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Federal income tax.

Tax Facts Q: 7519. What is "tax basis"?

UTAM Ltd. et al. v. Commissioner, No. 10-1262 (D.C. Cir. Jun. 21, 2011) & Intermountain Insurance Services of Vail, LLC v. Commissioner, 2011 U.S. App. LEXIS 12476.

Two D.C. Circuit companion cases were recently decided, regarding whether an understatement of income can trigger the six-year, extended tax assessment period under IRC Section 6501(e)(i)(A) when the understatement results from an overstatement of basis in sold property.

The key tax concept at issue in the two cases was "basis." "Basis refers to a taxpayer's capital stake in an item of property--generally the amount the taxpayer paid to obtain it, as adjusted by various other factors. 26 U.S.C. Sec. 1012. When a taxpayer sells property, he realizes gain from that sale, and that gain contributes to gross income. Id. Sec. 61(a)(3). But the taxpayer's gain from the property sale is not the sale price (or in technical terms, the 'amount realized') but rather the sale price minus basis. Id. Sec. 1001. Given the role basis plays in calculating gross income, a higher basis translates into a lower gross income. In the real world, of course, people generally prefer a higher gross income. But when dealing with the tax collector, lower gross income means a smaller tax bill. Taxpayers, therefore, prefer a higher basis."

The key question for the Tax Court, then, was whether such "overstatements qualify as omissions from gross income under Sections 6501(e)(1)(A) and 6229(c)(2) and thus trigger the six-year limitations period." The court answered in the negative, that basis overstatements are not "omissions from gross income." Intermountain Ins. Serv. of Vail, L.L.C.. v. Commr, T.C. Memo 2009-195, 2009 WL 2762360 (2009).

Shortly after the court's decision--"and implicitly contradicting that decision--the Internal Revenue Service issued temporary regulations that interpret the phrase "omits from gross income" in Sections 6501(e)(1)(A) and 6229(c) (2) to include basis overstatements outside the trade or business context. [citations omitted]."

The IRS reasoned that because IRC Section 61(a)'s standard definition of "gross income" includes "gains derived from dealings in property," and because such gains are ordinarily calculated by subtracting basis from the amount realized, "outside the context of a trade or business, any basis overstatement that leads to an understatement of gross income under Section 61(a) constitutes an omission from gross income for purposes of Sections 6501(e)(1) (A) and 6229(c)(2)." [citations omitted]. The question determined by the circuit court was "whether a taxpayer who overstates basis in sold property and therefore understates gross income triggers the extended statute of limitations periods."

The court reasoned that the Section 6501(e)(1)(A) "omits from gross income" text is at least ambiguous, if not best read to include overstatements of basis; and neither the section's structure nor its legislative history nor the context in which it was passed nor its reenactment history removed that ambiguity."

Thus, the court concluded that, "outside the trade or business context, nothing in Section 6501(e)(1) (A) unambiguously forecloses the Commissioner from interpreting "omissions from gross income" as including basis overstatements." In other words, the court found the six-year limitation could apply to basis undervaluations.
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Title Annotation:Monthly Round-up
Publication:Tax Facts Intelligence
Date:Oct 1, 2011
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