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ENCOURAGING THE OTHERS

March 21, 2008

Spring is here. The snow is melting, the grass is turning green, the daffodils are starting to push away the mulch, and the IRS is making examples to encourage the rest of us to stay on the straight and narrow.

Last week the IRS and the Justice Department Tax Division set out to make examples of three Minnesotans, who they indicted on separate tax charges. Two of the indictments were for garden-variety false refund schemes. The other one is a bit more interesting.

The IRS accuses William Franklin Jones of Park Rapids of concocting phony Section 1031 "like-kind" exchanges to avoid taxes on property he sold. The indictment alleges that he identified property he already owned as property to be received tax-deferred in a Section 1031 swap.

Section 1031 allows taxpayers to exchange "like-kind" property without paying taxes the appreciation of the property given up. The basis of the old property carries over to the new property, and no gain is recognized until the new property is sold. Because it's hard to find somebody who wants to do a straight-up real estate swap, most exchanges are done through intermediaries. The taxpayer sells property, the intermediary receives holds the proceeds, and then buys a new property to give in "exchange" for the sold one. If this is done within strict time limits, with no cash touching the "seller," the tax law recognizes this a valid Section 1031 swap.

According to the indictment, the scheme worked as follows:

Mr. Jones opened accounts in other people's names. He sold some properties, with the cash going to an intermediary. He told the intermediary that the people whose names were on the bank accounts were the owners of the property he wanted to receive in the exchange, but he actually owned that land already. He would then arrange for the intermediary to "buy" the land he already owned by sending the cash to the phony bank accounts. The idea was to pretend to buy property to receive in an exchange, but instead to really cash out. He then reported the transaction as a tax-deferred exchange, instead of a taxable sale.

Mr. Jones has not been convicted and remains entitled to the legal presumption of innocence until he has had the opportunity to defend himself in court. The indictment alleges a $90,000 tax loss; the federal sentencing guidelines provide for 21-27 months in prison for that size of tax loss.

The Moral? If you do an exchange, you can't have your cake and eat it too. Either you get property and defer the tax, or you get the cash and pay the tax.

Link: Copy of Indictment, United States of America v. William Franklin Jones.

Tags: like-kind.Section 1031.tax crime.