Court Rules that Basis Overstatement does not Extend Statute of Limitations

The IRS may generally assess a deficiency against a taxpayer within three years after the date a tax return was filed.This time period is extended to 6 years in cases where the taxpayer omits an amount from gross income that is greater than 25% of the gross income stated in the tax return.

In the case of Home Concrete, the taxpayer reported an overstated basis in property sold and, therefore, understated gain realized. The IRS failed to act within the three year statute of limitations, but issued a deficiency notice before the six year statute expired.The issue at hand was whether the taxpayer’s overstated basis (resulting in the understatement of gain) constituted an omission from gross income which would extend the statute of limitations to six years.

A District Court ruled in favor of the IRS and concluded that the overstatement of basis extended the statue of limitations from three to six years. On appeal, however, the Fourth Circuit, and later, the Supreme Court affirming, ruled in the taxpayer’s favor and concluded that the word “omit” clearly meant to leave out or fail to mention.Since the taxpayer had reported the transaction, the extended period for assessment did not apply and the statute of limitations was determined to be three years.

While litigating the statute of limitations issue, the IRS issued final regulations in December 2010 related to this matter stating that, in fact, an understated amount of gross income resulting from an overstated basis is an omission of gross income for purposes of the six-year period for assessment.

The results of this case and the subsequent change in the Internal Revenue Regulations makes it clear that taxpayer’s need to properly keep track of asset basis to avoid such a situation.