October 2008 Information supplied by David Gorenberg of LandAmerica
1031 Exchange Update
§1031 Tax-Deferred Exchanges to Undergo Scrutiny
On September 17, 2007, the Treasury Inspector General for Tax Administration issued a report regarding taxpayer compliance in the context of IRC §1031exchanges (the "Report"). The Report was prompted in part by the fact that from 1998 to 2004 the number of Form 8824s filed more than doubled to 338,500, and the gains deferred more than tripled to in excess of $73.6BB. The Report, is the culmination of an audit by the Treasury IG for Tax Administration, and also incorporates concerns raised in a Government Accountability Office report on the so called Tax Gap. The overarching conclusion is that the Service's reliance on voluntary compliance of taxpayers (for instance in correctly reducing basis in calculating and characterizing gain from the ultimate sale of replacement properties where successive prior exchanges are involved) likely results in the underreporting of capital gains.
In connection with the same, The Report underscores there are no direct Code provisions mandating the filing of Form 8824, and that that while sufficient authority apparently exists to mandate the filing (the Service refers to authority under IRC §§6011 and 6012) there is uneven guidance on the point and few if any enforced penalties for failing to file the form. Presently, the form is an attachment and is not otherwise an information return or reporting document. While accuracy-related penalties of IRC §6662 can be assessed for failure to file Form 8824 with regard to a partially completed or incomplete exchange, there is no information available to indicate that such action is ever taken. The Report concludes and the Service concedes in written response that the Service must improve (both in consistency and completeness) guidance to taxpayers and their representatives as to when and how Form 8824 is to be filed.
Also in connection with examining the risk of underreporting of gains, The Report considers IRC §1031 exchanges of vacation homes or second homes. The Report notes that if used exclusively by taxpayers the same are "are not eligible for like-kind exchanges", but that where not all the use is personal the rules are complex and little exists with respect to a published position by the IRS on like-kind exchanges involving such properties." Here too the Service concedes in its written response that it needs to improve compliance through the publication of guidance on the topic.
In short, in response to three key recommendations contained in the report:
i) The Service will conduct a study of reporting and compliance issue associated with §1031 exchanges, based on returns
selected by the National Research Program. Based on this study, the Service will recommend audit target areas for §1031 compliance enforcement.
ii) The Service will revise certain guidance to provide that taxpayers must file Form 8824 if the taxpayer completes an exchange under §1031. Among the revisions will be Section 11.4 of the FAQs on www.irs.gov; Form 1099-S; and Publication 17 "Your Federal Income Tax".
iii) The Service will also provide additional guidance regarding §1031 exchanges of second- and vacation-homes that were not used exclusively by the owners. Part of the guidance will be in the form of a Tax Gap Sheet to stakeholders and practitioners about the filing requirements of Form 8824.
Now, more than ever, the selection of a qualified intermediary for your next exchange is critical. LandAmerica established its 1031 exchange services in 1990 solely to facilitate tax-deferred exchanges. To ensure the highest caliber service to our clients, each office has passed a rigorous internal certification standard.
This communication is not intended to be a "reliance opinion" within the meaning of Circular 230, and we do not provide tax advice on any matter; therefore we are not providing any guidance to the recipient on a "more likely than not" or higher confidence level and have not assured the recipient of success on such level, if the Internal Revenue Service were to disagree with our conclusions. If such communication were to be considered a "reliance opinion" within the meaning of Circular 230, then the recipient may not rely on such advice for penalty protection. No recipient of this communication may use any information in this communication for the purpose of promoting, marketing or recommending to another party any transaction or matter addressed herein.
Why LandAmerica 1031? The selection of your qualified intermediary (QI) is crucial to the success of your exchange. Many QIs provide inadequate financial guaranties or security for the net proceeds of your sale. We back our documents and provide 100% security of your funds at no additional cost through a guaranty by our parent company, LandAmerica Financial Group, Inc. (NYSE: LFG).
As a member of LandAmerica Financial Group, Inc., we have unparalleled financial strength and the resources to guide your transaction to a satisfactory, tax-deferred outcome. We service every type of exchange: deferred, build-to-suit, front and back reverse, and even personal property.
Strength and Security - LandAmerica is a premier provider of commercial and residential real estate transaction services including title insurance, valuation services, assessment, flood certification, tax payment services and more. The individual and combined strength of each of the operations within LandAmerica is reflected by the high financial ratings from Standard & Poor's, Demotech, and Fitch ratings.
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