Getting audited by State Tax & Revenue--Anyone got tips?

General Real Estate Investing
1

Just received a letter from the state notifying me of an audit July 31st. The audit is for Gross Receipts Tax, Compensating Tax, Withholding Tax, and Income Tax.

They are asking for an incredible amount of papers: every contract written, every bill and receipt, every bank statement and deposit slip back to 2002, before I was even in business.

I immediately faxed it to my CPA, and she is flummoxed: “I’ve never had anyone audited like this.” I faxed my attorney, and am waiting to hear from him.

This almost is harassment. My rental home business is not subject to NTTCs (Nontaxable Transaction Certificates) for deductions (had never heard of it).
Not subject to Gross Receipts Tax (this was confirmed when I started the business).
Not subject to Compensating Tax (except we have bought mattress covers and pillowcases at Overstocks.com).

Should I be really worried by this? Does this happen often?
Anyone have experience with a state tax audit?

Furnishedowner

2

Find a tax attorney who handles audits and start gathering up your records. Audits are no big deal if you have the receipts to justify the deductions.

3

Thanks, BLL.

I will do that. We have every receipt, have reported every dollar rent ever received, and have shown losses every year due to depreciation and massive on-going rehab. Built this whole business in about 4 years.

I am concerned about when the business was brand new and I didn’t even know it was a business. I was working out of the dining room, had all my relatives working for me, was moving very fast. Tenants would come right into the living room, sit and visit with grandma, rent a house.

I’m sure I didn’t do it all correctly then with CRS reporting, W-2’s. etc. It took a while to figure out that I had made a business. I thought I was just renting out houses. It took the CPA telling me, “You’ve got to do this, you’ve got to do that.” She wanted me to make a business plan. I still don’t have one, other than “Buy, fix, furnish, rent. Buy, fix, furnish, rent.” Then I added “Lease, furnish, rent.” Rolled earnings back in.

Sorry to go on and on. I just read that “Tax is a penalty for making money.” I guess it’s also for growing a business.

Furnishedowner

4

I suspect that it appears to the tax collector that you are operating a “hotel” business. Once the auditor sees that your business is a residential rental activity, a lot of the audit issues will probably go away.

5

my opinion: Either you are the subject of a “compliance” audit or they’re fishing.

best defense is a good offense. have EVERYTHING clean, neat and organized. Every property with every receipt stapled and totaled to exactly the amount on the return. if you fudged anywhere, KNOW EXACTLY WHERE so you don’t get surprised. missing receipts? create a hand written one for “cash” so that it looks like you made an actual purchase and lost the receipt, but kept good notes. bring your mileage log. don’t have one? make one.

90% of your battle will be won or lost by creating the perception that you are clean, organized and honest. this perception is not created by having to dig through a box of papers for stuff. don’t give them any reason to suspect anything: never miss the opportunity to shut up. (I could only cringe when a client said “gee, I never thought you’d audit me for XX, I was worried you’d look at YY”)

this strategy works. if it’s a compliance audit, they will check ever number on the return and you’re golden. if it’s a fishing expedition, the auditor will immediately sense that there is no revenue to be made on you and he will drop it.

6

Thanks for the advice. You guys are golden. Now I feel like I can handle this additional stress.

I HAVE the receipts to justify the expense. We ARE clean, honest, and organized. We are NOT running a hotel business.

The letter said: “Your business has been selected for audit.” So now I am guessing it is a compliance audit.

And yes, I can shut up. Totally. I will let you know how it goes.

Thanks again, Furnishedowner

7

All the way back to 2002? Six Years? The IRS web site states you only need to keep records 3 years except in a few special circumstances where fraud is involved. I’d have a good talk with my CPA and lawyer regarding the scope of the audit. There may be a difference between the documentation they REQUIRE and the documentation they DESIRE.

jmd_forest

8

jmd_forest,

My local attorney felt he didn’t have the expertise for this. He referred me to a big-city tax attorney. I spoke to him yesterday, and faxed the letter.

The tax attorney said he “Had only seen people given 10 days to respond if the tax people had special info. that they were planning to bolt.” Normal response period would be 60 days. He is doing more research.

This has made me think about bolting! Just to sit under a palm tree and sip a Margarita…

I have no idea why they are gunning for me.
Thanks for your input.

Furnishedowner

9

Furnishedowner,

I’m sorry about your problem. I bet things will work out fine. I do have a couple of questions for you though…

  • What state are you in?
  • Do you pay a state income tax, in your state?

