The burden of proof for line items on a tax return is always on the taxpayer’s shoulders.
Tax agencies generally have three years from the filing date of the tax return to provide notice of an audit.
Documentation is categorized as either permanent or temporary. Permanent records are documents that may be needed for a future tax return and include items such as:
- Purchase and improvement records for your home
- Cost basis for investments such as stocks and bonds
- Cost basis for rental properties (purchase and capital improvements)
Permanent records don’t have a specific retention period. These are kept for as long as you hold the investment and at least three years from the date the tax return is filed that reports the sale of the item.
Another example is the basis of a rental property that was acquired in a 1031 exchange. The documentation for the cost of the property (and capital improvements) and acquisition of the subsequent property (applies to every property in the exchange history) must be kept following the procedure discussed previously.
Temporary records are those used to prepare a current year tax return and do not impact a future return.
Items include Forms such as W-2, 1099 and 1098.
Documentation of deductions such as charitable contributions or a casualty loss is additional examples.
I suggest keeping four years from the current year to allow for extension periods (e.g. we’re in 2017 so destroy records prior to 2013).
Documents can be stored electronically, in fact, I highly encourage scanning documents! Be sure to have multiple backups of your data to prevent anxiety that comes with hard drive failure!
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