Summary of What This Blog Covers:
- Explains Why Real Estate Investors Are Prone to IRS Audits
Highlights the complexity of real estate tax filings including depreciation, passive losses, multiple-state operations, and contractor payments that make investors a frequent target for IRS audits, especially when deductions and income aren’t reported accurately. - Outlines Six Common IRS Red Flags That Trigger Audits
Breaks down the most common mistakes investors make, such as claiming large rental losses without qualifying as a real estate professional, misclassifying capital improvements, underreporting short-term rental income, or failing to issue 1099 forms for contractors. - Provides Practical, Audit-Proofing Strategies to Stay Compliant
Offers clear steps like tracking every expense digitally, separating business and personal accounts, accurately reporting income, filing proper forms like 1040 and 1099-NEC, and working with a real estate-savvy tax accountant to maintain clean, IRS-compliant records. - Reinforces the Value of Working with an Experienced CPA Firm
Describes how Insogna CPA, a leading Austin tax accounting firm, helps investors minimize audit risk with year-round support, customized tax planning, multi-state filings, FBAR compliance, and capital gains tax guidance tailored to real estate professionals.
As a real estate investor, your tax strategy can be your biggest ally or your biggest risk. Between depreciation, repairs, 1099 contractors, and the tricky rules around passive activity losses, real estate tax returns are complex and the IRS knows it.
That’s why investors like you are often a prime target for audits.
At Insogna CPA, one of the leading CPA firms in Austin, Texas, we’ve helped countless real estate investors across the U.S. build smart, IRS-compliant tax strategies that protect their income and avoid unnecessary scrutiny.
Whether you own a few rental homes, run a short-term vacation property, or manage a growing portfolio, here’s everything you need to know about avoiding IRS red flags and protecting your profits.
Why Real Estate Investors Are on the IRS Radar
Real estate investors often:
- Deduct large depreciation and repairs
- Report passive activity losses
- Use complex LLC or partnership structures
- Operate in multiple states
- Hire independent contractors
- Own properties with personal use elements
Combine that with cash flow fluctuations, potential underreported income from short-term rentals, and a mix of passive and active activities, and you’ve got a return that’s inherently more complex than the average W-2 taxpayer.
That complexity draws attention and it’s why you need a bulletproof tax filing.
Let’s dig into the top six IRS red flags for real estate investors and how to avoid them.
1. Claiming Large Rental Losses Without Real Estate Professional Status
This one’s at the top of the list because it’s both common and often misunderstood.
Real estate investors often have losses on paper due to depreciation. But if you also have W-2 income, you generally can’t use those losses to offset your active income unless you qualify as a real estate professional under IRS rules.
What Does the IRS Look For?
To claim real estate professional status:
- You must work at least 750 hours per year in real estate activities
- Real estate must be your primary occupation
- You must materially participate in your properties (not just hire a manager)
If you work full-time in a non-real estate field and still claim rental losses against W-2 income on your IRS Form 1040, the IRS is going to take a closer look.
How to Stay Audit-Safe:
- Track your hours with a time log
- Keep records of every property-related activity
- If you don’t qualify, ask your Austin tax accountant about grouping elections or passive loss strategies
Even if you can’t claim full-time status, there are legal ways to optimize your deductions. That’s where working with a certified public accountant near you makes a big difference.
2. Writing Off Capital Improvements as Repairs
You replaced the HVAC. Installed a new roof. Repainted the house. Is it a repair or an improvement?
The IRS is strict here. Capital improvements (things that add value or extend the property’s life) must be capitalized and depreciated. Repairs (things that maintain condition) can be deducted immediately.
Audit Risk:
- Claiming a full deduction for $20,000 of “repairs” that were really a remodel
- Consistently showing high repair costs without documentation
How to Protect Yourself:
- Document repairs vs. improvements clearly
- Keep detailed invoices
- Get help from an Austin CPA firm to classify expenses correctly on your return
A mistake here not only raises audit risk. It can throw off your depreciation schedule and lead to misstatements.
3. Underreporting Short-Term Rental Income
If you rent properties on Airbnb, VRBO, or any other platform, the IRS is watching. These platforms are required to send 1099-K forms to you and the IRS. If the numbers don’t match? You’ve got a problem.
