Once you’ve submitted your tax return to the Internal Revenue Service each year, the last thing you probably want to think about is how to store your tax records. But making these arrangements is essential to protect yourself in the event of a future IRS audit.
The general rule is to keep your tax records for three years, but there are several important exceptions for when you might need to keep your tax records for a longer period as a taxpayer.
Determining Expiration of the Statute of Limitations
Typically, the statute of limitations for the IRS to audit your tax return is generally three years. For an income tax return, the period of limitations is three years. But the IRS says it’s wise to keep your tax returns even longer. For example, if the IRS audits you, you’ll have the documents you need to protect yourself from an audit. The statute of limitations starts running on the later of the due date for your tax return or the date on which you file your taxes.
Special Tax Items
You’ll need to keep your records for seven years if you claim a deduction of worthless securities or bad debts. For example, if you lent a friend $10,000 under a promissory note and the friend went bankrupt, keep records to prove that it was a legitimate debt discharged in bankruptcy that was never paid.
Another special tax item is employment taxes. Keep records for employment taxes for four years from the later of the date the tax is due or the date you pay the tax.
Records Related To Property
When your tax return includes information related to property, keep those records until the statute of limitations — typically three years — runs out for the year in which you sell or otherwise dispose of the property.
For example, if you bought a car in 2010, use it as part of your business and then sell it in 2020, you should keep all of those car-related tax records until the statute of limitations expires for your 2020 tax return.
In addition, keep your old property records until the statute runs out on the tax year you dispose of the new property if you exchange the property for another property to which you transfer your cost basis.
For example, say you use a 1031 exchange to sell a rental property and invest the proceeds tax-free into a new rental property. Your basis in the new property is dependent on your basis in the old rental property. As a result, keep the old rental property records until the statute runs on the tax year that you sell the replacement property.
Other Circumstances for Extended Statutes of Limitations
In some circumstances, the statute of limitations is longer than three years. For example, if you don’t report income that you’re required to report, and it exceeds 25% of the income shown on that year’s tax return, the IRS has six years to audit your return.
In addition, not filing or filing a fraudulent tax return allows the IRS to audit you indefinitely. So keep any tax records for those years permanently.
How To Store Documents
You can keep your tax documents in a fireproof safe or a bank’s safe deposit box. But to conserve space, consider scanning all of your tax-related documents and saving them to an external hard drive or on a cloud service. As long as you can reproduce the documents and they are legible, the IRS accepts electronic copies.