years if they audited more rental property claims and insisted that the IRS pay more attention to rental taxation from here on out.
Expected Increase in IRS Audits
In its recommendations to the IRS, TIGTA suggested July 15, 2013 to be the commencement time for the IRS audit on rental income in a bid to narrow the tax gap based on the loss of taxes through rental income. The TIGTA suggested that the Small Business/Self-Employed Division director of IRS audits be involved in further scrutinizing the rental income returns to find out the tax returns that have erroneous reporting. This will simply result in more IRS audits for small scale rental property returns.
The IRS Responds to the Pressure on Rental Income Taxes
The IRS still remains reserved on a start date on audits for rental property related returns and instead, chooses to address the immediate review of the problem by monitoring the various corrective measures put in place through its internal management controls. The corrective measures for the rental taxes loopholes include the revision on the Form 8582, Passive Activity Loss Limitations and the IRS requiring all the real estate professionals to schedule their net rental income losses and earnings as part of their tax returns for comparison purposes. This is to take effect from the 2011 tax year onwards.
Either way, the scrutinizing of people with incomes from rental property is set to increase in the foreseeable future. This may happen through increased IRS audits or increased internal reviews for people with rental income. Therefore, to remain on the safe side, it is best for every person with rental property to thoroughly understand IRS tax reporting guidelines for rental income and to comply accordingly.