received one hundred ninety four million dollars in cash during his lifetime on which he paid knowing income tax he did that by taking these contracts that he had entered into with the banks called variable after his death but that god's law just doesn't allow a taxpayer to postpone the day of reckoning by fundamentally or materially changing the terms of the contract and so that that's the central issue in this case was that seventeen month change of the term of the the contracts in a fundamental or material change when you say is the central issue i understand your point that that absent a fundamental or material change that there could be a constructive sale this statute doesn't necessarily foreclose it but we've treated it as sort of a first step because with the fundamental material change you treat the modified contract as a new contract and so then with constructive sale you're looking at well what are the terms of the new go so for the constructive sale you're saying the material change is a necessary but not a sufficient condition and that's how we've treated it yes and you couldn't take it possibly determine the amount of gain from a constructive sale without something beyond the material change  there values yes and i believe you could actually determine the amount of gain but what on the constructive sale issue what would remain for the court to determine if the court found there was a fundamental change the issue then would be whether the amount of property to be delivered under the the new modified contract was at that time substantially fixed and we've argued that that it was in  reality it was substantially fixed because there was only a very remote chance that the amount of property to be delivered would be separate anything issue yes yes that's that then that's the construct that's the constructive sa that by a year and a half when you're talking about something in a paper property like like a publicly traded stock that has a substantial price volatility built seventeen month change is a huge and if you look at for example call options that were traded on the day that mr mccauley entered into the original contracts the longer the maturity date on the call option the the greater the premium one would have to pay to to acquire that option than the the maturity date of a call option goes it goes to the very essence of an option and that the same is true with what these v p f c if there's enough of a mad at first of all you say material or fundamental which i take is a phrase you get from one place and then you say material which is a free word alone you take from another place i think if fundamental or material change is the language that's used in the revenue ruling and i think we've approached those a sort of being a interchangeable if we treated them as such and in our briefing that becomes it becomes fairly complicated and so on the amount of gain we actually asked the court just determined that to the tax court it could potentially involve factual findings and was disputed issue in the tax court which the tax court  the liability under that morgan stanley v p s c was reduced by two point two eight million i think and then the other the bank of america one is reduced by about one point eight so it's around four million short term capital gains is that change in value based on the extensions according to the expert was about four million dollars because he's liability that's not the game you're proposing the tax that you know that's correct that the game would be the difference would be experts ability not not to come up with the four million dollar figure that's almost trivial here in this case we're talking about his ability to give you the eighty eight million or maybe eighty three million depending upon which version you li part of that gain was the constructive sale issue and that's where the probability analysis comes into play i'm not talking now about constructive sale and staying with your first issue yes again from acquiring the second contract formula as the black holes formula use a probability analysis the black shows formula gives you a probability but my understanding is that in coming up with those dollar amounts i don't believe that factors into it and then i don't get that answer first you said it uses a probability analysis and then you just now said but it doesn't factor in those seem to be in can sync the black shows formula gives you a value that the same probability analysis that is used for the value of the gain on the constructive sale that is the probability analysis that we are relying on a more to say that there was a constructive so we now o i'm not sure how the probability figures into the valuation of the option and my understanding is that is reason our list of how is it the same in the two transactions it is and is it in the records so that we can look at it is it is where is that yes it well it's in the expert's report which is the page or a report is there does his report ever tell us how the probability analysis works i don't i don't recall specifically ask a different one is there any other area of tax law where the value of anything is determined on a probability bas at i believe so i think that the the the value of a option for example is most commonly determined as according to the expert by using this black shoals formula and that's that's how options are typically i guess valued and what the question is essentially what what's the fair market value and so when you have a complicated financial instrument like this it's not apparent what the fair market value is and you have to turn to an expert in this instance and so the you know the expert made the appropriate methodology so far on the short term gain you're proceeding take it on the assumption that what was exchanged was proper we are we are not proceeding on that assumption no we believe that it was property but what argument is that when you have a fundamental or material change that establishes that there's a deemed terminations of the original contract in the modified contract is treated as a new cancellation of an obligation correct you've got to have one or the other right correct is the calculation of game the same for either theory no not necessarily a differences would be that under section one thousand and one into the regulations that if you if it's a property then the gain the amount realized it is based on  the the amount of cash that he received and plus of the value of the property that was received so you're going to be based on the value of the new modified contract whereas the value  if you're talking about a term nation obligations you're going to be looking at what were the obligations that were terminated and those would be the obligations under the original contract and as the expert showed there's a there's a difference in those valuations of about four million dollars so the gain is going to be very similar under either approach but but in our view it would come out different and that's one of the reasons why we think it's a best to do remand that issue  did not exchange property for other property nor was he relieved of any liability it's liability under these two contracts was measured in terms of