Saving Time and Taxes Through Good Recordkeeping

    Most likely, many of you face an endless stream of paperwork on the job, and the last thing you want to read about is what kinds of records you need for tax purposes.

    But maintaining the necessary records is critical to substantiating deductions, credits, and income for purposes of computing your tax liability. In addition, maintaining good records helps you to defend against an IRS assessment and the imposition of interest and penalties as long as the statute of limitations for a particular tax year is open. An added benefit: Organized records will help your tax adviser work better for you and should minimize the cost of tax services.

    Form versus Substance

    Surprisingly, the IRS requires only that a taxpayer keep accurate records, but does not dictate a specific procedure for recordkeeping. At a minimum, the IRS recommends you keep records of income, deductions, and credits—including gains and losses—until the statute of limitations for your return expires. You must also retain records that document the basis of property (e.g., closing statements for the purchase of real estate, brokers' recommendations for the purchase of securities, etc.) to compute gain or loss upon disposition, as well as allowable depreciation, amortization or depletion, until the expiration of the statute of limitations for the year in which you make a taxable disposition of property. Generally, the statute of limitations expires three years after the tax return due date, including extensions, or two years after the tax is paid, whichever is later. There are, of course, exceptions. For example, the statute is extended if a waiver is signed to extend it; the statute runs for six years when gross income is understated by more than 25%; and the statute runs indefinitely when a return is false or fraudulent.

    Important Records that Might be Overlooked

    Although you undoubtedly are already aware of the more obvious tax records to retain, such as W-2s, 1099s, K-1s, 1040s, and receipts of business expenses, other documents can significantly affect your taxes. Here's a rundown of some records that might easily fall through the cracks of your recordkeeping system but should be readily accessible in case of IRS inquiries.

    "Sell" instructions to brokers for securities or mutual funds

    For each security investment you sell or exchange during the year, you must know the number of shares you bought; the amount per share you paid; the date of each purchase; the total dollar amount of each purchase including commissions and sales fees; the number of shares you sold or exchanged; the price you received per share sold or exchanged; the date of each sale or exchange; and the total dollar amount you received for each sale or exchange. This information enables you to identify which shares were sold for the purpose of determining the basis (cost) of those shares to figure your gain or loss on the sale. Some of this information will be reflected on monthly statements and Form 1099-B, "Proceeds from Broker and Barter Exchange Transactions," provided by your brokerage firm or financial institution. Obviously, you should retain these documents.

    But in situations where you sell less than all the shares of securities you own, you need to instruct your broker as to which shares you want to sell. Do this through dated written instructions to your broker or fund transfer agent, and retain a copy for your files. This is particularly important if you are selling shares of a mutual fund in which you have a combination of non-taxable dividends, undistributed capital gains, reinvested dividends, and past sales. By specifically identifying the shares you want sold and retaining a copy of the instructions, you can minimize the tax consequences. If you are unable to specifically identify the shares sold, the IRS will use the first-in, first-out approach, thereby eliminating any option you might have to minimize the tax bite.

    Closing statements from the sale of your home
    When you sell your home, your attorney typically prepares a closing statement showing a detailed breakdown of the sales price, selling expenses (such as brokerage commissions, advertising costs, recording fees, attorney fees, title fees, etc.), a proration of real estate taxes and mortgage interest on the home that you have paid up to the date of the sale, and other items resulting from the sale of your home. Retain this statement to substantiate deductions and the determination of "net" amount realized associated with the sale of your home.

    For example, broker commissions are selling expenses to be deducted from the sale price to arrive at the amount realized from the sale. To determine gain on the sale, subtract the basis of the home from the amount realized. [See IRS Publication 523: Selling Your Home" for more information.]

    The prorated mortgage interest and real estate tax you have paid up to the date of the sale qualify as itemized deductions. Banks often omit this mortgage interest amount from Form 1098, "Mortgage Interest Statement," so your closing statement may be the only source you have to substantiate this deductible expense.

    Receipts for improvements to your home
    The cost of home improvements (but not ordinary repairs or maintenance costs) increases the basis of a home, thereby helping to minimize the gain on its subsequent sale. Therefore, it is important to maintain accurate and detailed records of all the improvements you have made to show the basis (cost) of property to compute gain or loss upon the sale of the property.

    If you are selling your home, also keep receipts of fixing-up expenses—amounts paid for repair and maintenance work done on your home to help spruce it up for sale. The work must be done within 90 days before the signing of the contract to sell the home and paid within 30 days after the sale. These expenses are not the same as home improvements, which are added to the basis of the home. Rather, fixing-up expenses are subtracted from the amount realized on the sale, reducing the adjusted sales price of the home. However, it is essential to retain detailed records of such expenses, especially in light of the time requirements the law imposes on their use for tax purposes.

    Records of charitable donations
    The kinds of records of charitable contributions you must keep depend upon whether you contribute cash or property. For cash donations, a canceled check or a receipt from the charity showing its name, the amount, and the date of the contribution is usually sufficient. When you donate property, keep a receipt from the charity showing its name, the date and location of the donation, and a reasonable description of the property. If you claim a deduction for donations of property of more than $500, you must also file Form 8283, "Noncash Charitable Contributions" with your return.

    Appraisals for certain charitable contributions
    If you made substantial donations to qualified charities, the law rewards your generosity with a tax deduction. However, you might not be aware that to claim a deduction for charitable donations of property other than money or publicly traded securities whose value exceeds $5,000 ($10,000 in the case of non-publicly traded stock), a qualified appraisal verifying and substantiating the value claimed must be performed. A summary of the appraisal must be attached to your tax return, so appraisals should be obtained well in advance of the filing deadline.

    The appraisal of the donated property must meet certain requirements:

    • It must be prepared, signed, and dated by a qualified appraiser;

    • It cannot involve prohibited appraiser fees (i.e., those based upon a percentage of the property's appraised value); and,

    • It must be summarized on Form 8283, "Noncash Charitable Contributions," which must be attached to the income tax return that claims the charitable contribution deduction.
    Form 8283, which includes the appraisal summary, must list a detailed description of the property, its adjusted cost or other basis, the manner of acquisition, and its fair market value as of the date of contribution. A separate Form 8283 must be completed for each property donation exceeding $5,000 (or $10,000) and for contributions of similar items of property, such as books or coins, the aggregate value of which exceeds $5,000. Donated works of art with a total value of $20,000 or more must have color photos attached to the return.

    In addition to the deduction for the property donated, the cost of an appraisal is deductible, not as a charitable contribution but as a miscellaneous itemized deduction. However, the deduction is limited to the extent that it and other miscellaneous itemized deductions exceed 2% of adjusted gross income.


    Paper reduction is the goal of many individuals who are overloaded with bulging file drawers. But make sure you don't throw out the good with the bad. An uncluttered file drawer won't look so "neat" if the IRS comes calling and your supporting documents are no longer available.

       A Checklist of Easily Overlooked Records
    • Sell instructions to brokers or transfer agents
    • Home sale closing statements
    • Receipts for home improvements
    • Records of charitable donations
    • Appraisals for charitable donations of property