Audits & the §1031 Exchange

A §1031 Exchange typically will not trigger an audit. However, it is the policy of the NCS Exchange Professionals to provide our clients and their tax advisors with full documentation and accounting of the exchange in the event of an audit.  If you are ever in such a predicament, you will be ready with the proper exchange documents and other evidence to confirm compliance with exchange regulations. 

When you work with NCS Exchange Professionals, you will receive copies of the closing and exchange documents for the sale of the relinquished property. If an auditor reviews your documentation, he will find evidence that: a) you entered into a bona-fide Exchange Agreement with a Qualified Intermediary; b) the Intermediary was not a disqualified person; c) the Exchange Agreement contained specific provisions which severely limited your use, enjoyment and control of the sale proceeds; d) you assigned all or your rights under the sale contract to the Intermediary;  e) the Intermediary was substituted as seller at the closing; and f) 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, he will find it will be dated and noted that it was received by NCS Exchange Professionals by the 45^th day.

We also provide 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) you had assigned your rights under the purchase agreement to the Intermediary; c) the deposit consideration paid to bind the agreement did not violate the constructive receipt provisions; d) the replacement property was acquired and deeded to you prior to the end of the exchange period; and e) you actually acquired property that was properly and timely identified pursuant to the identification rules.

Additionally, you will receive a Banking Detail Report of the exchange including statements of facts relating to the relinquished and replacement property funds.  We suggest

that our clients 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.

3.  Evidence that you held the replacement property either for the productive use in a trade or business or for investment. This evidence should be in the form of tax returns for years following the termination of the Exchange such as Schedule E and Schedule C and rental agreements

Nobody wants to be audited.  However, if you are audited and have the above documentation, you will be better equipped to endure the audit process.  As always, NCS Exchange Professionals is here to help you every step of the way. 

NCS Exchange Professionals is a sister company to Placer Title Company.