Not reporting rental income can lead to serious consequences. Here’s what you need to know:
Penalties and Interest
The IRS imposes various penalties for underreporting or failing to report rental income. An accuracy-related penalty typically amounts to 20% of the understated tax and applies in cases of substantial understatement or negligence. If the underreporting is deemed fraudulent, a civil fraud penalty can reach up to 75% of the unpaid tax. In severe cases, criminal charges may be pursued for intentional tax evasion or filing false returns.
Rental income is usually reported on Schedule E (Form 1040). This form lets you list your rental income, claim expenses, and figure out if you made a profit or loss. Most rental income is considered passive, which means losses can only be used to offset other passive income unless you’re actively involved in managing the property.
Increased Audit Risk
The IRS has enhanced its data collection methods, making it easier to identify unreported income. For example, the IRS utilizes various methods to detect unreported income, including Information Returns Program (IRP), Economic Reality Ratio (ERR), and the Unreported Income Discriminant Function (UI DIF).
Legal Consequences
Failing to report rental income can lead to severe legal consequences. The IRS may pursue criminal charges for tax evasion, a felony offense that can result in substantial fines and imprisonment. While criminal charges are rare, they are reserved for the most egregious cases of intentional fraud.
These legal repercussions can have long-lasting effects on your financial stability and reputation. Ensuring timely and accurate rental income declarations is essential to avoid these serious legal issues.
Best Practices
To avoid these issues:
Report All Income: Ensure you declare all rental income on your tax returns. Maintain Accurate Records: Keep detailed records of all rental transactions and related expenses.
Consult a Tax Professional: If you’re unsure about your obligations, seek advice from a qualified tax advisor.
At Ascent Tax, we specialize in tax services for real estate investors. We can help you navigate the complexities of tax reporting, ensuring compliance and maximizing your tax savings.