This year marks 110 years since the Sixteenth Amendment was first ratified by a majority of states, which was the birth of the income tax. The Internal Revenue Service (IRS) has been auditing people and small businesses ever since. Even Al Capone couldn't evade their grasp. So knowing just how best to present your rental business in the event of an audit is very important. To help with this we have the Cohan Rule, which applies especially to small rental businesses when receipts are hard to track.
The Cohan Rule allows you to deduct business-related expenses even if a taxpayer cannot present relevant receipts. The rule itself was established in the 1990s when George M. Cohan wasn't allowed to deduct some of his expenses because he never kept receipts or checks. Cohan appealed to the court asking it to oblige the IRS to deduct some of his business expenses due to his proven accounting and tracking. Surprisingly, it worked out, and from that moment the Cohan Rule has been considered a legitimate way to deal with the IRS and its financial auditing.
Related: Tax Season 2021: The IRS Tax Tips, Tax Deductions For Landlords
The Cohan Rule will only apply if a consistent process of accounting can be proven to have been followed. Recently a business consultant had to pay nearly $23,000 in back taxes because of a lack of documentation for expenses related to entertainment, meals, and travel. As we see in another small business case in the same year, documentation can be as simple as handwritten notecards. In fact, documentation can be the process in which you track costs. The case was emphasized because some of the handwritten notes were missing, and yet the small business was still able to claim as much as $7,000 in mileage expenses, all because there was a consistent process for accounting in place.
Why the IRS would take into account one business's word and not another's solely because one has a consistent process of accounting in place does seem unfair - until now. Accounting software that you can manage from your phone which allows you to track both income and expenses is now free and readily available to any landlord.
This consistent process for accounting, which stems from the Cohan Rule, allows landlords to stress less about that drawer full of receipts and relax because of the established, consistent process in which they do their accounting: TenantCloud. Having an accounting system that automatically registers receipts for tenants and invoices is at the heart of a consistent process. If a tenant pays rent, late fees, or a deposit, then the transaction is automatically accounted for landlords. If repairs or lawn-mowing services need to be completed, the landlord can pay the contractor, and the receipt and payment are accounted for with no extra entries. This doesn't just save countless hours a year, but potentially thousands of dollars in the event of an audit.
Related: Tax Identity Theft Protection: Tips To Protect Your Identity Online
What Landlords Need to Know about the Tax Filing Extension
The tenant, landlord, and service professionals are able to go about normal life while TenantCloud helps them communicate, invoice, keep track of accounting, and much more - all for free. Most importantly, TenantCloud is by default a consistent process of accounting, and therefore it is your easy way to meet the Cohan Rule. With TenantCloud you don't need to panic over audit notices, because you have all your income and expenses in one place with additional transaction details you might need to show an auditor.
The key to the whole system is its easy-to-use automatic accounting software for your rental business - and it's free. In 2013 there were 13 million single family rentals in the U.S. Now there are over 15 million, and the vast majority of them are managed by do-it-yourself landlords. Add in the fixer-uppers and duplexes, and we're looking at nearly 20 million households who are the most likely to lack a consistent process of accounting for their rental business.
TenantCloud's ability to track all expenses and income and then create a year-end report based on IRS form 1040 Schedule E categories saves a lot of time, but it also has the potential to save you thousands in the event of an audit. TenantCloud's tax preparation report is a great solution for landlords and property managers who want to stay on top of their finances by making sure they get all deductions come tax time. The expenses in the report are categorized to match the IRS Schedule E categories. The report also includes management fees, depreciation, and interest expense. Thus, the accounting system as well as tax preparation report available at TenantCloud make filing your taxes less stressful and much more accurate when it comes to presenting your rental business to the IRS.
How do you handle IRS audits? Any secrets? Share your experience and advice on the topic by leaving a comment below. :)
Rental Property Security Deposit: Basic Tips You Need To Know
Cash vs Accrual Accounting: Best Method for Landlords