Introduction
Let’s cut straight to the point. In 2025, the IRS is targeting real estate owners using aggressive depreciation and cost seg strategies. Bonus depreciation and REPS claims are drawing scrutiny. This guide explains the audit triggers, how to spot them, and what you need to be ready. Think of this as a friendly, yet serious briefing.
Latest IRS Enforcement Data
IRS enforcement is ramping up, especially on wealthy investors and partnerships. Despite recent budget cuts, audits remain intense where deductions are risky.
- As per the TIGTA, the IRS lost ~11,000 employees (11% of staff), including 30% of revenue agents as of March 2025. That weakens audit horsepower, but the agency is still focusing on high-value cases with complex tax structures like cost segregation and bonus depreciation.
- A watchdog report indicates the IRS is still developing audit metrics for those earning under $400K, while continuing to prioritize audits of high earners and partnerships.
- High-asset returns (e.g. >$10M) are facing up to an 8.7% audit rate, while returns under $500K hover at under 0.4%.
Here’s a quick snapshot:
IRS Audit Rates by Income Bracket (TY2018)
| Income Level | Audit Rate |
|---|---|
| Under $200K | ~0.2%–0.4% |
| $500K–$1M | ~0.4% |
| $1M–$5M | ~1.1% |
| $5M–$10M | ~1.95% |
| Above $10M | ~8.7% |
Given this, real estate investors claiming major deductions can get flagged even with reduced staff.
High‑Risk Areas (partial asset disposals, luxury STRs)
Certain deduction types are especially risky:
1. Partial Asset Disposals
Selling or replacing only parts of a property (e.g., HVAC or carpet) can trigger depreciation recapture if not handled correctly on Form 4562.
Common mistakes:
- Failing to attach required statements
- Misapplying conventions like mid-quarter or half-year
- Forgetting to report disposals on the correct line
2. Cost Segregation Without Engineer-Based Reports
The 2025 IRS Audit Techniques Guide (ATG) stresses the need for CCSP-qualified engineers and proper methodology in cost seg reports. Studies using generic or rule-of-thumb allocations (especially for properties under $500K) increase audit risk.
3. Luxury Short-Term Rentals (STRs)
Using cost seg or bonus depreciation aggressively on STRs like high-end Airbnb properties can raise flags. The IRS scrutinizes whether personal use is correctly allocable and whether business-use thresholds are sustained.
4. REPS Claims on Form 4562 Combined with Aggressive Depreciation
Claiming real estate professional status (REPS) alongside large bonus depreciation deductions is a classic trigger. If you haven’t also documented material participation, the IRS may reclassify losses as passive.
Documentation Packet Checklist
If you’re using these strategies, prepare a solid audit packet.
Documentation Packet: What to Include
| What to Include | Details |
|---|---|
| Cost Seg Report | CCSP‑engineer report with assumptions and allocations |
| Form 4562 Assembly | Proper Part I–Part V entries; attach explanations for listed property and disposals |
| Time Logs & REPS Proof | Material participation logs—dates, tasks, hours trail |
| Asset Disposal Records | For partial disposals: sales records, replacement costs, Form 4797 entries |
| State Conformity Notes | e.g. California disallows bonus depreciation unless conforming rules applied |
| Support for STR Use | Rental days vs personal use documentation, logs |
Form 4562 Common Errors
Recent audits reveal errors like:
- Incorrect conventions (half vs mid-quarter)
- Mixed-use assets not documented
- Line errors or math mistakes
These can trigger audit notices quickly.
When to Hire a Tax Attorney
Big deductions deserve professional backup. Bring in a tax attorney if:
- The audit letter mentions significant depreciation recapture.
- You’re asked about partial asset disposals or STR use.
- Your case involves millions in bonus depreciation.
- You need help negotiating with the IRS or penalty relief.
An attorney can help negotiate audit adjustments, propose compromises, or even represent you in Tax Court.
