What is the most proper approach in this situation and what would the IRS want to see in the event of an audit? 

Buyers are presented with information in a truly impartial way so they can best determine best markets to deploy their capital and invest.

If you SCOUR the FBI fraud website (an impartial source) then you will see that "the extent of short sale fraud nationwide is unknown" http://www.fbi.gov/stats-services/publications/mortgage-fraud-2009Michael, can you show us the Fannie Mae source that puts the covenants on a deed?

It takes significant planning and meticulous accounting as it is a very high audit risk, but it can be done.

We hire third-party security specialists to perform yearly audits.

While you can supply important information to the appraiser, such as recent improvements or distinguishing features, they must ultimately provide an impartial market valuation.

The financial statements likely won't be audited so you have to keep that in mind.

I just finished an audit from IRS that cost me lots of money .

Since these properties are far away from me (memphis and I live in California), I have been thinking about employing some 'auditing' practices to help me verify that they are making sure the property condition is being maintained.  

There was a guy here in KC (had 3 rentals) that was put out of business when he was audited by the EPA and ended up being hit with over $100k in fines because his window installer wasn't licensed in lead paint procedures.