Avoiding IRS Red Flags in Real Estate Accounting

Everybody fears the IRS.

Rightfully so or not - it's not for us to judge.

That usually happens mainly because people don't know how and what to optimize for when doing their books.

Real estate offers some of the best tax advantages in the business world, but with those advantages come responsibilities.

And that's the thing that people fear.

If your books aren't tight, your deductions aren't defensible, or your structure isn't aligned with IRS guidelines, you're painting a target on your back.

At Cutler & Co., we help Colorado real estate investors keep their financials clean and their strategies compliant.

Here’s how to avoid the red flags that can trigger costly IRS scrutiny.

Why Real Estate Gets Audited More Often

As we already said - the beauty of the real estate as a sector is that investors benefit from unique deductions and depreciation strategies that lower taxable income.

These include mortgage interest, cost segregation, repairs, 1031 exchanges, and accelerated depreciation.

Now here's the thing, because these write-offs can dramatically reduce a tax bill, they naturally draw the attention of auditors.

And the reason being, is that the IRS has identified real estate as a high-risk category due to frequent use of aggressive deductions and inconsistent reporting.

Which is why - one mistake can cascade into a full audit.

If your numbers don’t hold up under review, you risk fines, penalties, or worse.

And let's be honest, nobody wants that.

This can easily be avoided.

The way to do that is to first be aware of the common IRS audit triggers in real estate.

Common IRS Audit Triggers in Real Estate

There are several issues that tend to raise red flags in real estate accounting.

The most frequent include:

Overstated deductions

Large losses or expenses without supporting documentation often get flagged.

Make sure you have receipts, contracts, and justifications for major repairs or improvements.

Mixed-use properties

If you rent out part of a property and use the rest personally, your expense allocations must be clearly documented and proportioned accurately.

Improper cost segregation

This strategy can be powerful, but if done without a certified study, it can be considered overly aggressive.

Personal expenses in business books

Commingling funds between personal and investment accounts is one of the fastest ways to raise suspicion and lose credibility.

Missing or late-filed 1099s

Contractors and vendors must receive 1099s for services over $600.

The IRS cross-checks these documents against your deductions.

As you can see, there are quite a few IRS audit triggers.

Now that you are aware of what to look for - let's see what the best practices are to implement and be aware of, so that you and your business stay audit-proof.

Best Practices to Stay Audit-Proof

Keeping clean books and defensible records is your best protection.

There's nothing you can do better than having clean books.

And to do so, like always, you should follow a few very important and key ideas.

This starts with setting up proper accounting software, keeping business accounts separate, and reconciling accounts monthly.

You should also:

• Document all repairs and improvements with before-and-after photos, receipts, and invoices

• Track mileage and travel logs if claiming vehicle expenses

• Avoid mixing business and personal expenses, especially in payment platforms like Venmo or PayPal

• File 1099s on time for all independent contractors

• Maintain depreciation schedules aligned with IRS guidelines

The goal here is not just to be organized but to ensure every number on your return is supported by accurate, accessible records.

Here's a real-life example from one of our clients.

Real Example: Clean Books Saved an Investor $40K

A Lakewood-based real estate investor came to us after being flagged for an audit on two rental properties.

They had taken substantial deductions for repairs and home office use, but lacked a clear paper trail.

So, to fix this, we had to do a few things.

We rebuilt their financials, categorized expenses correctly, and reconstructed their depreciation schedule.

Was it easy?

No, not really.

Was it worth it?

Absolutely.

The result?

They avoided penalties and recovered over $40K in missed depreciation from earlier returns.

Had their records been audit-ready from the start, the stress and cost would have been avoidable.

Which is why it is super important that you have the right CPA in your corner.

One that acts not just like an order taker, but like your strategic partner.

How Cutler & Co. Helps You Stay Compliant and Confident

We said it before, and we don't shy away from repeating it.

We don’t just file taxes - we proactively audit-proof your real estate business.

What does that mean, you might ask?

That means ensuring your books match your return, your deductions are fully documented, and your strategies align with IRS rules.

So whether you're managing two properties or two dozen, our specialist team helps you stay clean, compliant, and strategically positioned to reduce taxes without raising red flags.

Don't believe us?

Book a Compliance Review with Cutler & Co. and find out for yourself.