How long to keep tax returns is one of the most asked questions in personal finance.
Did you know the average American spends 13 hours every year preparing federal tax returns? For small business owners, that figure almost doubles to 24 hours!
It's always a relief once taxes are filed for the year. But what do you do with all the paperwork afterward? How long should you keep your tax returns and records?
For most people, three years is a good time frame, but it could be much longer in many situations. Plus, it can often be a good idea to hold onto records longer than the required time for other non-tax reasons.
Keep reading to find out exactly how long you should keep your tax records in your situation. The answer may surprise you!
What is the Period of Limitations?
First, let's start with some definitions. As always, the IRS has some slightly confusing terminology around how to measure the amount of time you should keep tax returns.
According to the IRS, the period of limitations is the “period of time in which you can amend your tax return to claim a credit or refund, or the IRS can assess additional tax.”
You would obviously want to keep all of your tax records for the period of limitations that applies to your specific situation, which we'll get to in more detail below.
To measure the period of limitations, it starts at the time when the tax return was filed. Returns filed early are treated as filed on the due date. So if your taxes were due on April 15th, but you filed in February, the clock still starts on April 15th.
However, if you got an extension and filed on September 15th, the period of limitations would start on that date.
How Long to Keep Tax Returns (according to the IRS)
For the actual tax return itself, the IRS advises keeping them forever. I would 100% agree with that. Especially in the digital age, where everything can be saved on a hard drive or backed up in the cloud, there's no reason to toss your actual tax returns.
Past tax returns can help prepare future returns and in calculating amended tax returns if necessary. For example, if you own rental property as I do, you would depreciate it over 27.5 years. Having past tax returns as a backup for my calculations makes it much easier to enter the depreciation when I sit down to do my taxes the following year.
However, many other records help support your tax return, such as W-2 forms, 1099s, charitable donation receipts, mileage logs, and many more. How long should you keep all of those documents?
Here are the rules for the period of limitations and how they apply, straight from the IRS website.
Period of Limitations That Apply to Income Tax Returns
- Keep records for 3 years if situations (4), (5), and (6) below do not apply to you.
- Keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later if you file a claim for credit or refund after filing your return.
- Keep records for 7 years if you file a claim for a loss from worthless securities or bad debt deduction.
- Keep records for 6 years if you do not report income that you should report, and it is more than 25% of the gross income shown on your return.
- Keep records indefinitely if you do not file a return.
- Keep records indefinitely if you file a fraudulent return.
- Keep employment tax records for at least 4 years after the tax becomes due or is paid, whichever is later.
In plain English, most people should keep their tax records anywhere from three to seven years. (Remember this is measured by the period of limitations and starts either on the due date of the tax return or when you actually filed, whichever is later).
If you want to play it safe without having to think through the fine print and how it applies to you, you can plan to keep your tax records for seven years.
However, if you want to dig a little deeper, the next section will cover some specific scenarios.
One interesting thing to point out is the recommendation to keep records indefinitely if you do not file a return or file a fraudulent return. I hope the readers of this article do not fall into this camp, but to emphasize the point, there is no statute of limitations on when the IRS can come after you if you file a fraudulent income tax return. So please don't do it!
Unique Requirements for Property Owners
One of the first possible exceptions to the rules is for keeping tax records related to property (such as your personal home, cars, or rental property).
According to the IRS, you should keep records relating to property “until the period of limitations expires for the year in which you dispose of the property.” So if the three-year period of limitations applies to your situation, you would need to keep all property records for at least three years.
These documents would include anything that supports your calculations for depreciation, amortization, or depletion deductions.
For example, if you bought a house 20 years ago and sold it this year, you would need to keep any records related to that property that supports the deductions claimed on your tax return for an additional three years. This would include loan documents or closing statements from when you purchased the property 20 years ago.
Another thing to consider, especially if you invest in real estate, is the 1031 exchange. If you utilize a 1031 exchange to defer taxes by selling one investment property and buying another, you will need to keep property records for three (or more) years after you sell the new property.
This is because the cost basis from the old property helps determine the cost basis of the new one, and you need a paper trail going all the way back to support the final gain or loss on the sale of the new property.
As a general rule, I plan to keep all property records forever. It's easy to digitize them, and it comes in handy for reasons other than preparing taxes, such as applying for a loan or cash-out refinance.
One of the things I've learned along the way as a real estate investor is to keep good rental property accounting and bookkeeping records throughout the year. It makes tax time so much easier, and I'm not scrambling to find months' worth of receipts and expense records.
How Long Should I Keep Tax Returns as a Small Business Owner?
If you own a small business, have a part-time side hustle or freelance gig, or get a lot of your income from 1099s or under-the-table jobs, there are some special considerations for you.
While it's not intentional (or at least it shouldn't be), if you receive a lot of various 1099s, it can be easy to miss reporting some of that income. According to the IRS guidelines above, they have up to six years to audit you if you forgot or neglected to report at least 25% of your income.
For that reason, a business owner probably should plan to keep at least six years worth of 1099s and other records of business income and expenses to be safe.
This also applies to those with a W-2 job but who receive a significant amount of income from side hustles or other sources. If you're using a few apps to make an extra $20 here or there, this probably doesn't apply to you.
But if you started a bookkeeping business on the side of your day job as a financial analyst, and it generates a decent amount of revenue, I would strongly consider following the guidelines in this section for business owners.
What if I Have Claimed Investment Losses or Bad Debt Write-Offs?
Sometimes your financial investments don't go as planned, and you take a significant loss on a stock, business investment, or loan to your deadbeat uncle that never gets paid back.
The silver lining is you get to claim this loss to offset your income (in most cases) on your tax return. However, per the IRS, filing a claim of loss for bad debt or a worthless investment triggers a seven-year period of limitations.
In this situation, you'll want to make sure to keep your tax records for at least seven years in case of an IRS audit.
How Long to Keep State Tax Returns
In most cases, following the IRS guidelines for how long to keep federal tax returns will keep you in the clear for state tax records as well.
However, be sure to check your individual state requirements. Some states may have longer to audit your state tax return than the IRS has to audit your federal return.
For example, there is a period of limitation of up to four years to audit your state income tax return in California. If you live in California, you would want to be sure to keep your records for at least that long.
How Long to Keep Tax Returns: Summary
It's never fun to prepare and file taxes, and it's even less fun to worry about how long you need to keep all of your tax returns and records. However, a few rules of thumb and guidelines from the IRS help you sort it all out.
In the end, there's no one-size-fits-all solution. If you want to play it safe, keeping all tax-related documents for seven years is a good idea. If you have a corporate job with a W-2 salary and no property investments or significant losses, then three years is probably long enough.
Here is a quick summary to wrap things up:
- In most situations, keep tax records for a minimum of three years from the filing date
- If you own a small business or have multiple streams of income, it's safer to keep tax records for at least six years
- If you claim a loss from an investment or bad debt, keep your tax records for at least seven years
- If you own property, keep all purchase and tax records for that property until at least three years after it is sold
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This article was authored by Andrew Herrig. It originally appeared on Your Money Geek and has been republished with permission.