Treasury
Inspector General for Tax Administration
Office of Audit
ACTIONS ARE NEEDED IN THE
IDENTIFICATION, SELECTION, AND EXAMINATION OF INDIVIDUAL TAX RETURNS WITH
RENTAL REAL ESTATE ACTIVITY
Issued on December 20, 2010
Highlights
Highlights
of Report Number: 2011-30-005 to the
Internal Revenue Service Commissioners for the Small Business/Self-Employed
Division and the Wage and Investment Division.
IMPACT ON TAXPAYERS
The Internal Revenue Service’s (IRS) Examination function
plays a vital role in the IRS mission of promoting voluntary compliance with
the tax law. Given the magnitude of
underreporting, even small improvements in the IRS’s examination of tax returns
with rental real estate activity could increase taxpayer compliance and
generate substantial revenue to the Federal Government to reduce the tax
gap. In addition, increased tax
compliance can increase the public confidence in the IRS’s ability to enforce
tax laws in a fair, equitable, and consistent manner.
WHY TIGTA DID THE AUDIT
This audit was
conducted because in August 2008,
the Government Accountability Office stated that “at least 53 percent of
individual taxpayers with rental real estate activity for Tax Year 2001
misreported their rental real estate activity, resulting in an estimated
$12.4 billion of net misreported income.” The overall objectives of this review were to
evaluate the IRS’s coverage of individual tax returns with rental real estate
activity and identify changes to aid in the identification, selection, and
examination of tax returns with rental real estate activity.
WHAT TIGTA FOUND
The IRS should increase the number
of examinations of tax returns with losses from rental real estate activity. TIGTA
found that the criteria used to select tax returns included in the Compliance
Initiative Programs (CIP) are producing
results that are more productive than tax returns selected for examination
based on other criteria. TIGTA
determined if the IRS performed more examinations through their rental real
estate CIPs, it could increase the
potential tax assessments by $27.3 million over a 5-year period.
TIGTA also found that
requiring taxpayers with prior year unallowed Passive Activity Losses to submit
Passive Activity Loss Limitations (Form 8582) and increasing the amount of
data input from tax returns to the Master File would further improve the
efficiency of the programs used to select tax returns with questionable real
estate activities for further examination.
WHAT TIGTA RECOMMENDED
TIGTA recommended that 1) the Director, Examination,
Small Business/Self-Employed Division, conduct an analysis to determine the
population of tax returns with rental real estate activity that meets the
criteria for inclusion in the CIPs; 2) the Director, Media and Publications,
revise the instructions for Form 8582 to require all taxpayers with prior
year unallowed Passive Activity Losses to submit the form with their tax
return; and 3) the Director, Customer Account Services, Wage and Investment
Division, ensure the information taxpayers provide to report the net amount of
income earned or losses incurred from being a real estate professional is
transcribed.
IRS management agreed with all three
recommendations. The IRS, in connection
with the development of compliance strategies, plans to consider whether
additional CIP examinations are appropriate.
In addition, the IRS plans to revise the 2011 Instructions for Form 8582
and transcribe the information taxpayers provide to report the net amount of
income earned, or losses incurred, from being a real estate professional.
However, the IRS disagreed with the proposed
monetary outcome measures. TIGTA computed the outcomes conservatively
using historical data from the Examination program. TIGTA maintains that the potential $27.3
million of increased revenue over a 5-year period is reasonable considering the
assumptions used to calculate the estimate.
READ THE FULL REPORT
To view the report,
including the scope, methodology, and full IRS response, go
to:
http://www.treas.gov/tigta/auditreports/2011reports/201130005fr.html.
Email Address: TIGTACommunications@tigta.treas.gov
Phone
Number: 202-622-6500
Web Site: http://www.treas.gov/tigta