An IRS audit of rental property usually centers on a landlord's Schedule E: the rent reported, the expenses deducted, depreciation, and whether rental losses were used to offset other income. Rental returns draw attention because the rules on losses, repairs and depreciation are detailed and easy to get wrong. Knowing what the examiner looks for makes it easier to answer with the right records.
Why the IRS audits rental property
Several features of a rental return can prompt a closer look: a loss reported year after year, large repair deductions, expenses that are high relative to the rent, or a property that is also used personally. None of these is wrong on its own, but each depends on facts the IRS wants to verify. An audit is a request to show those facts.
If an examiner has questioned your rental schedule, call (415) 754-0115 to schedule your free consultation, or send the notice through our contact page and we will review it with you.
What examiners check on a rental audit
On the income side, the IRS confirms that all rent was reported, including advance rent, payments a tenant made on the owner's behalf, and security deposits kept to cover unpaid rent or damage. On the expense side, it tests whether deductions are ordinary, necessary and documented. Frequent areas of dispute include mortgage interest, property tax, insurance, management fees, and travel to the property.
Repairs versus improvements
This is one of the most common audit issues for landlords. A repair that keeps the property in ordinary working condition is generally deductible in the year paid. An improvement that betters the property, restores it, or adapts it to a new use is capitalized and recovered through depreciation over time. Treating an improvement as a repair accelerates a deduction the IRS may disallow, so invoices that clearly describe the work matter.
Depreciation
Examiners check when the property was placed in service, whether the value of the land was separated from the building, and whether the recovery period and method match the type of property. Errors here can repeat every year, so the original closing statement and depreciation schedule are central records.
Passive loss rules and participation
Rental activity is generally treated as passive, which limits how much of a rental loss can be used against wages or other income. There are important exceptions, including a special allowance for owners who actively participate, subject to income limits, and different treatment for qualifying real estate professionals who meet strict time and participation tests. Examiners scrutinize these claims closely.
Proving participation
Claims that rely on a participation exception turn on evidence of the time spent and the work done.
Keeping a defensible time log
A log kept as the year unfolds, showing dates, hours and the tasks performed, carries far more weight than a reconstruction made after a notice arrives. Calendars, emails with tenants and contractors, and invoices can help corroborate it. An attorney can review whether the records actually support the position taken on the return.
Personal use and vacation rentals
When a property is used personally for part of the year, such as a vacation home that is also rented, the number of personal-use days affects how much of the expenses can be deducted and whether a loss is allowed at all. Days spent mainly doing repair and maintenance work are counted differently from days spent staying there for enjoyment. A booking calendar showing which days were rented at a fair rental price and which were personal is the kind of record that settles the question quickly. Travel to and from a rental also draws questions; mileage logs and a note of the purpose of each trip help separate ordinary management visits from personal travel.
Records that support a rental return
Useful documentation includes leases, rent ledgers and deposit records, invoices and receipts for every expense, closing statements, the depreciation schedule, loan statements, and proof of any personal-use days. Organizing these by property and by expense category, tied to the lines on Schedule E, makes it possible to answer the examiner's questions quickly and on point. If the examiner proposes to disallow losses or expenses and you disagree, the IRS generally issues a report and a letter offering independent review. Our guide to the IRS audit appeals process explains that step, and owners who also run a business may find our article on the IRS audit when you're self-employed useful.
East Bay representation for landlords
The Somal Law Firm in Pleasanton represents individuals and small businesses across the Tri-Valley, Alameda and Contra Costa Counties and the East Bay in IRS audits, disputes and appeals. Attorney Bob Somal can review your rental records, respond to the examiner, and present your position on repairs, depreciation, losses and participation. Learn more on the firm's practice areas page.
Frequently asked questions
Why would my rental property be audited?
Recurring losses, large repair deductions, high expenses relative to rent, or mixed personal and rental use can all draw review. Each depends on facts the IRS wants documented, which organized records can supply.
What is the difference between a repair and an improvement?
A repair keeps the property in working condition and is generally deducted in the year paid; an improvement betters, restores or adapts it and is depreciated over time. Invoices describing the work help support how each cost was classified.
Can rental losses offset my salary?
Often only in part. Rental losses are generally passive and limited, with exceptions for active participation within income limits and for qualifying real estate professionals. Time logs and records are key to supporting any exception.
Will an IRS rental audit affect my California return?
It can. If the IRS changes your federal income, California generally requires the change to be reported to the Franchise Tax Board, which may adjust the state return as well.
If the IRS is auditing your rental property, call (415) 754-0115 to schedule your free consultation. When you get in touch, we will review your Schedule E and records, explain the issues the examiner is likely to focus on, and discuss representation through the audit and any appeal. You can also use our contact page to send the details.
Attorney Advertising. This article is general legal information for Bay Area residents, not legal advice, and does not create an attorney–client relationship. Every situation is different — please consult a licensed attorney about your specific circumstances.