By Harvey S. Jacobs
Friday, March 18, 2011; 7:40 PM
Many taxpayers are preparing for their annual battle with IRS form 1040 by gathering up all their documents, statements, checks and other assorted papers. At the end of this process, taxpayers are often left with piles of neatly sorted, tabulated and cross-indexed piles. From a homeowner's perspective just what documents do you need to keep, and for how long?
At the risk of incurring the wrath of those followers of the maxim "When in doubt, throw it out," there are certain documents you should never throw out and certain documents to hold for six, three or even as short as one year. Among them are the documents you received at your settlement.
Yes, I know that pile of papers now exceeds 100 pages. Many settlement attorneys are now providing digital copies of those documents in addition to, or in place of, paper. If offered that digital option, take it. Copies are fine; there is almost no reason the homeowner would need the original documents.
The essential documents are your HUD-1 settlement statement, the promissory note, the deed of trust (mortgage), the truth-in-lending disclosure and the deed.
The HUD-1 settlement statement identifies your cost basis (purchase price) and those settlement costs that are added to your cost basis when calculating capital gains or losses upon sale. Examples of settlement costs that get added to your cost basis include legal fees for preparation of the sales contract and deed, title search fees, recording fees, transfer taxes, surveys, owner's title insurance premiums, and any amounts that seller owed but that you, as buyer, agreed to pay.
The IRS has identified other settlement costs that cannot be added to your home's cost basis, such as fire insurance premiums, any pre-settlement occupancy rent, utility services, or any charges incurred in connection with obtaining any mortgage loan (points, mortgage insurance premiums, credit report fees and the lender-required appraisal).
However, such mortgage-related costs may be capitalized and deducted over the life of the loan. Documents proving all these expenses should be retained for at least three years after the year in which you sell or otherwise dispose of the property. This three-year holding period following the sale of your home will allow you to justify your capital gain or loss calculations should the IRS come back and challenge your position.
If you opted to purchase an owner's title insurance policy at settlement - and I highly recommend that you do - you will receive your owner's title insurance policy weeks or months after settlement. As a result of this time lag, this original insurance policy is often misplaced. Once you are in the "chain of title," you are potentially liable for defects in title even after you sell your home. For this reason your owner's title policy is one document you should keep in a secure location and never throw out.
Title insurance companies maintain extensive databases of the policies they issue, but you may not want to rely on the insurance company, potentially liable for paying the claims, to be responsible for maintaining the only copy of your policy.
Over the years in which you own the home, you should also keep copies of all paid invoices for all major repairs, improvements and additions that affect your cost basis in the home. Those improvements are called capital improvements and include the following: building an addition, replacing the entire roof, paving a driveway, installing central air conditioning, and rewiring. IRS Publication 551 , available at IRS.gov, provides detailed information for determining increases and decreases to your home's cost basis.
Paid receipts for other home improvement items such as appliances, furniture, furnishings or decor should be retained indefinitely. In case of a fire or other casualty loss, these documents will be useful to establish the amount of your losses for insurance or the casualty-loss tax deduction.
Warranties covering appliances, materials or labor should be retained for the life of those warranties plus your state's statute of limitations for breach of contract. Virginia has a five-year statute of limitations for breach of written contract. The District of Columbia and Maryland both apply a three-year statute. In each case the trigger date from which such a statute of limitations starts will also vary, so it's best to keep these documents for the time stated in the statute or as long as you own the home.
Annual real-property tax bills and mortgage interest statements should be retained for three years after you file the tax return on which you claim them as tax deductions.
Utility bills - and incidental bills for repairs, upkeep and maintenance of the home, but not rising to the level of capital improvements - need only be kept until they are accurately reflected on your credit statements. With the prevalence of online banking and online bill delivery and payments, keeping the hard copy of these documents is even less of a issue, since the homeowner can have almost immediate access to these documents should it become necessary to challenge a charge.
IRS Publication 522 provides useful guidance on these and other record retention requirements.
Harvey S. Jacobs is a real estate lawyer in the Rockville office of Joseph, Greenwald & Laake. He is an active real estate investor, developer, landlord, settlement attorney and lender. This column is not legal advice and should not be acted upon without obtaining your own legal counsel.