The IRS is stepping up scrutiny of like-kind exchanges—also known as 1031 exchanges. This popular tax strategy used by real-estate investors generally allow participants to defer, or sometimes even avoid, capital-gains taxes when they sell a business or investment property and replace it with a similar asset within a specified period.
A report issued by the Treasury Inspector General for Tax Administration urges the IRS to do a better job of explaining the rules surrounding like-kind exchanges to taxpayers, and says clearer guidance will help deter unscrupulous promoters from trying to abuse the system.
The use of like-kind exchange has surged over the past decade. According to the report, taxpayers (individuals, partnerships and corporate) filed more than 338,500 forms reporting like-kind exchanges in 2004—double the number of exchanges reported in 1998—deferring more than $73.6 billion.
In response to the report, the IRS will be revising form instructions, publications and other communications, as well as conduct a research study of reporting and compliance issues involving like-kind exchanges.
The report also said IRS staff reported potential abuses, such as transactions involving properties that aren't like-kind, or exchanges with related parties, or incorrect property basis figures. However, more oversight is needed.
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