Cheating on a 1031 Identification is Tax Fraud; Penalties Severe
There is no doubt that 45-days is a short period of time to select just a few properties as possible replacement properties for your 1031 tax-deferred exchange. This is especially true for those who made the last minute decision to initiate an exchange. The quest to find the desired property can be quite stressful and for a few, it creates the temptation to cheat. Failure to identify the replacement property within the 45-Day Identification Period will make the exchange a taxable event.
1031 CORP. has had our fair share of Exchangers who have asked us to break the rules and change a 45-day identification. Some have been a little more extreme than others like the man who drove over 300 miles to ask in person after explaining the financial hardship a failed exchange would create for his family or the one who threw a wad of money on my desk. While we appreciate their desire to avoid this tax bill, we also cannot help them commit tax fraud and we always warn about the dangers of getting caught. The case we always share is the Dobrich case which demonstrates the severe consequences of cheating.
Dobrich v. Commissioner, TC Memo 1997-477, was a United States Tax Court case involving an appeal by David and Naomi Dobrich who had had a fraud penalty imposed against them by the IRS. They sold 117 acres of property in Antioch, California in a 1031 exchange. The agreement with the buyer did include 1031 exchange language and they entered into an Exchange Agreement with a Qualified Intermediary (QI). The relinquished property closed on August 22, 1989 so their 45-Day Identification Period ended on October 6, 1989 and the 180-Day Exchange Period ended on February 18, 1990.
The QI was a corporation (QI) owned by their long standing real estate attorney but because the case was pre-Regulations their attorney was not deemed to be a “dis-qualified” intermediary as he would today. Following is a summary of their transaction:
- The Dobriches were repeatedly advised by their QI and real estate professional to identify replacement property within the 45-Day Identification Period.
- In December, 1989, they put offers in on several properties and the QI paid the earnest money deposits from their exchange proceeds but none of them were acquired by the Dobriches.
- On October 12, 1989, six days after the 45-Day Identification Period ended, the Dobriches told their real estate professional, Ms. Love, that they were interested in the Skyland property in Lake Tahoe, Nevada.
- On January 11, 1990, another real estate professional, Mr. Van Voorhis, told the Dobriches that property in Pleasant Hill, California was for sale and on January 26, 1990, they offered to purchase the Pleasant Hill property.
- Neither property was identified within the 45-Day Identification Period.
- The Dobriches purchased both the Skyland and the Pleasant Hill properties on February 15, 1990, three days before their 180-Day Exchange Period ended. The Agreements with the Sellers were assigned to the QI and the exchange funds were transferred from the QI to the closing agent.
- In January 1990, Mr. Dobrich asked Ms. Love, the real estate professional who sold them the Skyland property, to write a false letter addressed to the Dobriches stating that the Dobriches had expressed an interest in purchasing the Skyland property as of September 1989. She did so and her letter was backdated to September 18, 1989. In January 1990, Mr. Dobrich also asked one of the real estate professionals involved with the Pleasant Hill property to write a similar letter about the Pleasant Hill property identification.
- On January 8, 1990, the QI provided a sample identification letter to the Dobriches.
- In January 1990, Mr. Dobrich wrote a letter to the QI identifying two possible replacement properties, Pleasant Hill and Skyland. The letter was backdated to September 18, 1989.
- Their accountant, relying on the information provided by the Dobriches, reported the transactions as a 1031 exchange on Form 8824.
Their return was audited and the IRS disallowed the 1031 treatment. During the audit, the backdated 45-day identification letter was provided to IRS. The Dobriches appealed but ultimately, the Tax Court found the transfer of the relinquished property was a taxable sale.
Additionally, Mr. Dobrich entered into a written plea agreement with the U.S. Department of Justice and pleaded guilty to two counts of violating § 7207 for causing the delivery of false documents to the IRS. The IRS imposed a civil fraud penalty equal to 75% of the tax that was due.
The Dobrich decision does not address what happened to the “accommodating” QI or the real estate professionals who had assisted the Dobriches in their fraudulent identification. Such assistance amounts to criminal conspiracy and is subject to federal criminal prosecution.
As a QI, it seems funny to get the occasional request to accept a backdated identification letter or to help an Exchanger acquire a replacement property that was not identified. Most of these same Exchangers carefully chose 1031 CORP. based on our reputation, our references and experience yet they seem okay asking for help when they decide it is okay to break the law. Our Exchange Officers are quick to remind them why they chose 1031 CORP. and adamantly deny their request. We prefer not to wear orange polyester.
This case is as a cautionary reminder to 1031 Exchangers, their agents and advisors that the 45-day identification is an integral component of a successful exchange and trying to get around it is tax fraud. Our Exchange Team at 1031 CORP. is always happy to help you properly identify your replacement property and keep you aware of the 1031 requirements.