Audit Risk and 1031 Deal Hub Keywords
If your properties involve 1031 exchanges or NNN investments, pay special attention:
- Buying bonus depreciation–eligible property within a triple net (NNN) 1031 exchange still comes with audit risk if documentation isn’t solid.
- Mixing passive net-lease income from single-tenant NNN investments with aggressive depreciation is a red flag unless you materially participate and file Form 4562 accurately.
- Using safe-harbor 1031 timelines or tracking the replacement property 45‑day rule is vital but if deadlines slip, exchanges get disqualified.
Explore relevant listings to see how structured these investments can be:
- Chicago 1031 exchange properties for sale
- Phoenix NNN listings
- Dallas NNN listings
- Austin 1031 exchange properties for sale
Frequently Asked Questions
What triggers an IRS audit when using cost segregation?
Triggers include non‑engineered studies, overly aggressive allocation to short‑life assets, lack of documentation, and mismatches between federal and state depreciation treatments.
Why are errors on Form 4562 a red flag?
Form 4562 reports depreciation and disposals. Mistakes especially around partial asset dispositions, conventions, or listed property can easily trigger notices. Attach required statements and reconcile totals carefully.
Does the IRS still audit REPS claims heavily?
Yes. Claims combining REPS status with large bonus depreciation or cost seg deductions are under tight scrutiny. The IRS expects documentation of material participation, supporting logs, and accurate grouping elections.
Should I hire a tax attorney if I receive an audit notice?
Consider it if your case involves large deductions, recapture potential, or complex issues like STR usage. A tax attorney can negotiate or represent you formally.
How does REPS affect my ability to use depreciation to offset income?
REPS allows real estate professionals to treat rental losses as non-passive, meaning depreciation (including bonus depreciation from cost segregation) can be used to offset active income, such as W-2 wages, business income, or capital gains. This can result in significant tax savings, especially in years where large property purchases are made.
Can REPS status be used retroactively?
Yes, you can amend your prior tax returns (typically up to 3 years back) to claim REPS and unlock passive losses that were previously suspended. You must show proper documentation for the hours worked in real estate during the amended years and file the appropriate elections. It’s best to consult a tax professional before amending.
What are the risks of claiming REPS on my tax return?
Claiming REPS draws IRS scrutiny, especially for high-income taxpayers. Risks include:
- Audits to verify time logs and material participation
- Loss of deductions if you fail to meet requirements
- Penalties and interest on disallowed deductions
- Reclassification of losses as passive
To minimize risk, keep detailed logs, use time-tracking tools, and file grouping elections.
Conclusion
Audits in 2025 may be stretched thinner due to staffing cuts but high-value deductions tied to cost segregation, bonus depreciation, and REPS are still squarely in the IRS crosshairs. Mistakes on Form 4562, weak documentation, or aggressive depreciation claims can all spark scrutiny.
Make sure your documentation is airtight: certified cost segregations, accurate depreciation filings, time logs, and exercise caution in STR and partial disposal scenarios. When in doubt, consult a tax attorney or an experienced CPA.
If your projects involve NNN property for sale, triple net (NNN) 1031 exchange opportunities, or passive net-lease income, you can still reap benefits but only if you’re audit-ready.
CTA: Ready for passive income? Visit https://1031dealhub.com/ to browse NNN 1031-eligible properties now.
DISCLAIMER
I am not a CPA, attorney, broker-dealer, or investment adviser. This content is for general education and must not be relied upon for tax, legal, or accounting advice. Always consult your licensed professional. Federal and state rules change frequently; info may become outdated. Circular 230 Notice: Nothing here is intended for, nor can it be used for, avoiding U.S. tax penalties.
Advertising Disclosure: Posts may reference services offered by AMC Real Estate Investment Services and affiliates, including 1031DealHub.
Forward-Looking Statements: Any opinions or projections are based on current data and may change without notice.
