What Really Happens During an IRS Audit (and How to Win One)

Think audits don’t happen? Think again. While audit rates may be low overall, real estate investors, especially those leveraging strategies like short-term rentals (STRs), real estate professional status (REPS), and cost segregation, can find themselves under the microscope.

In a recent episode of the Tax Smart REI Podcast, we broke down three real audit case studies and shared lessons from the trenches on what happens when the IRS comes knocking and more importantly, how to walk away unscathed.

Here’s a recap of what you need to know.

Case Study #1: The STR Audit That Went Nowhere (In a Good Way)

A long-time Hall CPA client received an IRS letter triggering an office audit (handled virtually). The IRS wanted to verify losses claimed on Schedule E for a group of self-managed short-term rentals in another state.

The two big audit targets?

• Proving the average stay was under 7 days
• Demonstrating material participation

Because the client had been guided to keep detailed records, including time logs and guest stay data, we were able to provide everything the auditor asked for. The result?

No change audit. No taxes owed. No penalties. Just validation of doing things the right way from the start.

Case Study #2: A REPS Audit Saved by Documentation (and Real Talk)

A prospect came to us mid-audit after their CPA refused to help. We quickly identified two major issues: unreported income (a guaranteed loss) and REPS substantiation (winnable… with work).

The client was a broker who managed their own rentals but didn’t keep a time log. We helped them rebuild one from calendar records and emails, documenting their material participation.

Despite a demanding auditor and thousands of documents exchanged, the client won on REPS. And with our help, they even had their penalty for unreported income abated, saving more than what they paid us for the audit defense.

Case Study #3: The Crypto Mining Nightmare (Turned Around)

This client attempted to handle their audit on their own until the IRS told them they owed $209,000.

We stepped in late, reopened the case, and discovered two major issues:

• The auditor had disallowed crypto mining equipment expenses (claiming crypto “isn’t tangible”)
• A short-term rental cost segregation was rejected due to confusion about depreciation changes

After months of detailed memos, documentation, and one very stubborn auditor, we reduced the total liability to $296.

Yes, from $209,000 to under $300.

Two Quick Wins You Should Know About

One taxpayer came to us after their tax influencer-CPA refused to represent them. We took over and secured a no-change audit outcome.

Another short-term rental audit was recently wrapped up by our team, also a no-change result.

These aren’t flukes. They’re part of a growing list of successful defenses we’ve delivered for real estate investors.

Lessons Learned: How to Set Yourself Up to Win

Keep detailed, contemporaneous records. Time logs, receipts, settlement statements, and guest data all matter, especially for STRs and REPS.

Don’t assume your CPA knows audit defense. Being a CPA doesn’t automatically make someone qualified to defend a real estate audit.

Don’t go it alone. Even our smartest, most experienced clients can get tripped up trying to handle an audit themselves.

It’s not “if”—it’s “when.” Audits can occur years after a return is filed. Being audit-ready is a must.

Need Help With an Audit (or Want to Avoid One)?

If you’ve received an IRS letter and need expert help, or want to make sure you’re set up to win if an audit ever happens, book a free discovery call. We’ll let you know honestly if we can help and how.

Click here to schedule your call

We don’t just talk tax. We walk the walk. And we’ve got the track record to prove it.

Transcript

Introduction: Audits Do Happen

Thomas Castelli [00:00]:
Thanks for tuning into this week’s episode of the Tax Smart REI Podcast. Today we’ll be talking about audits. Believe it or not, while audit rates are pretty low, audits do happen. We’re going to talk about some of the audits we’ve seen over the last year or so, including REPS, short-term rentals, and other things. We’ll walk through the audit process and dive into case studies of audits we’ve successfully defended—not just for our clients, but even for competitors’ clients. Stay tuned.

Meet Troy Silfies, VP of Tax at Hall CPA

Thomas Castelli [00:48]:
We’re joined today by Troy Silfies, who is VP of Tax here at Hall CPA. He’s handled many audits for our clients and overseen many more. Troy, can you give us a brief intro to yourself and how you got involved in these cases?

Troy Silfies:
Thanks, Tom. As Tom said, I’m VP of Tax here at Hall CPA. We strive to go above and beyond by making sure our clients are audit-ready. That’s not required of us, but we’ve found a lot of CPAs and clients run for the hills when they get that scary letter from the IRS. That’s not us. We’ve even supported taxpayers who weren’t originally our clients. This really ramped up after the Inflation Reduction Act and all the news about 80,000 IRS agents; some of that wasn’t true, but a lot of it was. And it did lead to a rise in audits, especially around areas like short-term rentals and real estate professional status. Because of our technical depth in these areas, we made sure we were ready.

The Three Types of IRS Audits

Thomas Castelli [02:07]:
Before we get into the case studies, let’s give our listeners a quick overview of the audit process. What actually happens when an audit is initiated?

Troy Silfies:
There are three general types of IRS audits. First is the correspondence audit—that’s the lowest level. It’s all done via snail mail and fax. You rarely, if ever, speak to a real person. Just a back-and-forth through paper. Quick note: the IRS never calls you first. If you get a call without a letter, it’s a scam. Next is the office audit. You physically go to a local IRS office, sit down with an auditor, answer questions, and present documents. The third and most intense is the field audit. That’s where the IRS comes to your business or home office, especially if you’re running a rental operation or a business entity. They want to see things, touch them, and verify they exist. It can go pretty deep.

What to Do When You Get That IRS Letter

Thomas Castelli [04:57]:
What’s the first thing someone should do when they receive that dreaded IRS letter?

