366. AI vs. The IRS: What Every Investor Must Learn from This Tax Court Case

Feb 24, 2026

A Tax Court case unravels after DIY returns trigger an IRS reconstruction from bank deposits and 1099s. The defense leaned on AI-generated, fabricated case citations that destroyed credibility. Missing closing statements lead to disallowed depreciation on rentals. The conversation highlights why precise bookkeeping, solid documentation, and qualified tax help matter for real estate investors.

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ANECDOTE

Self Prepared Returns Led To Audit

The taxpayer was an attorney and restaurant owner who self-prepared late returns for 2015–2019 and was audited by the IRS.
Bank summons revealed $228,000 in unreported cash receipts and large discrepancies between reported and actual deposits.

INSIGHT

Bank Reconstructions Can Reverse Losses

The IRS reconstructed income from bank statements and turned an apparent restaurant loss into taxable income.
Reported 1.6M versus reconstructed 2.29M gross receipts showed material underreporting that the IRS can prove with third-party records.

INSIGHT

AI Hallucinations Ruin Court Credibility

AI-generated legal citations can be fabricated and destroy credibility in court.
The taxpayer used AI-hallucinated Tax Court cases as defenses; the court found the citations did not exist.

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In this episode of the Tax Smart REI Podcast, Thomas Castelli and Nathan Sosa dive into a recent Tax Court case that’s turning heads in the tax community. They break down how a taxpayer’s DIY tax returns spiraled into a full-blown IRS audit, with the IRS reconstructing income through bank deposits, uncovering significant underreported receipts, and disallowing deductions when documentation couldn’t be produced, including depreciation tied to rental properties. But the wildest part? The defense relied on AI-generated, hallucinated Tax Court case citations that didn’t actually exist. It's an expensive lesson in why AI isn’t ready to be your CPA and why “close enough” recordkeeping can get you crushed when the IRS starts asking questions. If you’re investing in real estate, running a business, or leaning on AI for tax answers, this episode is a must-listen on why bookkeeping, documentation, and competent representation matter more than ever. To become a client, request a consultation from Hall CPA, PLLC at go.therealestatecpa.com/3KSEev6 Subscribe to REI Daily & Enter to Win a FREE Strategy Call: go.therealestatecpa.com/41JuQBX The Tax Smart Real Estate Investors podcast is for general information purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Information on the podcast may not constitute the most up-to-date legal or other information. No reader, user, or listener of this podcast should act or refrain from acting on the basis of information on this podcast without first seeking legal and tax advice from counsel in the relevant jurisdiction. Only your individual attorney and tax advisor can provide assurances that the information contained herein – and your interpretation of it – is applicable or appropriate to your particular situation. Use of, and access to, this podcast or any of the links or resources contained or mentioned within the podcast show and show notes do not create a relationship between the reader, user, or listener and podcast hosts, contributors, or guests. Any mention of third-party vendors, products, or services does not constitute an endorsement or recommendation. You should conduct your own due diligence before engaging with any vendor.