10 Red Flags That Can Trigger an IRS Audit

For most taxpayers, the word "audit" inspires a unique kind of dread. While the reality is that audit rates are historically low, they are not zero. The IRS uses a sophisticated computer system called the Discriminant Information Function (DIF) to score returns and flag those that fall outside the statistical norms.

As a real estate investor or small business owner, your tax return is inherently more complex than a simple W-2 employee's, which can mean more opportunities for scrutiny. Knowing the common red flags can help you prepare a stronger, more defensible tax return. Here are 10 triggers to be aware of.

1. Making a Lot of Money (High Income)

It's a simple fact: the more money you make, the more likely you are to be audited. The IRS gets the best return on its time by auditing high-income earners, as any discrepancies found are likely to result in a larger tax recovery. While this isn't something to "avoid," it's a reason to be extra meticulous as your income grows.

2. Reporting Unusually Large Losses (Especially Rental Losses)

A small paper loss on a rental property due to depreciation is normal. A massive, six-figure loss on a portfolio of properties that wipes out your high W-2 income is a major red flag. This signals to the IRS that you might be improperly claiming losses you're not entitled to, perhaps by violating the passive activity loss (PAL) rules or not qualifying as a Real Estate Professional.

3. Claiming 100% Business Use of a Vehicle

Claiming that you used your only vehicle 100% for business, 100% of the time, is an immediate red flag. The IRS knows that virtually everyone uses their vehicle for at least some personal errands. It's far more believable to claim 80% or 90% business use, and it's absolutely critical to back this up with a contemporaneous mileage log.

4. Large or Aggressive Home Office Deductions

The home office deduction is a fantastic write-off, but it must be claimed correctly. The "exclusive and regular use" rule is strict. Claiming a suspiciously large portion of your home (e.g., 50% of your 2,000 sq ft house) or using the regular (actual expense) method to deduct huge, out-of-place expenses will draw attention.

Internal Link Idea: Make sure you claim it right. Read our [Maximizing Your Home Office Deduction: The Definitive Guide].

5. High Charitable Donations Relative to Income

The IRS computers know the average charitable contribution for every income bracket. If you earn $80,000 and claim $25,000 in donations, your return will be flagged. This doesn't mean it's disallowed, but you must have flawless documentation (bank records and written acknowledgments from the charities) to prove it.

6. Failing to Report All Income (1099s, K-1s)

This is one of the easiest ways to get caught. The IRS receives a copy of every 1099-NEC, 1099-MISC, 1099-K, and Schedule K-1 that is sent to you. Their computers automatically match these forms to your tax return. If you "forget" to report the $5,000 you made from a side gig, you will almost certainly receive an automatic notice (a CP2000 letter) assessing tax, penalties, and interest.

7. Using Too Many Round Numbers

When you fill out your Schedule C (Profit or Loss from Business) and list your expenses, does it look like this?

• Advertising: $2,000
• Supplies: $5,000
• Travel: $3,500 This looks estimated and lazy. Real-world expenses are rarely perfect round numbers. Your actual expenses are more likely to be $2,015, $4,982, and $3,521. Using exact figures shows you are basing your return on actual books and records, not estimates.

8. Excessive Meal and Entertainment Deductions

Claiming very high expenses for meals is a classic red flag. The IRS knows it's an area ripe for abuse (mixing personal meals with business). Remember, business meals are typically only 50% deductible and must have a clear business purpose documented. (Note: "Entertainment" expenses are almost entirely non-deductible).

9. Filing a Schedule C with Consistent Losses

Running a small business that loses money for one or two years is normal. Running a "business" that loses money for five, six, or seven years in a row looks less like a business and more like a hobby. The IRS may reclassify your venture as a hobby, which means they will disallow all of your losses.

10. Sloppy Filing and Mathematical Errors

While most software catches simple math errors, a return that is messy, incomplete, or has obvious mistakes signals to the IRS that the taxpayer might be equally sloppy with their record-keeping. A clean, accurate, and complete return is your first line of defense.

---

Conclusion: Your Best Defense is Good Records

The common theme across all these red flags is a lack of proof. The single best way to survive an IRS audit—and to avoid being flagged in the first place—is to keep meticulous, organized, and contemporaneous records. A good accounting system and a detailed mileage log are your best friends.