46.1 Keeping Tax Records

To maximize tax-savings opportunities, you must keep good records throughout the year. Good record-keeping makes it easier to prepare your return, reduces errors, and provides a defense to any challenge from the IRS.

• Make a habit of jotting down deductible items as they come along.
• Keep a calender or diary of expenses to record deductible items.
• Keep a file of bills and receipts. This will remind you of deductible items and provide you with supporting evidence to present to the IRS if audited.
• Use your credit card receipts, online account statements, and checkbook stubs as a record. If you own a business, you must keep a complete set of account books for it.

IRA records.

If you have made nondeductible contributions to a traditional IRA, keep a record of both your nondeductible and deductible contributions. This will help you when you withdraw IRA money to figure the tax-free and taxed parts of the withdrawal (8.9). Also keep records of contributions and conversions to Roth IRAs (8.20–8.21). For these purposes, you should keep copies of Form 8606 and Form 5498 (8.8).

Reinvested mutual-fund or ETF distributions.

Keep annual statements that record the amount of mutual-fund or ETF distributions that you have reinvested in additional fund shares. The reinvested amounts are part of your cost basis in the fund. Unless your fund keeps track of basis for you, you need to know your basis when computing gain or loss on the redemption of fund shares (32.10).

IRS Alert

Getting a Copy of an Old Tax Return

You can obtain a copy of a prior year tax return from the IRS by filing Form 4506 and paying a $57 fee per return. Copies of Forms 1040, 1040A, and 1040EZ are generally available for seven years from filing before they are destroyed.

You can use Form 4506-T to order free of charge a transcript of tax return information that provides line entries from tax returns for the three prior years and a transcript of data from Forms W-2 and 1099 for up to 10 years in some cases.

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Passive losses.

If you have losses that are suspended and carried forward to future years under the passive loss restrictions (10.13), keep the worksheets to Form 8582 as a record of the carry-forward losses.

Home mortgage interest.

Keep your bank statements and cancelled checks. If a loan secured by a first or second home is used to make substantial home improvements, keep records of the improvement costs to support your home interest deduction (15.5).

How long should you keep your records?

Your records should be kept for a minimum of three years after the year to which they are applicable, since the IRS generally has three years from the date your return is filed to audit your return. Some authorities advise keeping them for six years, since in some cases where income has not been reported, the IRS may go back as far as six years to question a tax return. In cases of suspected tax fraud, there is no time limitation at all.

Keep records of transactions relating to the basis of property for as long as they are important in figuring the basis of the original or replacement property. For example, records of the purchase of rental property or improvements thereto must be held as long as you own the property.

As mentioned above, if you have made any nondeductible IRA contributions, records of IRA contributions and distributions must be kept until all funds have been withdrawn. Similarly, you should save mutual-fund confirmations or other records showing reinvested dividends and cash purchases of shares; these are part of your cost basis and will reduce taxable gain when you sell shares in the fund.