Hopefully you filed your taxes on Monday, or at least filed an extension, but just because you’re done filing doesn’t mean you can forget about your taxes. There’s always the paperwork left behind. It’s probably taking up space in that old file cabinet of yours. If you’re doing some spring cleaning you might be wondering if you can get rid of any of those old returns.

The simple answer is that you need to keep tax returns for a minimum of seven years.

The IRS can audit an individual for any reason for up to 3 years from the filing date and it may go back further if there is a suspicion of fraud.

If you want to avoid an audit altogether, you should be aware of the things on your federal income tax return that can trigger an audit (but that doesn’t mean you should throw out your returns)

• Individuals with incomes of over $100,000 or under $20,000 are more likely to be audited
• If 1099s and W2 statements don’t match income that is reported on the form, your return might also be flagged
• If you do business or are linked with another individual whose return has been chosen for an audit, you might also be audited
• Your return might be also be selected for audit by a computer-generated random list

If you’re selected for an audit, you will be contacted by mail or telephone. The IRS, however, does not use email to correspond with taxpayers.

For more detailed information on audits, check out Publication 556, Examination of Returns, Appeal Rights and Claims for Refund, available at IRS.gov.

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Question:

About 3 years ago my neighbor moved out and abandoned her home. Now I find that the house will be auctioned off for tax delinquency. The starting bid is very low.

I would like to bid on and try to buy this home, and then use it as a rental property. I know about the laws requiring me to wait one year before foreclosing on the owner, but I am unsure if the house was paid for, or the lender has just decided it won’t get its money back. (You would think after three years abandoned the bank would have foreclosed already.)

I am real nervous about the whole idea because I have never invested in real estate before.

Do you have any advice or pros and cons I should be thinking about? I am planning on purchasing the property and then doing some repairs to make the house habitable.

I have a set amount I put aside, to pay for the property and then for repairs so I’m set financially. I am just worried about things that I might not know legally that might come back and bite me.

Buying and renting this property seems like a win-win proposition, but is there any way someone can come take the property and I will lose my money?

Answer:

Here’s what happens when you bid on property at a tax sale: you can purchase the tax delinquency, but you will probably have some competition. If the bank finds out that the property is being sold for back taxes, it might jump into the fray and pay the taxes that are owed.

In some parts of the country, when you buy a home for the real estate taxes that are owed, you don’t get title to the home. You get the right to start the process of owning the home but the current owner of the home has the right to redeem herself and come current with the taxes: that’s the one year period you were referring to. If you somehow made improvements to the home, you might not get that money back.

Depending on the process in your jurisdiction, the homeowner or the lender can simply repay the real estate taxes that are owed, with penalties, fines and other costs and the tax sale would be cancelled.

On the other hand, if the homeowner doesn’t pay and the lender decides not to pay either, you, as the tax buyer, have the right to wipe the slate clean and become the owner of the home. There are certain steps that you may have to take to make sure that the slate is clean when the final tax deed is issued to you and for that reason you’d better make sure you know the rules in your jurisdiction and know what you are doing.

Why don’t you hire a real estate attorney or an attorney that has experience in tax sales to walk you through the process for the first time?

I often recommend that wanna-be investors hire a team of people who can help them achieve their real estate investing goals. You’ll want to chat with a tax preparer (accountant or enrolled agent), a contractor (who can advise you on how much money you’ll have to spend to get the property into habitable condition), a mortgage lender (if you decide to finance part of the purchase), and a real estate attorney to draft up the paperwork and make sure you’re protected.

You’ll pay a little bit of money, but will have peace of mind that you will understand what your risks are.

But if you get the home, what I like best about your plan is that you live right next door. You’ll always be able to keep an eye on your investment.

Q: I was divorced a little more than 20 years ago, and a quit claim deed transferred the property to my name. My name was never on the original deed or mortgage. When I sell my home will I have to pay taxes on profits over $250,000 over the value of the home when it was built in 1972, or can I use the valuation when the quit claim deed was signed in 1984? Many thanks.

