Every April 15, after working diligently and filing your returns, you may wonder: How long should I keep the pile of supporting paper, i.e., receipts, forms, bank and credit card statements, W2s, and other employment records?
Unfortunately, the answer is not simple. Generally, you have to keep tax returns and many financial documents for at least three years, according to the IRS, but that is not the whole story because you may have to hold on to some records for much longer.
The IRS’s general rule of thumb about how long to keep tax documents is a bit complex, which is probably not surprising. The amount of time required to store tax papers depends on the “action, expense, or event which the document records,” according to the IRS. You must keep your records that support an item of income, deduction, or credit shown on your tax return until the period of limitations for that tax return runs out, or more simply, the end of the period when the IRS can conduct an audit.
Naturally, that begs the question, what is the period of limitations? The IRS explains that it is the period of time that you are allowed to amend your tax return to claim a credit or refund, or the IRS can assess additional tax.
Every tax return and all supporting forms should be kept. These include 1099s, expense tracking, W-2s, and mileage logs if you itemize. Other important documents to retain if you itemize include credit card and other receipts, invoices, and canceled checks.
You must also store financial records. Suppose you have conducted financial transactions during the year, such as purchasing or selling mutual fund shares, equities, or other securities. In that case, you must store confirmation slips (or brokerage statements) that detail the purchase prices and how much you gained or lost when you sold the investments.
Most brokerages will calculate your cost basis for equities, bonds, and mutual funds, though they will only compute that information for stock transactions since 2011 and sales of mutual fund shares since 2012. As a result, it may be wise to hang on to your transaction records, especially if you change brokers.
Likewise, if you sold your house, you must keep records to verify what you paid and the sale proceeds. Also, if you sold a rental property, you must maintain detailed records of how much you have invested in the property since you acquired it, along with the amount you deducted for depreciation. A prudent suggestion is to hold onto Schedule E, the form you must fill out annually for rental income, for as long as you own the property.
The IRS recommends storing records relating to property until the period of limitations expires for the year in which you either sold or disposed of the property. You must keep these records to compute any depreciation, amortization, or depletion deduction (a form of depreciation for mineral resources that allows you to deduct from taxable income and show the declining production of reserves over time. This calculation enables you to figure out the gain or loss when you sell or otherwise dispose of the property).
These records allow you to correctly calculate the gain or loss when you sell or dispose of the property. When you obtain a profit from the sale of a property, you will have to pay capital gains on that profit. To compute the capital gain, you will have to store your records as long as you own the property or investment. These records will enable you to calculate the property’s cost basis, i.e., the property's actual cost, adjusted up or down by other factors, such as significant upgrades or enhancements to the property.
You should also maintain records of inherited or gifted property and its value when the owner passed away, which will be your tax basis. For gifted property, your basis usually is the same as the donor's basis. You should keep documents and records that help you establish the property's basis for at least three years after selling or disposing of the property.
People also exchange property without paying each other cash. If you received property in a nontaxable exchange, your basis in the property is the same as the basis of the property you gave away, plus any money you paid. In these exchanges, the IRS recommends maintaining the records for the old property and the new property until the period of limitations expires for the year in which you eventually dispose of the new property.
It may also be worthwhile to research your state's tax record retention requirements. Your state’s tax agency rules may grant it more time to audit your state tax return than the IRS can take to audit your federal return. For example, many states have four years to audit residents’ state income tax returns, including Arizona, California, Colorado, Kentucky, Michigan, Ohio, and Wisconsin. Therefore, residents of these states should keep the necessary documents for at least that long.
Before you take any action, be sure that a company does not need your documents. For example, insurance companies will sometimes request copies of older tax documents. If not, it would be wise to shred the documents because they contain sensitive information.
Finally, there is no harm in keeping your records longer than the IRS recommends. It is now convenient to scan documents and store them in the cloud while maintaining paper records. It is always wise to have two sets of records, mainly to prevent the destruction of all your documents in a fire, flood, or other natural disasters.
Get the latest posts delivered right to your inbox