October 1, 2007--San Diego, California--The Inspector General of the Department of the Treasury issued a report on 1031 Exchanges entitled "Like-Kind Exchanges Require Oversight to Ensure Taxpayer Compliance" and has recommended additional oversight of 1031 Exchanges by the IRS.
IRS Performs Internal Audit of 1031 Exchanges
The Internal Revenue Service conducted a recent internal audit regarding issues in Section 1031 of the Internal Revenue Code (IRC). The findings were that there is little oversight of 1031 Exchange transactions by the Internal Revenue Service, that the Internal Revenue Service is relying upon taxpayers to comply voluntarily using the honor system, and this has resulted in underreporting of gain.
Audit Addresses IRS Form 8824
The findings also address Internal Revenue Service Form 8824. While Form 8824 is not explicitly required to be filed in the language of Section 1031 itself, the IRS believes it has the authority to require the taxpayer to file Form 8824 under IRC Sections 6011 and 6012. Form 8824 is just an attachment to the taxpayer's income tax return and is not an information return or a reporting document. Thus, there is no penalty for failure to file IRS Form 8824. However, accuracy related penalties under IRC Section 6662 can be assessed if Form 8824 is not filed for a partially taxable exchange that was not reported or disclosed. The Report states that other IRS guidance needs to be revised to let taxpayers know that they need to file Form 8824.
Findings Also Address 1031 Exchanges of Vacation Properties or Second Homes
Finally, the Report addresses vacation or second home exchanges. It states that a vacation home used exclusively by the owner or related parties may not be exchanged. When the home is not used exclusively by such persons, or where this is some rental history or attempts to rent, there is no published position by the IRS. This leaves “unrebutted the sales pitch of like-kind exchange promoters” who may encourage taxpayers to exchange non-qualifying vacation homes. Many of these promoters also advise the taxpayer on exchanging primary residences with gain over the IRC Section 121 gain exclusion. It also notes that realtors “who may not be well versed in tax law” may advise amateur real property “flippers”, who are really dealers, that these flips qualify for Section 1031. Likewise, taxpayers also claim an exchange despite that they’ve taken possession of the cash proceeds from the sale. Unscrupulous or uninformed promoters are taking advantage of the IRS’s silence on the vacation home issue.
Exeter 1031 Exchange Services, LLC has been concerned about this issue for quite sometime, especially in light of the fact that certain 1031 Exchange Qualified Intermediaries have published guidance suggesting that 1031 Exchanges of vacation property or second homes may qualify based on a very old Private Letter Ruling. See our article entitled "1031 Exchanges of Vacation Homes or Second Homes: Do They Really Qualify?"
IRS Agrees to Act
The IRS agrees to act on the Report’s three recommendations as follows:
The IRS will conduct a study of reporting and compliance issues associated with like-kind exchanges based on returns selected by the National Research Program (a comprehensive effort by the IRS to measure payment, filing and reporting compliance). From the study, the IRS will recommend audit target areas for Section 1031. Implementation Date: 8/15/08.
The IRS will revise the following guidance to provide that a taxpayer must file Form 8824 if the taxpayer completed an exchange: IRS.gov Section 11.4-Frequently Asked Questions, Sale or Trade of Business, Depreciation, Rentals, Sales, Trades, and Exchanges (to be posted by 1/1/08); Form 1099-S (Copy B), Instructions for Transferor; Publication 17 (to be implemented by 12/15/07).
The IRS will provide additional guidance regarding exchanges of second and vacation homes that were not used exclusively by the owners. The request has been submitted and there is no date given for the publication. It will also caution taxpayers to be wary of individuals promoting improper use of like-kind exchanges. It will also provide a Tax Gap Sheet to stakeholders and practitioners about the filing requirements of Form 8824. Implementation Date: 3/15/2008.
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Exeter 1031 Exchange Services, LLC is a leading national provider of Qualified Intermediary, Exchange Accommodation Titleholding, and Advisory services for individual, corporate and institutional 1031 exchange clients.
Exeter administers all types of 1031 exchange transactions, including forward, reverse and improvement (build-to-suit or construction) 1031 exchange structures, in all 50 states. Exeter 1031 Exchange Services, LLC currently has national office locations in San Diego, Irvine, Ontario, Bakersfield, Fresno, and San Francisco, California and Springfield, New Jersey and Winston-Salem, North Carolina.
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