A: When you were given the property, you were given the property at its original cost basis. So, if the property was purchased for $25,000 and someone gave that property to you, the cost basis is still $25,000 even if the property was worth $100,000 when it was given to you.

If you’re single and use the property as your primary residence, you’re allowed to exclude from federal income taxes up to $250,000 of profit from the sale of the home. And, if you’re married, you are allowed to exclude from federal income taxes $500,000 of profit on the sale of the home.

The key question for you will be what is your cost basis and how much profit will you receive from the sale of the home.

To determine the cost basis, you take into account what the home was purchased for and add to that number the costs associated with the purchase of the home.

Then you add all capital improvements made to the home over the years. If you put on an addition to the home, install a new kitchen and put on a new roof, all of these items will increase your basis in the home. And then when you sell the home, the costs of sale will get factored into determining your basis and the profit you get out of the home.

Given all of these issues, you should talk to a real estate attorney, tax expert or accountant who can help you figure out the cost basis for the home, and assist in helping you figure out whether you’ll have any taxes to pay or estimate the amount of taxes you will have to pay the federal government.

Good luck.

I had a reader recently ask about avoiding capital gains taxes on the sale of a real estate property. It’s an interesting question and there are a couple of different options if you’re in a situation like that. Read below to see what I told them:

Q: I am 67 years old and own a rental property. I would like to sell the home but don’t want to pay taxes on the gain. Should I live in the property for two years and then sell it?

I’d like to avoid paying capital gains taxes on the sale. I am still working but I’m in the poverty income tax bracket. The house has no mortgage but the taxes, insurance and utilities are eating up my savings. Is there any way I could declare a hardship and avoid the capital gains taxes?

A: Before you make any decision, you need to know what effect the sale of your home would have on your federal income taxes. If you don’t make much money now, you’re probably not paying much to the federal government. If you know what sales price you might get from the sale of the rental property, you then can decide whether to sell it and not worry about the tax consequences.

However, if you’ve owned the property for many years and the taxes you owe will be quite large, you may have some options to limit the amount you pay without fully eliminating the entire tax bill.

The only sure way to defer the payment of capital gains and other federal income taxes on the sale of rental properties is to use a company that specializes in 1031 exchanges. When you use a company that handles 1031 exchanges you basically sell the current investment property, place all the proceeds from the sale with the exchange company and buy a replacement investment property of like kind within a certain time period.

Using a 1031 exchange will allow you to sell the property, but won’t let you get to the money. That money would be tied up in the new property you would be required to buy.

It seems that you probably want to sell the property and keep the money. If that’s the case, you won’t want to use a 1031 exchange. You’ll need to sell the rental property outright.

You talked about living in the rental property for at least two years. Well, when it comes to your primary residence, if you have lived in the primary residence for two out of the last five years, you can exclude from federal income taxes all profits up to $250,000 (or $500,000 if you are married). But the key there is that the home must be your primary residence and you must live in the home for two out of the last five years.

In your situation, you could move out of your current home and into the rental property and live there at least two years. But a couple of years ago, the IRS changed the rules: If you owned a rental property that was later converted into your primary residence, you would still have to pay capital gains and other federal income taxes due on the sale of that property based on how long the property was an investment property and how long it was your primary residence.

So moving into the home would not eliminate your obligation to pay capital gains taxes or other taxes to the federal government, but over time would decrease some of the tax obligation.

Still, it’s worth finding out exactly what you’d owe. Because the highest capital gains tax rate right now is 15, you might find that if you sell the property now, you won’t pay all that in capital gains taxes.

But you may owe more to the IRS because you have to recapture any depreciation you took on the property over the years.

Real estate investors typically take a tax break on their federal income taxes by depreciating the property. That depreciation may result in a reduction in your federal income taxes previously paid. When you sell the rental property, the federal government requires you to repay that benefit previously given to you at a rate of about 25 percent.

In other words, if you took $100,000 in depreciation on your rental property over the years, you’d owe $25,000 to the government when you sell.

Given all of this information, you need to understand what you ultimate liability would be if you sold the property. If you have someone that helps you with your federal income taxes, you can work with that person to see what it is you might have to pay if you sell the rental property.