You should keep detailed and organized records as though you expect to be audited. Then if you ever have to prove your income or deductions you won't be scrambling to find receipts and other documents, and facing possible disallowances from the IRS.

Records to Keep

What types of records should you keep? Hang on to any documents that identify your sources of income (W2s, 1099s), help determine the value of assets (brokerage and mutual fund statements), and prove your deductions (receipts or invoices and canceled checks, property tax statements, mortgage interest statements, and proof of any business expenses if you file Schedule C). Checks alone may not prove the deductibility of an expense. The best proof is an itemized invoice accompanied by a canceled check proving that you paid it.

Keep your tax records in a separate file for each year. After six years you can throw the backup documents away if storage space is an issue, but keep your income tax returns, retirement account statements, home purchase or sale documents, and stock or other investment documents indefinitely.

Home Ownership Records

Even though profits (up to $250,000 for singles and up to $500,000 for married couples) on the sale of your primary residence are no longer taxable, you should keep all records related to the sale and purchase of your home(s), including settlement papers and documentation for improvements or additions to your home. To calculate whether you can claim exemption from taxes if you make a gain on the sale of your house, you have to be able to accurately document its cost basis.

If you bought or built your home, the original basis is the price you paid, plus any closing costs. Improvements you make to your home increase your basis as long as they pass the IRS requirements of adding to the value of the house, extending its useful life, or adapting it to a new use. You must differentiate between improvements and repairs. Repairs can't be added to the basis of your home. If you hire contractors to do improvements, the entire cost can be used to increase your basis; if you do the work yourself, you can only add the cost of supplies.