You both very well may be audited. But if you report the 100% honest truth on your tax return as it should be, and not as your closing agent said, you'll be fine. Basically, your closing agent screwed up. Both of you were at the closing. Both of you agreed that only one check should be made out, and that one check should be payable to you. *YOU* paid that closing agent, and I'm surprised you didn't stand your ground and insist that closing agent do it "YOUR" way. The closing agent does not have "ANY" final say in this. The seller's have the final say, and if the closing agent doesn't like it, then that's just to bad.
I myself have always closed on property with my family lawyer present, so when these piddly-assed things start to pop up, they usually "go away" rather quickly. 🙂 The funniest part of this is that my family lawyer doesn't know a damn thing about real estate law or tax law. But for $100 for him to show up at a closing to ensure it goes smooth, has paid for itself on more than one occasion.
Remember, your closing agent is not a tax authority. But then, I don't claim to be such authority either. However, after 25 plus years of dealing with this stuff on rental property, I've been there, done that, got the T-Shirt.
Generally, such an audit is NOT where the IRS knocks on your front door for a sit down. More than likely it would be a paper audit where the IRS sends you a letter in the mail that basically says to substantiate your claim. You have the financial history records to prove it (bank statements and the such) so it's no big deal. For a situation like yours, more than likely all it will take is a notarized affidavit (probably from both of you) stating the truth, and you're done.
Besides, when you sell real estate at a loss, you're generally not required to report it on your tax return anyway. However, if you receive a 1099-S as you did, then you're required to report it, gain or loss.
