How Long to Save Your Tax Records

One of the most asked question that I get at the tax desk is how long should I keep my tax returns. You've probably heard that seven years is the perfect period to hold onto your tax returns. However, the actual time to keep records isn't quite that simple. You probably don't need to keep every little piece of paper, because different records require different holding times. Let's take a look at some of them.

What to keep

If you lost your job last year and received unemployment benefits from the government, be sure to keep your 1099-G form, which reports the amount you have received. There is a misunderstanding by a lot of people that this is not taxable, but you will owe federal income taxes on the entire amount. 

When they almost doubled the standard deduction starting in 2018, most people no longer needed to itemize their deductions on Schedule A. However, if you are able to itemize your deductions, keep receipts for these: medical out of pocket expenses, mileage logs for medical appointments. mortgage interest, property taxes, charitable contributions, mileage logs for any charitable work and any sales tax paid on large purchases like vehicles.

If you've bought or sold mutual fund shares, stocks or other securities, you'll need confirmation slips (or brokerage statements) that say how much you paid for the investments and how much you received when you sold them. Keep a copy of all your investments for at least three years after you have sold them.

How long to keep them

In most cases, tax records don't have to be kept for seven years because there's a three-year statute of limitations. That means if there's no fraud or nothing else wrong, the IRS cannot look at your tax returns beyond that three-year statute.”

The statute of limitations does have some important exceptions, and if your tax return has any of these, you'll need to keep your returns and your records longer than three years. For example, the statute of limitations is six years if you have substantially underestimated your income. The threshold for substantial understatement is 25 percent of your gross income. If you claim your gross income was $50,000 and it was really $100,000, you've substantially understated your income - so don't forget to be honest and include all your income.

The six-year rule also applies if you have substantially overstated the cost of property to minimize your taxable gain. Say if you sold a piece of property for $150,000 and claimed you paid $125,000 instead of the actual $50,000, the IRS has six years to take action against you. And if you have omitted more than $5,000 in income from an offshore account, the statute of limitations is also six years.

Keep records for seven years if you file a claim for a loss from worthless securities or bad-debt deduction. If you haven't filed a return (but legally are required to), or if you have filed a fraudulent return, there's no statute of limitations for the IRS to seek charges against you.

Property records can be forever

When you sell a property at a profit, you will owe capital gains tax on that profit. Calculating your capital gain often requires you to hang on to your records as long as you own your investment - even if it is decades. You'll need those records to calculate the cost basis for the property, which is the actual cost, adjusted upward or downward by other factors, such as major improvements to the structure. If it is business or investment property, you will also need to keep the depreciation records.

Calculating the cost basis on property you live in is relatively simple because most people can avoid paying capital gains tax on their primary residence. If you sell your primary residence, those filing individual returns can exclude up to $250,000 in gains from taxes, and couples filing jointly can exclude up to $500,000. You must have lived in your home for at least two of the past five years to qualify for the exclusion (it doesn't have to be the last two years). Even so, you'll need to save your records of the transaction for at least three years after selling the property.

If your sale doesn't meet the above exclusion, you'll need to keep records of significant improvements for at least three years after the sale. IRS Publication 523, “Selling Your Home,” spells out what improvements you can add to your cost basis — and reduce your capital gains bill. The same holds true for rental property.

Most brokerages will compute your cost basis for stocks, bonds and mutual funds, although they are only to calculate your cost basis for stock transactions since 2011 and mutual funds since 2012 - so if you purchased them before that, you may have to produce records showing what you bought it for. It's a good idea to keep all your transaction records, however, in case you change brokers. Your broker is not obligated to hold your records indefinitely. In addition, keep records of any inherited property and its fair market value when the owner died, which becomes your tax basis.

There's nothing wrong with saving your records longer than the legal limits if it gives you peace of mind and you can stand the clutter. You might consider storing some records in the cloud — remote computer storage space that you rent. I have my business records stored in the cloud back to 1984! I'll probably never need them, but sometimes its fun to look back and it's peace of mind on top of that.

Although many people keep paper records, it's also smart to have the documents converted to electronic files and stored in the cloud. It's a good idea to have two sets, in case one is destroyed. Finally, remember that your state may have separate rules for keeping records; check with your tax professional, accountant or state tax department.