The Treasury Inspector General for Tax Administration has issued an internal audit report which recommends that the IRS give more oversight on like-kind exchange transactions. The report noted that the number of exchanges had doubled between 1998 and 2004 and the amount of gain deferred had tripled.
Specifically, there were three recommendations:
1. Like-kind exchanges require oversight to ensure taxpayers are complying with the tax laws.
2. Taxpayers should be given consistent, adequate guidance on like-kind exchange filing requirements.
3. The rules and regulations for like-kind exchanges of second and vacation homes may be unclear to taxpayers.
In response, the IRS indicated that it has agreed to take corrective action and will conduct a research study of reporting compliance issues associated with like-kind exchanges based on the issue related returns selected by the National Research Program. At the conclusion of the study, recommendations will be made to the examiners on what particular data should be captured in order to ensure appropriate IRS oversight of taxpayer compliance with the tax laws pertaining to like-kind exchanges. Implementation dates for each recommendation range from now to August 15, 2008 and can be found in the last three pages of the report.
In recent years, we have received many inquiries about whether or not personal use vacation homes qualify for 1031 treatment. It has always been our view that they do not but there seemed to be a growing segment of the market that felt that they did. Because there was no specific, published guidance on this question, we could not produce a direct reference as to our position. In this audit report it clearly states, "While second and vacation homes used exclusively by owners are not eligible for like-kind exchanges, the rules for like-kind exchanges of second and vacation homes not exclusively used by owners are complex and little exists with respect to a published position by the IRS". This clear and concise statement by the Treasury Inspector General of Tax Administration appears to be the direct guidance which supports our opinion.
Additionally, they have also added a question to form 1065 (partnership return) to be used after 2008 designed to find out if there has been a drop and swap or a swap and drop.
Bottom line - we are going to see more audit activity on 1031's in general with a particular emphasis on vacation home properties and partnership transactions that incorporate drop and swaps. I would recommend that taxpayers and their council consider adopting a conservative approach when dealing with these specific areas.
