IRS looks to cut rental tax losses

By Kay Bell

The Internal Revenue Service needs to keep a closer eye on landlords. They apparently are not reporting all their income.

That's the word from the Treasury Inspector General for Tax Administration, or TIGTA, the federal office that keeps tabs on the IRS. TIGTA recently looked more closely at rental activity and its associated tax revenue because in August 2008, the Government Accountability Office reported that more than half of taxpayers with rental real estate activity in 2001 misreported their income and losses to the tune of $12.4 billion.

So what did TIGTA's follow-up find? That the IRS is indeed leaving lots of rental tax money uncollected.

If the IRS reviewed more returns that contained rental real estate claims, the U.S. Treasury would grow by $27.3 million over five years.

"Given the magnitude of underreporting in our voluntary system of tax compliance, even small improvements in the IRS’s examination of tax returns with rental real estate activity could increase taxpayer compliance and generate substantial additional revenue to the federal government, helping reduce the tax gap," said TIGTA Inspector General Russell George in the report's preface.

While the IRS questions whether that much rental income money is going uncollected, it doesn't dispute that there's room for improvement here.

The tax agency agrees with TIGTA recommendations, including the one calling for the its Small Business/Self-Employed Division director of examination ("examination" is what the IRS calls audits) to conduct an analysis to determine which tax returns with rental real estate activity need a closer look.

If that analysis does find tax returns with questionable rental real estate activity, the IRS will increase its audits of such returns.

When will these additional audits happen? TIGTA recommends they start by July 15, 2013. The IRS says it will "monitor this corrective action as part of our internal management system of controls." Essentially, that means the IRS will get to it when it has sufficient resources.

But this tax year, the agency will begin implementing another TIGTA suggestion regarding rental real estate income reporting.

The Tax Reform Act of 1986 created passive activity loss, or PAL, rules that limit deductions for rental real estate activity losses. To reduce some of the revenue loss in these claims, the IRS plans to revise the 2011 tax year instructions for Form 8582, Passive Activity Loss Limitations. The change will mean that taxpayers with prior year unallowed passive activity losses must submit the form with their tax return.

The IRS also plans, per TIGTA's recommendation, to require this 2011 tax year that real estate professionals report the net amount of income earned or lost.

The bottom line for folks with rental property is to make sure you know and follow the tax rules. The IRS is expecting to get more money from this sector and it's going to start auditing returns it believes will help it reach that goal.