What To Do If your Exchange Is Audited

An exchange typically will not trigger an audit. In fact, since 1999, to our knowledge, only three Exchange Authority clients have been audited for their exchange. And not one dime in additional taxes have been paid. However, it is the policy of the Exchange Authority to provide our exchange clients and their tax advisors with a fully documented report and accounting of the exchange, just in case of an audit. We call the report the Exchange Authority Audit Preventor. The report contains all the exchange documents and other evidence to confirm compliance with the exchange regulations. It is arranged in such a manor that an auditor will easily find the supporting and collaborating information for your tax return. The report contains a sample Form 8824 and all backup calculations for your exchange. Your tax advisor will love the attention to detail and the in depth presentation of the facts.  You will like the security of having all of the form and substance of your exchange contained in one document. Let the auditor attack. You will be prepared.

As part of the report, you will receive copies of the closing and Exchange documents for the sale of the relinquished property. If an auditor reviews the report he will find evidence that you:  a) entered into a bona-fide Exchange Agreement with a Qualified Intermediary; b) that the Intermediary was not a is-qualified person; c) that the Exchange Agreement contained specific provisions which severely limited your use, enjoyment and control of the sale proceeds;  d) that you assigned all or your rights under the sale contract to the Intermediary;  e) that the Intermediary was substituted as seller at the closing, and; f) that the settlement agent actually paid the seller’s proceeds to the Intermediary. The auditor will also be able to determine the initial transfer date for compliance with the identification period and the exchange period.

If the auditor reviews the identification section of the report, he will find copies of your identification letter(s) which will be date stamped and noted received by the Exchange Authority along with evidence that the letters were timely delivered such as a copy of a post office return receipt or a Federal Express air bill. If you identified more than three replacement properties, the auditor will also find value data in the form of agreements, broker’s listings, or other information to demonstrate that you were not in violation of the 200% rule.

And that s not all. The report also contains copies of all closing and exchange documents associated with the acquisition of the replacement property.  These documents provide evidence that: a) you are the same taxpayer as the seller of the relinquished property;  b) that you had assigned your rights under the purchase agreement to the Intermediary; c) that the deposit consideration paid to bind the agreement did not violate the constructive receipt provisions; d) that the replacement property was acquired and deeded to you prior to the termination of the exchange period, and; e) that you actually acquired property which was properly and timely identified pursuant to the identification rules.

The hart of the report contains a summary of the exchange including statements of facts relating to the relinquished and replacement properties, an exchange balance sheet, a listing of the taxable interest and operating statement income as well as the realized gain, recognized gain and exchange basis and a copy of Form 8824 along with all of the supporting back up calculations.

We also suggest to out clients that they gather the following information together and attach it to our report.

1.  Copies of the transfer and settlement documents for the relinquished property from the closing that occurred when you originally acquired title to the property.  An auditor may want to see these records for several reasons including: a) to determine when the property was acquired and the term of ownership prior to the exchange; b) to determine the original basis and the method of acquisition, (by gift, Exchange, purchase, etc.);  and c) to determine the identity of the taxpayer eligible for the Exchange.

2.  Copies of supporting documents which verify that you held the relinquished property for either the productive use in a trade or business or for investment. In most rental cases this would include copies of prior years Schedule E showing the receipt of rental income and deductions for rental expenses and depreciation, or Schedule C showing business expense deductions from the ownership of real estate use in the taxpayer’s trade or business and copies of leases and rental agreements.

Nobody wants to be audited.  However, if you are prepared for the unlikely event of an audit,  you will probably prevail. In fact, you may stop the auditor in his tracks.