If you try to claim this is not a flip and you flip another property in the future, you will subject this transaction to audit risk and potentially large penalties.The biggest variable here is whether or not you can prove the intent was something other than that of flipping.

In the event of an audit with a system like this would the IRS request physical receipts, or would the itemization the system generates satisfy them?  

The last audit I had was a while back and they came back and said I owed them under $200.

As for the deduction for paying people in cash, it depends on what your tax advisor is comfortable defending should you be audited.

I had done 400 plus loans when I had my first audit by the state and told them I was exempt.. well you know how that went.

I learned today that if I refinance the properties immediately that will be flagged as a second tax free transaction during the year and as such it will 1) trigger an IRA audit and 2) ultimately trigger payment of the taxes.

You would have to be able to demonstrate your intent to hold for rental or investment purposes (and not for resale purposes) should you get audited. 

And there always is the risk that you do something not quite right and fail an audit should one ever occur.There are a lot of things that are possible, but just don't make sense.

I'm trying to look at this from the tax audit perspective and the FHA lender's perspective.Thanks in advance for your reply.

I agree to audit leases and other financials carefully.