I get asked this question quite a bit and my quick answer is "generally 7 years". Here is a bit of a deeper dive, and a recent court case that indicates that certain records should be retained a lot longer.
General Rules:
IRS can assess for 3 years after return was due (extensions count) or the date return was filed (whichever is later). Theoretically, you can toss returns and records after that. However.....
IRS can assess for 6 years if you underreported your income by 25% or more, and....
IRS can assess indefinitely if there was no return filed or a "fraudulent" return was filed.
Noteworthy recent case:
To summarize the relevant results, the taxpayer filed returns for 2008 when his restaurant business began. He listed about $1,600,000 as property cost basis for tax depreciation. Depreciation deductions for certain real business property can go on for 39 years. This 2008 return was not audited and the 3 and 6 year periods for audit/assessment ran out. Despite this, in later year tax returns, the IRS ended up disallowing this cost basis used for current depreciation deductions (about 50% of the amount was used as the basis for current depreciation).
The taxpayer argued that since the 2008 period ran out, the return cannot be audited and the cost basis should be deemed accurate and stick. The taxpayer currently could not substantiate the costs since he no longer had the records to prove the $1,600,000 basis.
The court found that even though the current deprecation deductions stem from 2008 listed basis, the current deductions are subject to scrutiny. Since the taxpayer could not prove the accuracy of the basis for current deductions, the IRS can decide what is reasonable when there is no records to back up the accuracy of the current deductions.
Moral of the story:
My takeaway is that taxpayers should INDEFINITELY keep any records that are the root of any current tax return deductions. What comes to mind is:
-depreciable property purchases
-tax returns and records that support net operating loss carryforwards, capital loss carryforwards, and credit carryforwards
-basis in IRAs
I'm sure there are plenty more.
Saving these returns and records will be particularly important if you are a taxpayer whose compliance record is not the best. In the case I described, the taxpayer filed a few returns after 2008 late, and a few not at all. This will make an IRS auditor lose faith in the credibility of the tax return data you submit. Highlights the importance of being a "good taxpayer". Ensure you enlist a good CPA for help staying out of "tax trouble".
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