That's what the Government Accountability Office (GAO) is saying.
According to a report by the Treasury Inspector General for Tax Administration (TIGTA), "there appears to be little IRS oversight of the capital gains (or losses) deferred through like-kind exchanges."
And the Inman News reported that "the Inspector General discovered that the IRS generally will not impose any penalties if a taxpayer does not file Form 8824."
Wow... ain't that something... people are doing 1031's and not filling out their 8824's, and the IRS did not have anything to say about it?
The Inspector General reported that more than 338,500 8824's were filed in 2004, which amounted to deferred gains of more than $73.6 billion. Although this was more than double the number of exchanges reported in 1998, the total amount of deferred dollars had more than tripled.
There are many reasons for this - but there is one in particular that bothers me - which is step transactions, and related party transactions.
Part of the problem is that 1031 exchange rules are not clear enough. You can exchange real estate for raw land, an office building for a shopping center, or a condo an apartment - but you can't exchange your principal residence for any other real estate, and you can't exchange a business for real property because it is not "like-kind."
Knowing this, consider this transaction: I am Person A, my brother is Person B. I own Property A, he owns property B (assume identical values). I live in property B and pay rent, he lives in my property A and pays the rent. Lets just say I live in his property because it's closer to my job, he lives in mine because it's closer to his work. So it makes sense for us to be able to do this - the reason is completely legitimate. From a tax perspective, this beneficial for the both of us as well, however, it is illegal to report it that way because it is considered a related party transaction, even though we would still do this if my brother and I were not related.
Ok, that's fine... I understand, I guess. Now take this transaction - Person A, B, and C - who own Properties A, B, and C. Lets say we pull a similar type of manipulation - ILLEGAL. This is considered a step transaction, and business transactions that occur only for the purpose of tax avoidance are illegal.
Now, I'm not going to spell it out because I don't want the Feds coming after me - but imagine the possibilities when you combine related parties, step transactions, and 1031 EXCHANGES. Now that's a nice disguise... not like I've never thought of it before, but I figured the IRS would go to town on you if they figured it out....
And now they say that the IRS hasn't been paying attention!
Shame on all you cheaters!
Isn't a 1031 exchange enough?
You can exchange until you drop, and never pay a penny in taxes - but apparently for some people that is not enough. They want to bend the rules so they can take even more advantage.
So now, because of a bunch of cheaters, you can bet that the IRS will be taking a very close look at all 1031's that occurred last year, and of course, any more that occur in the future. So be careful.
It's very easy to mess up on form 8824. Let me tell you, it is a very complex form and can be hard as hell to fill out. DON'T MESS UP because the IRS will come after you if you're off by a couple of bucks.
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