Troy Silfies:
First, take a breath. Review the letter carefully. It won’t say “audit” but will use the word “examination.” Once you see that, you’re in one of the three buckets I mentioned. Your next step is to get someone involved who can represent you. Unless you’re well-versed in tax law and substantiation rules, you’re better off getting a CPA or tax attorney. You don’t want to accidentally say the wrong thing. It’s not about trying to hide anything. It’s just easy to misstate something when you don’t know how the process works.

Thomas Castelli:
And we’ve seen even CPAs give away too much or handle it poorly. Representation matters. And not all CPAs are qualified to handle audits, even if they are technically credentialed.

Case Study #1: Short-Term Rental Audit

Troy Silfies [08:07]:
This one was an IRS office audit, but we handled it virtually. The client was scared after receiving the letter, but they had been with us for years. As part of our process, we make sure clients are audit-ready. That means things like having material participation logs and documentation to support short-term rental status. When the audit started, we had a call with the client immediately and got everything prepped.

The main focus of the audit was Schedule E losses on short-term rentals in a different state. The taxpayer self-managed everything and lived several hours away by flight. We had the participation log ready with dates, activities, and time spent. The IRS auditor actually thanked us and said we made their job easy. They still requested supporting documents—flight tickets, proof of working during trips, etc.—but we had everything ready. Another key focus was making sure the rentals qualified as short-term, under 7 days per stay.

The auditor spent time confirming guest stays, check-in/check-out, and rental platforms like Airbnb and VRBO.

Thomas Castelli:
So the two key areas were verifying that the stays were under 7 days and proving material participation. And having those logs built trust.

Troy Silfies:
Exactly. And the final result was a no-change audit. That means the IRS didn’t make any adjustments to the return. It’s the best outcome you can get in an audit.

How Long Did It Take?

Ryan Carriere [13:52]:
Did the client use cost segregation studies? And how much time did this all take?

Troy Silfies:
Yes, they had cost segs on all four or five properties. The IRS reviewed everything—purchase statements, depreciation schedules, land/building splits—but didn’t challenge anything. For us, the audit took around 8–10 hours. For the client, maybe 1–3 hours. And from start to finish, the whole thing was wrapped up in about three months.

Case Study #2: Real Estate Professional Status Audit

Thomas Castelli [16:49]:
Let’s get into the next one. This one involved REPS, right?

Troy Silfies:
Yes. This one was interesting because the taxpayer came to us during the audit after their CPA refused to help. The first thing I noticed during the sales call was that they hadn’t reported a K-1 or unemployment income. I told them straight up: you’re going to lose on those points. But we could help them salvage the rest. The big issue was whether they qualified as a real estate professional.

They were a broker, managed their rentals, and materially participated—but had no documentation. We helped them build a spreadsheet based on their calendar and document everything to prove it.

The auditor in this case was very intense. They asked for every single HSA receipt. Thousands of documents. But in the end, they agreed with our position on REPS. They did lose on the unreported income, but we got a penalty abated since the prior CPA made the error. That refund covered more than what they paid us.

Thomas Castelli:
Another win—and another example of why you want the right team from the start.

Case Study #3: Crypto Mining + Short-Term Rental

Thomas Castelli [28:21]:
Let’s talk about the crypto audit. This one came in hot.

Troy Silfies:
Yeah, this one came in late. We were already representing the client, but they didn’t tell us they were being audited until the IRS was about to close the case. The IRS said they owed $209,000. We got on the phone, reopened the audit, and went to work. The IRS had disallowed all crypto mining equipment because the agent believed “crypto isn’t tangible.” So we had to explain the whole business model and prove that mining requires actual hardware.

They also disallowed a cost seg study because they didn’t understand Section 481A adjustments. We sent memos, depreciation schedules, and full substantiation. After nine months of back and forth, we got the final number down to $296. They lost on one item because they couldn’t produce a receipt, but otherwise, a huge win.

Thomas Castelli:
That’s a massive turnaround—and a good example of why handling an audit solo can be risky.

Bonus Wins + Closing Thoughts

Thomas Castelli [39:08]:
Two quick bonus case studies before we wrap up. One came from a well-known real estate influencer who told their client they wouldn’t represent them in an audit. That client came to us, and we defended them with a no-change result. Another STR case was recently wrapped up by Paul on our team—also a no-change audit. Just more proof of the work we’re doing here.

Ryan Carriere:
This isn’t about bragging. It’s about showing the difference that comes from preparation and qualified representation. We’ve even seen clients leave us for these influencers and come back when things don’t go as promised. If you’re growing your portfolio, you want to work with a team that’s best-in-class from day one.

Troy Silfies:
Most audits are lost due to poor documentation and bookkeeping. Get your systems in place early, and if you ever get that IRS letter, don’t wait. Get someone experienced in your corner immediately.

Thomas Castelli:
If you’re in an audit right now or want to make sure you’re audit-ready before one ever hits, head to the link in the show notes and book a free discovery call. We’ll give you an honest opinion and help you navigate the next steps. With bonus depreciation likely making a comeback, this space is only heating up. That’s it for this week. Thanks for tuning in to the Tax Smart REI Podcast.

If you’re not already working with a qualified real estate CPA, start that conversation today. You can book a free 30-minute discovery call with our team using the link in the show notes. We’ve successfully defended over 20 audits, many involving REPS and STR strategies. Don’t wait until it’s too late. Get ahead of the curve now.

Disclaimer: This podcast summary and transcript were partly generated and may contain some errors or miss key points from the audio recording.