Common Mistakes:
- Depositing rent into a personal account and forgetting to report it
- Thinking short-term rental income is exempt
- Not reporting cash payments
Audit-Proof Tips:
- Use a dedicated business account
- Reconcile 1099-K totals with actual deposits
- Report all rental income even small stays
Need help? A tax preparer near me with short-term rental experience can save you from mismatches that trigger audits.
4. Overstating Rental Use vs. Personal Use
Do you ever stay in your rental property? That’s fine but if you use it too much for personal purposes, you can’t deduct as much.
IRS Rule:
If you use a property for more than 14 days per year (or more than 10% of rental days), it becomes a personal residence and that limits your deductions.
IRS Red Flag:
- Writing off 100% of expenses on a vacation home
- Inconsistent reporting across multiple years
How to Handle It:
- Track personal vs. rental days clearly
- Keep booking records, calendars, and guest logs
- Work with a CPA in Austin, Texas who can help with mixed-use property reporting
This area is nuanced, and filing it wrong can cost you thousands.
5. Rounding Numbers or “Guessing” Expenses
Too many round numbers? The IRS assumes you’re estimating or worse, making them up.
Examples:
- Reporting $5,000 in utilities
- Listing $10,000 in repairs with no breakdown
Audit-Proof Tactics:
- Use QuickBooks, WaveApps, or ZohoBooks for real-time tracking
- Maintain digital copies of invoices and receipts
- Categorize expenses monthly with help from a chartered professional accountant
The more precise your records, the stronger your defense.
6. Not Filing 1099-NEC Forms for Contractors
If you pay $600+ to a contractor, you must issue a 1099-NEC and file it with the IRS.
IRS Red Flag:
- Reporting thousands in maintenance or cleaning expenses with no matching 1099 forms
- Failing to collect W-9s from vendors
Stay Compliant:
- Collect W-9 forms before work begins
- File all required 1099-NEC forms by January 31
- Need help? A small business CPA in Austin can manage the entire process
Missing 1099s is one of the most avoidable audit triggers and one of the easiest to fix.
Best Practices to Stay IRS Audit-Proof
Avoiding red flags is step one. Step two? Set up systems that keep you compliant year-round.
1. Use a Separate Business Bank Account
- Keeps income and expenses organized
- Helps you prove income was reported
- Required if you operate under an LLC
2. Track Every Expense Digitally
- Use accounting software or an Excel log
- Save receipts and documentation for all deductions
- Organize by category: repairs, mortgage interest, taxes, insurance, etc.
3. Hire a Real Estate-Savvy CPA
- They’ll file your 1040 tax form accurately
- Guide your estimated payments via Form 1040-ES
- Help minimize capital gains tax and short-term capital gains tax
- Flag deductions you may have missed
Working with a CPA near me who understands investor taxes is a game-changer and gives you peace of mind if the IRS ever does come knocking.
Common Questions from Real Estate Clients
“Do I qualify as a real estate professional?”
We’ll review your time logs and help document your hours properly.
“Can I deduct my mileage?”
Yes but only if it’s tracked. We’ll show you the right way to do it.
“What if I have properties in multiple states?”
We handle multi-state filings and can determine your tax nexus across jurisdictions.
“Do I need to amend past returns?”
Maybe. Let us review and correct anything that puts you at audit risk.
Why Work with Insogna CPA?
We’re not just a seasonal tax preparer. We’re a proactive team of:
- Certified public accountants
- Tax advisors in Austin
- Enrolled agents
- Taxation accountants
- Chartered public accountants
We offer:
- Customized tax planning and preparation services
- Franchise tax filings for LLCs and partnerships
- Capital gains planning
- Multi-state and non-resident alien compliance
- Full-service bookkeeping and tax help for short- and long-term rentals
We don’t just prepare your return. We protect your investment.
Final Thoughts: Audit-Proof Your Portfolio
You’ve worked hard to build your real estate business, don’t let the IRS derail it. With smart planning, good recordkeeping, and the right team behind you, you can stay compliant and maximize your deductions.
Book Your Real Estate Tax Strategy Session with Insogna CPA
Whether you’re:
- A first-time investor with one rental
- A short-term rental host on Airbnb or VRBO
- A seasoned landlord with a dozen properties
Insogna CPA is your go-to Austin small business accountant for real estate tax strategy, compliance, and audit protection.
Schedule your consultation today and let’s build a tax plan that keeps you in the IRS’s good graces and out of their audit queue...