Effectively managing your financial records and tax returns is a fundamental practice for maintaining financial order and complying with tax laws. As time passes, paperwork accumulates, raising questions about the appropriate duration for retaining these documents. With the advent of digital record-keeping and online accessibility, organizing these files has become more streamlined. However, it remains essential to strike a balance between decluttering and ensuring compliance with tax regulations. To help guide you, here are several suggestions:
Tax Returns and Supporting Documentation
The Internal Revenue Service (IRS) has up to three years after you file your federal tax return, or two years from the date you paid the tax, whichever is later, to audit you if it suspects a good-faith error. This is also the period to file an amended return to seek a refund. As such, three years would be considered the minimum amount of time that you should maintain copies of your federal returns, as well as any corresponding documentation that supports an item of income, deduction, or credit on a return.
Keep in mind, however, that longer so-called “periods of limitations” apply in certain circumstances. For instance, the IRS has six years to challenge your return if it has reason to believe you underreported your gross income by 25% or more, and seven years if you claim a loss from worthless securities or a bad debt deduction.
Consequently, it is generally advisable to keep copies of your federal returns and supporting records for at least seven years, rather than three years, for adequate assurance.
Also note that this guideline pertains only to federal tax returns, as state tax returns may be subject to different periods of limitations. For example, I live in the San Francisco Bay Area, where the California Franchise Tax Board has up to four years—instead of three—to audit state income tax returns.
Property-Related Records
Now, just because the period of limitations has passed for a given return does not mean you should automatically discard it and its supporting documentation. You should still review the information to identify parts that might be needed in the future. This particularly holds true for records connected to property (i.e., real estate and investments). In general, you should keep these records until the period of limitations expires for the year in which you dispose of the property. Again, seven years should provide a sufficient margin of safety.
Specifically regarding records associated with your home, you should maintain purchase-related documents, as well as records of substantial improvements you have made, such as remodeling projects and additions. You should also keep records of the expenses you may have incurred in selling your home, such as legal fees and real estate commissions. All these expenses factor into your “adjusted basis” (your home’s purchase price plus additional qualified expenses) and, subsequently, the calculation of any taxable gain when you sell your home. For those interested in more detail, a helpful resource is IRS Publication 523 (“Selling Your Home”).
Likewise, you should be diligent about maintaining records related to securities transactions. Specifically, you should hold onto purchase documents for positions held in taxable brokerage accounts, to substantiate a reportable capital gain or loss if or when these securities are eventually sold. Other records worth maintaining include those showing stock splits, dividend reinvestments, and nontaxable distributions.
If you have made nondeductible contributions to an Individual Retirement Account (IRA) or a workplace retirement plan (such as a 401(k)), it is wise to save records until seven years have passed since the account has been depleted. Relatedly, be sure to file Form 8606 with your federal return for the year in which you make a nondeductible IRA contribution; otherwise, such contributions will be considered pretax and, thus, taxed again when withdrawn. Keep copies of Form 8606 and your 1040s for each year that such nondeductible contributions are made. Moreover, you should also maintain Form 5498 or similar statements that reflect the amount of IRA distributions.
Finally, in the case of all forms of property, it is important to keep records if you inherit or receive it as a gift. For inherited property, you will need to know the date-of-death value, as this will represent your cost basis. For property you receive as a gift (i.e., property received during the donor’s lifetime), your cost basis is the same as the donor’s cost basis. In either case, after you sell the asset, be sure to keep documentation until the relevant period of limitations has passed for potential audits (again, seven years to be on the safe side).
Bank and Credit Card Statements
Keep your monthly bank and credit card statements for at least one year. This duration allows you to track your spending, reconcile accounts, and identify any discrepancies promptly. Retaining statements is also crucial in resolving disputes with vendors, creditors, or financial institutions. Having a clear history of transactions can help prove your case and rectify any inaccuracies. Bear in mind, though, that federal law gives consumers 60 days to dispute signs of fraud or other billing errors on their statement; after that, credit card issuers are not legally required to handle billing error disputes.
At the end of each calendar year, you can consider discarding your monthly statements, assuming you receive a detailed year-end summary from your financial institution. That said, consistent with the tax-related guidelines stated previously, you should hang on to statements that support your tax returns, deductions, or credits for a minimum of seven years. Relatedly, for significant transactions such as home purchases, renovations, etc., it is prudent to retain related documents for as long as you own the asset and up to seven years after the asset is sold.
Electronic Storage and Backup
Of course, if you access your banking and/or investment brokerage accounts online, you already have an electronic repository that can save you from needing to keep a lot of paperwork on hand. Nevertheless, it is important to understand the length of time records are available to you online, which may vary by institution.
To avoid losing access in light of eventual time limits, you can obviously print out the records you might need down the road. And you may want to continue to store these statements electronically on your own in a secure and easily accessible format. Scanning physical documents and saving them in a secure cloud or encrypted drive can help declutter your space while ensuring that all essential records are preserved.
In Summary
Understanding how long to retain financial records and tax returns is vital for maintaining financial order and complying with tax obligations. By adhering to the aforementioned guidelines, you should be adequately prepared for potential audits or other financial queries that may arise in the future. Regularly reviewing and purging unnecessary documents can help you declutter while keeping your financial house in order. And of course, a final obligatory reminder to always practice safe purging: Use a shredder (or a shredding service), not the trash!
Abramson Financial Planning, LLC does not warrant the accuracy of the materials provided herein. Although the information provided is from sources we believe to be reliable, we do not guarantee the accuracy or timeliness of any information for any particular purpose. This information is for information purposes and does not constitute a recommendation for the purchase or sale of securities. Individual investment decisions should be made on the basis of each investor’s financial condition, suitability, and risk tolerance. Investments may be volatile and can involve the loss of principal. Past performance is no guarantee of future returns. Abramson Financial Planning’s employees may trade for their own accounts in any of the securities of issuers mentioned herein or in related investments. Abramson Financial Planning does not undertake to provide clients with tax, legal, or accounting advice, and clients are admonished to consult their own attorneys and accountants for determining the tax, legal, and accounting consequences of investments made on their behalf.