1031 Advisor - Oct 20

Your Trusted
Section 1031 Advisor Newsletter (Special Report)
October 1, 2007

AUDIT REPORT OF THE TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION TO THE IRS:

On Monday, September 17, 2007, the Treasury Inspector General for Tax Administration released an audit report. The audit was conducted from November 2006 to May 2007.

Purpose:
The purpose of this audit was to evaluate the IRS's current oversight or review of Section 1031 like-kind exchanges.

Overall conclusion:
The General’s audit report concludes what many tax practitioners have known for years: that there is little IRS oversight or review of Section 1031 exchanges.

Significance related to Number of 1031 Exchanges and Dollar Amount Deferred
The report notes that U.S. taxpayers filed more than 338,500 Forms 8824, and deferred gains of more than $73.6 billion for the 2004 tax year. Individuals filed a majority of the Forms 8824 (65%), which reflected a smaller portion (39%) of the gains reported in the 2004 tax year. The results of this 2007 report represents a doubling of the number of like-kind exchanges and a tripling of the dollar amount deferred related to Section 1031 exchanges since 1998.

Erroneous Reporting
The report further observes that a significant number of taxpayers erroneously reported sales of depreciable capital assets as securities, avoiding depreciation recapture. What is the potential scope of the underreporting? The report noted that the Large and Mid-Size Business Division of the IRS has 6 audits of particular taxpayers, who have assessed deficiencies of approximately $873 million.

Abuses
The audit report includes specific reference to language taken from web sites and publications of “1031 Exchange Promoters” to illustrate actual and potential abuses of Section 1031.

Call to Action
IRS senior management including: the Large and Mid-Size Division, Small Business/Self Employed Division, Wage and Investment Division, the GAO, and the Treasury Inspector General; agree that further action must be taken. The actions will include a comprehensive study of taxpayers involved in Section 1031 Exchanges, in order to ensure taxpayer compliance of Section 1031 like-kind exchange rules.

Three Recommendations from the Treasury Inspector General for Tax Administration
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 tax returns selected by the National Research Program (a comprehensive effort by the IRS to measure payment, filing and reporting compliance). From this study, the IRS will recommend audits of target areas for Section 1031. Implementation Date: 8/15/08
The IRS will revise current publications to provide that a taxpayer must file Form 8824 if the taxpayer completed a Section 1031 exchange.
The IRS will provide additional guidance regarding exchanges of second and vacation homes that were not used exclusively by the owners. 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 on or before 3/15/08.

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