Take care,
Motivated CEO

10

New Mexico. Yes, there is State tax.

The good news is that I went to the tax office and asked to speak to the auditor. Instead I got the supervisor.

He kept grilling me on the name of my company, “Are you sure that you’re NOT XYZ? Where did you get your name?”

“No, we’re XY and we don’t do nightly rentals. We hate nightly rentals!”

He told me not to worry, just have my CPA represent me in the audit. So that is what’s happening. It might all be a case of mistaken identity, or having a name very similar to a company that is in non-compliance.

Furnishedowner

Furnishedowner

11

I suspected they believed you are running a “hotel” business.

Why didn’t the supervisor excuse you from appearance as soon as you expained that you were not the business they had intended to audit.

Good luck.

12

I don’t know. The audit letter had come from one of his underlings, so perhaps she has to be the one to sign off on it.

I don’t know how deep she will want to go. But I’ve got a good and audit-savvy accountant. I feel they will probably find some error on my part but we can handle it.

Furnishedowner

13

Here’s an update on the dreaded tax audit:

Our CPA met with the auditor and her boss at the CPA’s office. CPA copied reams of tax returns, rental info. sheets, etc. CPA told them she had not advised us of CRS filing.

In this state, if you have MORE than 3 rental homes, you must file a state tax form (CRS) every month or quarter showing your total rental income. Then you state your deduction, which again is your total monthly rental income. You are only subject to CRS (gross receipts tax) if you rent for 30 days or less.

CPA immediately sent us a bill for $1000 for 2 hours plus copying, preparing, talking, etc.

The auditors were not 100% satisfied so they came to our office this morning. One brand-new auditor–her first audit–and her supervisor. They seemed geared up for war.

We were very cordial, and explained the business…“We hate nightly rentals! That is not us!”

The auditors set up their computers on a vacated desk and went to work. They said IT MIGHT TAKE SEVERAL WEEKS TO GET ALL THE INFO. I was dying.

So we said, “Why not just take our computerized printouts back to your office, instead of going through each file one-by-one? Everything is there. If we have messed up and rented to someone for less than 30 days, we will certainly fix that and pay any tax, but it was not our intention to avoid state tax.”

Auditor A waved a file folder at me, “What about this file here on House C? There is a contract in here in January for House A!”

My mind was frantically trying to process that error. Our files were mixed up! It looked like we were trying to hide something! “No, wait,” I remembered, “It was a construction company and they rented 2 houses, A and C, but the wife of the one guy wanted the better kitchen, and so we just put “A” on both contracts until she could look at them!”

So that was how it went. They left with printouts of 2007-2008 and said they would be back doing 2005-2006 in our office later as we weren’t computerized yet in those years. So they will probably find a few contracts where the people didn’t extend and stayed less than 30 days. We will be fined and have to pay the tax.

I feel a lot better and I am going into the house for a glass or two of wine.

Furnishedowner

14

Good luck to you. May be you should require a minimum of 1 month rental to avoid this problem in the future.

15

We are looking into having it both ways; also having shorter term rentals and paying CRS and lodging tax. We are going to talk to the city to figure out if we qualify.

I hate having a vacant unit if someone wants it for 3 weeks. Plus we can charge a higher rate if it is short term. We will still be competitive with the hotels. Or maybe I just need to buy a small motel for the short timers.

Furnishedowner

16

Personally, I would separate the two businesses.

17

How about a one month rental with a pro-rated refund policy if the tenant vacates early.

18

Dave T and BLL:

Wouldn’t the pro-rated refund policy look like a short-term rental?

I hadn’t thought of separating the two ways of renting. It’s all on hold now. The tax office called and they are coming back on Monday and will be in our office, “a few days”. Not a pleasant thought. It is the auditor’s FIRST AUDIT so she is going to do a very thorough job.

Anyway, we are back to our comfortable 100% full status with a waiting list. So short-term rentals look less exciting.

Thanks for the helpful comments. I’ll let you all know how it went.

Furnishedowner

19

Auditors back today. All day. Every now and then one of them gets up, walks over and WHISPERS in the ear of the other one. I am so hating this.

We offer them coffee, questions to answer, anything. They just sit and read every darned personal comment made in every property file and input it into their laptops. I feel like they are personally rummaging through my underwear drawer. Those comments were written only for staff and me.

AARRGH!
Furnishedowner

They are now on 2005-2006. It is going to take more time

20

Sounds like it’s time for your A/C thermostat to “break” and have it get hot in there. :slight_smile: