An IRS Examination Exposes Past Tax Mistakes For A Couple

When I bring a client to an IRS hearing/examination, I always advise the following:

Be polite & respectful
Dress well and look good – no torn jeans, t-shirts, etc. Suit & tie not required but look tasteful
No overwhelming perfumes or colognes – usually meetings are in a small room or cubicle
Bring water or something to drink – IRS offices tend to be warm & dry
Answer questions directly and stay on topic
Don’t tell stories unless giving background information

The latter 2 items should have been told to one couple who talked too much during an examination. According to a Tax Court case (Cohen, District Court, N.Y.), a couple’s return was being examined for a particular tax year and hubby was chatting away & mentioned a home sale in the year prior to the audited year.

The couple claimed the home sale was tax free because of the home sale exclusion for principal (primary) residences.

Married taxpayers can exclude up to $500,000 in gains on the sale of a primary residence as long as:

They filed a joint return for the year the residence was sold
Either spouse owned the home for at least 2 years in the prior 5 years before the date the home was sold (ownership test)
Both spouses used the home as their primary residence for at least 2 years in the prior 5 years prior to date of sale (usage test)
Neither spouse took the $500,000 exclusion within 2 years prior to the date of sale

For individuals, the same basic tests apply as a sole owner, but the exclusion amount is $250,000.

Going back to the couple in question, even though the prior year wasn’t in question during the audit, the IRS agent decided to expand the audit to cover the prior year. The agent found out the home was actually rented out to their son and his family for a few years and the couple didn’t actually live in the home and the “usage test” noted above was not satisfied.

The IRS then issued a correction notice, and the couple appealed stating the IRS shouldn’t have audited that year since that wasn’t in question during the review. However, the District Court in New York sided with the IRS, and the couple had to pay over $150,000 in tax, penalties and interest. OUCH!!!

So, remember to only answer what is asked during an IRS examination!

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