The bank was audited and since I had a rental insurance policy on the property they questioned why I wasn't living in it.

The purpose I believe is to have a more experienced managing broker audit your contracts written over the 1st 2 years.

Management fee is 7% of the monthly budget at $13,000.The Property Managers/ HOA Board does not contract an independent CPA/ accounting firm to generate audited financials, which is a problem.

Joel,Yes, tax, accounting and audit representation is my niche.

They may deny it, but that would be in a audit and I'd make sure that my deductions (as with any questionable area) wouldn't cause a change in my return to trigger any significant issues with taxes and penalties.

So my 2015 (the year we started rehabbing properties full time) was audited.

We do internal audits periodically and even in this crazy sellers market over 90% of our clients are completing their exchanges with properties that they like.You'll love the power to take the deferred tax and make money off of it for yourself!!

my follow up question is, assuming an audit by irs where to take place, how would the irs determine, or ask you to prove, your primary residence?

If you were ever audited and the Service decided that you did a 1031 with the intention of purchasing your primary residence then your exchange would fail. 

That money will be treated as your money, judgments can be attached, taxes due as income, included in bankruptcy or assessments made in social security or other benefits.You get audited, the IRS wants to know where you got the additional 5K you failed to claim, it is in your account!