Overstatement of basis does not extend assessment statute of limitation.

• Author: Beavers, James A.

The Supreme Court held that Sec. 6501(e) (1)(A), which extends the three-year statute of limitation for assessing a deficiency against a taxpayer to six years where the taxpayer omits from gross income an amount in excess of 25% of the amount of gross income stated in a return, does not apply to an understatement of gross income due to a taxpayer's overstatement of basis on a return. The Supreme Court's decision resolved a split on the issue among the federal circuit courts.

Background

In 1999, the owners of Home Oil Co., in anticipation of its sale, devised a plan with the assistance of their accountants and lawyers to increase the basis of the assets of the company and thereby decrease the taxable gain on the sale of the company. To that end, they created Home Concrete and Supply LLC (Home Concrete), which was treated as a partnership for federal tax purposes. The owners initiated short sales of a large amount of Treasury bonds and transferred the proceeds from the short sale to Home Concrete as a capital contribution. The owners claimed the amount contributed as outside basis in Home Concrete, but they did not reduce the basis on account of the outstanding obligation to close the short sales.

Home Concrete used most of the amount contributed by the owners subsequently to close the short sales. Shortly afterward, Home Oil transferred its assets to Home Concrete as a capital contribution, and the owners transferred part of their ownership interests to Home Oil. Home Concrete sold substantially all the Home Oil assets a little more than a month later.

In reporting the sale of the assets on its timely filed 1999 return, Home Concrete elected under Sec. 754 to step up the basis in the Home Oil assets to equal its partners' basis in their interests in Home Concrete. The partners' basis in the partnership was much higher than the basis in the assets due to the owners' capital contributions. After step-up, Home Concrete claimed a basis in the Home Oil assets almost equal to the proceeds from their sale, resulting in Home Concrete's recognizing only a modest gain from the sale of the assets. The 1999 return properly reflected the basic components of the trans-actions, including an itemized accounting of Home Concrete's initial basis in the Home Oil assets, the amount of Sec. 754 adjustments to the assets, and their post-adjustment basis.

Despite the obviously questionable nature of these transactions, the IRS did not investigate them until 2003. As a result of the...