Elm3’s Guide to Shredding or Storing Your Tax Documents
At the beginning of every year, your mailbox and inbox is likely inundated with tax forms. You may use these forms to file your own return or hand them off to a tax preparer. Either way, what should you do with these forms at the end of tax season?
In general, you should keep all relevant tax records for 3-4 years. The IRS can audit your return for three years after the filing date. You can also file an amended return within three years of filing the original return. Accordingly, you should save W-2s, 1099s from freelance income, forms related to unemployment benefits or investment income, records related to rollovers, and receipts for deductible expenses for at least three years. Keeping these records will protect you in the event of an audit or allow you to file an amended return if you realize you could have claimed additional deductions or credits.
You may even consider saving your records for a longer period of time, especially if you work as a freelancer or have come into a significant sum of money. The IRS can audit your return for six years after you file if you underreport your income by more than 25%. Freelancers who lose track of a 1099 may accidentally underreport income, as could those who unexpectedly experience a financial windfall, such as from winning the lottery.
Homeowners should make sure to save all documents related to upgrades. As long as you’ve lived in your primary residence for two of the past five years, you can exclude capital gains up to $250,000 (for single filers) or up to $500,000 (for married filers) when you sell your home. This exclusion is especially beneficial in today’s real estate environment, where home prices are appreciating rapidly.
Additionally, upgrades or improvements to your home increase its cost basis. For example, pretend you bought your home for $200,000. You’ve lived in this home for five years, during which time you replaced the roof, remodeled the kitchen, and added a pool. These improvements equaled $100,000 in total, increasing your home’s cost basis to $300,000. You eventually sell your home for $500,000. Without your improvements, your capital gains would equal $300,000, and with the $250,000 exclusion for single filers, you would have to pay taxes on the remaining $50,000 in gains. However, with the upgrades, your capital gains would only equal $200,000, and you wouldn’t face any capital gains taxation when you sell your home.
Those who inherit a home due to a relative’s passing do not need to keep track of upgrades prior to the inheritance. An inherited home has a “stepped up” cost basis. Its cost basis becomes the market value on the day of the previous owner’s passing. However, if you inherit a home, move into the home, and then begin to make upgrades to the home, you should save records of these upgrades.
In general, you should save home improvement and upgrade receipts and documentation for at least four years after filing the return that documents your home sale.
You should save records related to stock and mutual fund trading for at least four years after the sale of the investment. These records will be able to prove each equity’s cost basis as well as the capital gain or loss you trigger upon the equity’s sale.
Some prominent brokers save these records for you. Charles Schwab archives brokerage statements and 1099 forms for 10 years. Fidelity saves account statements and trade confirmations for 10 years while only saving 1099 forms for seven years. You can check your broker’s website or give them a call to learn more about their storage policies. Should you change brokers, make sure to download relevant statements before you switch.
Trading in cryptocurrency will currently require you to keep many of your own records. You should document each time you buy or sell cryptocurrency, or use cryptocurrency to buy a service or good. Your records should detail the transaction’s date, value, and type.
When it comes to retirement accounts, you will want to focus on any records relating to a nondeductible account, including Roth IRAs, Roth 401(k)s, and nondeductible IRAs. These records will be used to prove that you have already been taxed on your contributions. With nondeductible IRAs, these records can be especially useful if you rollover the funds into a Roth, such that you will not be taxed at the time of the rollover.
You will likely receive a Form 1099-R if you rollover a 401(k) into an IRA or into another retirement plan account. You should save this form for at least four years to document the transaction.
Maintaining digital files can be especially helpful. Digital files are less likely to degrade and be lost. Many brokers will give you the option to receive paperless statements. Alternatively, paper statements can be easily scanned and uploaded using a phone app or printer.
Your digital files should be stored securely. They should only be accessible with a strong password and two-factor authentication. You can use programs such as Google Drive or Dropbox to better protect your information. Make sure to set up two-factor authentication before uploading your documents to any cloud storage service. You may also want to backup your documents on an external hard drive or flash drive in case you lose access to a cloud storage system.
Make sure to organize your documents in folders labeled by tax year. This organization system will make it easier for you to find your documents should you need them.
Do you have additional questions about storing your tax documents? Reach out to the Elm3 tax team, and we will be happy to assist in any way that we can.
