Many of us feel overwhelmed with paper and record keeping. I often get asked how long records should be kept, as well as what records to keep. Here’s a court case that will help you appreciate the need for good tax records.
Proving Basis in the Home
Riley and Joyce Pendergraft bought their home in San Jose, California, for $45,000. By the time they sold the house 28 years later, its value had grown to $790,000.
The Pendergrafts could pat themselves on the back for some of that growth in value. They installed a swimming pool, built a second story, and remodeled the interior and exterior of the home. Overall, they estimated that the projects cost them $286,070.
Note the bad word “estimated” in the last sentence above. The Pendergrafts did not keep good records—an expensive mistake.
The Pendergrafts sold the home and claimed no taxable gain because of the $286,070 in improvements to the home.
During its audit, the IRS found only $56,284 in improvements to the home since its purchase. The Tax Court upped that amount to $82,039, creating $101,907 in taxable capital gains.
Since improvements add to basis and reduce taxable capital gains, keeping track of improvements is important. That’s where the Pendergrafts failed: bad paperwork. But what the heck—the Pendergrafts saved a few hours of paperwork, and it only cost them the taxes they had to pay on $101,907 of capital gains!
Their final cost for not having records was probably somewhere in the neighborhood of $35,000 – $40,000, including penalties, interest, and costs of going to tax court.
The Pendergrafts owned their home for about 28 years, and they made various improvements during those years. How in the world would they keep records for 28 years?
You can find many methods. One simple method is to keep a large envelope where you put the home improvement receipts and canceled checks. (Note: you need both receipts and canceled checks or other proof of payment.)
How much you spent for improvements should not be a mystery. You never know when you will need to prove the basis in your home. Further, you can’t count on the tax-free $250,000 and $500,000 (exclusions) being there when you sell. Tax law changes. Benefits come and go.
Improvements add to your basis and reduce your taxable gain. This is a fundamental rule of tax law, which means you can count on this rule as long as there’s a tax code.
Talk to a Fairfax VA Tax Attorney
The Sodowsky Law Firm can help you create better record-keeping systems that require less effort. If you want to discuss how we might do this, please don’t hesitate to call us today to schedule a meeting.