Circular 230: Its Impact on Advising Your Clients regarding 1031 Exchanges (Part 1 of 3)

Circular 230 establishes minimum standards of practice for professional advisors (e.g., attorneys and CPA's) and their firms, who provide tax -related advice to taxpayers.

The standards of practice have been recently revised by the IRS for three purposes:

(1) to strengthen compliance with the tax rules and regulations;

(2) to provide clear standards on how, and under what circumstances, tax advise may be provided to taxpayers; and

(3) to provide sanctions for professionals and their firms who fail to adhere to the new guidelines.

"What kind of professional advice is regulated under Circular 230? Section 10.34 of Circular 230 applies in any situation where a professional advisor provides any written or oral advice that will be reflected or reported on the taxpayer's income tax return, post-return submissions, amended returns, or audits. This includes the reporting the tax consequences of a Section 1031 Exchange.

"Covered Tax Opinions for Tax Motivated Transactions" (Section 10.35) and "Other Written Advice" (Section 10.37) will be covered in future newsletters (Part 2 and 3).

"If I am not the primary advisor or tax return preparer, does Circular 230 apply to me?" Yes Any tax advice, which pertains to any and all of the positions reported on a tax return, constitutes advice under Section 10.34. This is true even if the advice is provided by a non-signing advisor.

In addition, a non-signing advisor must advise tbe taxpayer to disclose its tax return positions and the attendant consquences for failure to do so under the applicable civil or criminal penalties, or face their own set of penalties under Circular 230 and the Internal Revenue Code.

"What about professional advice, which is unsupported by current law?" A professional advisor is precluded from recommending or advising a tax return position that is unsupported by law or is not reasonable, defined as a position with a less than one third chance of success. If the advisor chooses a position that is less than one third chance of success, then this position must be disclosed on the tax return.

"What is the advisor required to disclose to the IRS related to the 1031 exchange?" The advisor must disclose a Section 1031 Exchange that failed to meet the requirements of Section 1031, and related Code Sections, where the exchange was partially or entirely taxable.

This disclosure is necessary to prevent violation of Section 10.34 of Circular 230 and Sections 6662, 6663, or 6694 of the Internal Revenue Code. This includes disclosure of improper indentification, improper investment intent, flipping, the impact of loan refinancing, a change in the ownership, related party transactions, and taxable boot.

"What if the taxpayer does not provide accurate information or chooses a non-substainable position?" First, the professional advisor has the duty to not accept, at face value, information which is provided by the taxpayer. For example, a client, Mr. M, lives in Cincinnati and has a home in Florida, which he states that he uses as rental property. The advisor should review the client's Schedule E to verify if, in fact, Mr M.'s Florida property was rented and was not used exclusively for personal use.

In addition, the advisor must disclose the applicable penalties to the taxpayer, if the taxpayer chooses to implement his unsustainable position. (See "Accuracy Related Penalties" under Section 6662, IRC)

"What if professional advisors do not comply with Circular 230?" Based on Circular 230, there are both monetary and professional sanctions for failure to comply with the minimum standards of practice for professional advisors. These sanctions can include suspension, disbarment and monetary penalties. Proper disclosure of an unsustainable position will protect the advisor under Section 10.34 of Circular 230; however, this will not protect the advisor against a $1,000.00 civil penalty under Section 6694(b) of IRC for reckless disregard of the rules and regulations.

That's where the professionals at Strategic Property Exchanges, LLC can help you and your clients. Our full time practicing tax attorney, who is Board Certified as a Federal Tax Specialist, will provide your client and your firm with strategies to execute a valid Section 1031 exchange with a covered tax opinion. This tax opinion will provide civil tax penalty protection for your clients, and protection for you and your firm from error and omissions, as well as protections from Circular 230 penalties.

Stephen L. Robison, J.D., LL.M.





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More than just commercial property can be exchanged in a 1031 process. To learn more about the other items, read our page on What can be exchanged?