The Internal Revenue Service has agreed with recommendations in a newly released government report urging the agency to increase its examinations of individual tax returns that report losses from rental real estate activity.
The Treasury Inspector General for Tax Administration (TIGTA) released a final report that recommended the IRS increase its examination of tax returns with rental real estate activity. They feel given the magnitude of underreporting, even small improvements in the IRS’s examination of tax returns with rental real estate activity could increase taxpayer compliance and generate substantial revenue to the Federal Government to reduce the tax gap. A report in August 2008 found that at least 53 percent of individual taxpayers with rental real estate activity for tax year 2001 misreported their rental real estate activity, resulting in an estimated $12.4 billion of net misreported income.
The objectives of TIGTA’s review were to evaluate the Internal Revenue Service’s scrutiny of individual tax returns with rental real estate activity and to recommend changes to help identify, select and examine tax returns with rental real estate activity.
In its report, TIGTA recommended that IRS officials conduct an analysis to determine the population of tax returns with rental real estate activity that meets the criteria for inclusion in Compliance Initiative Programs (CIP). TIGTA found that the criteria used to select tax returns included in CIPs are producing results that are more productive than tax returns selected for examination based on other criteria. The IRS should also revise the instructions for Form 8582 to require all taxpayers with prior-year unallowed passive activity losses to submit the form with their tax return. The report also recommended that the IRS ensure that the information taxpayers provide to report the net amount of income earned or losses incurred from being a real estate professional is transcribed.
IRS management agreed with all three recommendations. “We will ensure the information taxpayers provide to report the net amount of income earned, or losses incurred, from being a real estate professional is transcribed,” wrote Christopher Wagner, the commissioner of the IRS’s Small Business/Self-Employed Division. “These changes will assist in selection of the most high-risk returns for audit.”
However, the IRS disagreed with the proposed monetary outcome measures. TIGTA said it computed the outcomes conservatively using historical data from the examination program. TIGTA officials maintained that the potential $27.3 million of increased revenue over a five-year period is reasonable considering the assumptions used to calculate the estimate.
