Summary
As part of its most recent estimate of the tax gap, for tax year 2001, the Internal Revenue Service (IRS) estimated that individuals underreported taxes related to their rental real estate activities by as much as $13 billion. Given the magnitude of underreporting, even small improvements in taxpayer compliance could result in substantial revenue. GAO was asked to provide information on rental real estate reporting compliance. This report (1) provides information on the extent and primary types of taxpayer misreporting of rental real estate activities and (2) identifies challenges IRS faces in ensuring compliance and assesses options for increasing compliance. For estimates of taxpayer misreporting, GAO analyzed a probability sample of examination cases for tax year 2001 from IRS's most recent National Research Program (NRP) study of individual taxpayer compliance.
At least an estimated 53 percent of individual taxpayers with rental real estate misreported their rental real estate activities for tax year 2001, resulting in an estimated $12.4 billion of net misreported income. This amount of misreporting is understated because IRS knows it does not detect all misreporting during its NRP examinations and adjusts the amount of misreporting it detects to estimate the tax gap. Also, the rate of misreporting of rental real estate activity was substantially higher than for some other sources of income, such as wages, a disparity that undermines the fairness of the tax system. Misreporting of rental real estate expenses was the most common type of rental real estate misreporting. Limited third-party information reporting for rental real estate activity is among the challenges IRS faces in ensuring compliance for rental real estate reporting. While information reporting, such as financial institutions sending information to IRS about taxpayers' mortgage interest payments, improves compliance, it is not practical to implement and enforce broad, new information reporting requirements for rental real estate activities. However, improving existing information reporting requirements is one of various options that could improve compliance. For example, based on current law, whether rental real estate property owners must file information returns for certain expenses they incur depends on whether the owners' rental activities are considered a trade or business, but the law does not define how to make this determination. Another approach to improving compliance is to require taxpayers to report additional detail about their rental real estate activities on tax returns. For example, requiring taxpayers to report complete property address information, which GAO found that some taxpayers did not report, could help IRS address misreporting. Requiring additional detail on tax returns could also compel paid tax return preparers, used by about 80 percent of individual taxpayers who report rental real estate activity, to obtain more accurate information from taxpayers. Enhanced IRS guidance, such as on required recordkeeping, and additional IRS outreach to paid preparers and others about rental real estate misreporting could also improve compliance.
Recommendations
Our recommendations from this work are listed below with a Contact for more information. Status will change
from "In process" to "Implemented" or "Not implemented" based on our follow up work.
Director:
Team:
Phone:
James R. White
Government Accountability Office: Strategic Issues
(202) 512-5594
Matters for Congressional Consideration
Recommendation: To provide clarity for which taxpayers with rental real estate activity must report expense payments on information returns and to provide greater information reporting, Congress may wish to consider amending the Internal Revenue Code to make all taxpayers with rental real estate activity subject to the same information reporting requirements as other taxpayers operating a trade or business.
Status: In process
Comments: When we determine what steps the Congress has taken, we will provide updated information.
Recommendations for Executive Action
Recommendation: To help IRS identify taxpayers who may have misreported their rental real estate activity, the Commissioner of Internal Revenue should require third parties to report mortgaged property addresses on Form 1098 mortgage interest statements.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To elicit more accurate information from taxpayers on their rental real estate activities, the Commissioner of Internal Revenue should require taxpayers to report on the individual tax return the basis amount attributed to land versus structure when depreciating rental real estate.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To elicit more accurate information from taxpayers on their rental real estate activities, the Commissioner of Internal Revenue should determine if IRS uses property type information that taxpayers currently report on Schedule E in its efforts to enforce rental real estate reporting compliance, and if it is determined that IRS uses the information, the Commissioner should require taxpayers to provide specific information on Part I of Schedule E about the type of properties for which they are reporting activity, for example by answering a check-the-box question, and if it is determined that IRS does not use the information, the Commissioner should not require taxpayers to report any property type information.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To elicit more accurate information from taxpayers on their rental real estate activities, the Commissioner of Internal Revenue should require taxpayers to report the exact "address" of their rental real estate properties on Part I Schedule E instead of property "location," as currently worded, and require taxpayers to report property zip codes.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To help taxpayers understand the requirements related to certain aspects of reporting rental real estate activities, the Commissioner of Internal Revenue should include guidance within the instructions to Part I of Schedule E on the requirement for some taxpayers with rental real estate activity to report on Form 1099-MISC certain payments made in the course of renting out real estate.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To help taxpayers understand the requirements related to certain aspects of reporting rental real estate activities, the Commissioner of Internal Revenue should include guidance within the instructions to Part I of Schedule E on resources available to taxpayers for determining how to distinguish between the cost of land versus the cost of structures.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To help taxpayers understand the requirements related to certain aspects of reporting rental real estate activities, the Commissioner of Internal Revenue should include guidance within the instructions to Part I of Schedule E on recordkeeping requirements and the potential for disallowed expenses and penalties if taxpayers cannot produce documentation for reported expenses upon examination by IRS.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To enhance IRS's outreach efforts, the Commissioner of Internal Revenue should evaluate whether sending notices to some or all taxpayers who report rental real estate activity would be a cost-effective way to reduce misreporting of some types of rental real estate activity.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
Recommendation: To enhance IRS's outreach efforts, the Commissioner of Internal Revenue should expand outreach efforts to external stakeholders, such as paid tax return preparers, tax return preparation software providers, and industry groups related to rental real estate, to include common types of misreporting for rental real estate activity, such as those identified in this report.
Agency Affected: Department of the Treasury: Internal Revenue Service
Status: In process
Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.