an uncertain number of shares of stock when he extended the v turnover and uncertain number of shares of stock would be valued at a different date to be calculated at a different date yes there is a call option is extended it's similar to a written call option when those dates are extended there's a taxable event as there  is not your honor oh and also i do want to highlight that this is different from a written call option and one risk let's stay with your rant you're saying if a call option date is extended there's no taxable event for the writer of that call option we are iron and co coing coke is on point on this hicks is on point on this each of these cases stand for the proposition that when you keep open the same obligation from an option writer's perspective you have not yet terminated that first option and you have to keep the premium you received in suspense you sell the call option is or again if you sell a car call option so you're a holder of a call option and you sell it generally yes there would be  would be a gain or loss because even though it's uncertain whether the auction will be edges well at that point once you have sold it you are done with that transaction but again i think that's why you're selling is a piece of paper that is  certain as to his archers that's correct right still taxes when you sell because from the auction writers are option holders perspective that is property so if you dispose of that property your right to material or fundamental change here that think what was the purported realization of that and to analyze it properly one needs to know this is a property transaction the heat exchanger dispose of property in exchange for other property or the only other way he could realize game here is was he relieved from a liability you know property if you dealing with the exchange of property for other property that's handled  thousand one if it's potential relief from a liability it's under section sixty one those two those to use statutes have different rules that apply for when one realizes again and in fact that's what what is so important here is it's a realization question it's not simply did he reduce the expected cost of fulfilling his obligations the question is did he realize game did he close and complete his transaction and by extending the date here he did not use a reduction in liability again he did not actually reduce his liability cording to the expert who testified  persuasively i thought about how the black shows formula applies to options and so on the that the judge newman has pointed out the valuation date is a critical day in these transactions and  by changing it and putting on into the future for another twelve or fourteen months that significantly reduced his liability applying actuals formula to value to b p s c s at those two different times why what's wrong with that than what's wrong with that is he didn't reduce his liability he reduced his expected cost of fulfilling the obligation but his liability is measured in terms of stock and an uncertain number of shares of stock and what's important here mean i don't understand using he didn't reduce he changed his liability absolutely he changed his liability he changed he changed the date on which he would calculate and ultimately settle his liability but he didn't reduce quantum that he owed when he thought he was getting something better than a yes that's part of the eleven million dollars to get you paid on levin million dollars to put off having to deliver and you're saying that someone who pays eleven million dollars to get something else doesn't get anything materially different you're on it he didn't have something he didn't get he did not have something or get something he put off an obligation of he did this wasn't charity he he paid eleven million dollars to two bags absolutely and there was value to him in putting off his obligation but again that is different from actually lessening his obligation and what's critical is if the stock price had gone up and you say a man has eleven million dollars has has one contract says i want another contract i want one with a different valuation date and i'll pay you a leathern million dollars ford and you say that's not a material change whether it's a material change or not is not the relevant question for has he realized again because again at this point in time he has only an obligation he has a certain an obligation to deliver an uncertain number of shares of stock and when he paid this point in time i mean at the moment he gets the extension so that the moment in time and from every point after he's received the prepayments and why why do we determine whether his property only at that time why don't we determine whether u s property at the beginning of the transaction because the realization question is if it's even the theory of the i r s is that he realized gain through the exchange of property or deemed exchange for property question is what did he give up and what did he gain and a contract is just a bundle of rights and obligations at this point he didn't give up a right to receive a prepayment house he'd have property he would yes he had a house with a big with one hundred percent mortgage because you still got property this but that what he has in this point he has cash that he has received and he holds onto that and he has an obligation and he puts off that obligation and if the stock price had gone up after his extension his ultimate cost of satisfying that obligation would go up to and so next saying that at the time he did you know you were so far below the strike force that there was what would you say a fifteen percent probability they would even in the question is is there any real possibility that this stock is going to rise back up and result in him ultimately having a lost position on the c p s is there absolutely is that possibility in the first way could he have said to the banks run on certain settlement it objectively ascertainable but i'm certain one day after my death yes you could have thirty there's nothing in the record to suggest that again could any taxpayer do that if it were negotiated with his counter and i suppose one could and thereby assure the stepped up basis for the estate i think at that point you would have a different problem in that it would become income and reset respect of a dissident because at that point there would be nothing for the estate to extended within two months of he can extend it again as long as he is not reducing his liability which we absolutely think he did not do he he kept his uncertain liability measured the exact same way through the extensions you see measure the same way you mean the formula for measuring is the same yes but the data which is supplied is different because the dates differ and it could end up being more costly or less cost it's still uncertain that's true too but as of the day he did it it was only a fifteen percent probability it would be all that's destroyed yes that's true but that's that's a fair estimate based on one expert's probability and there's no conflicting evidence there we think that is a fair probability to rely on here we just don't think that that is has ever been held to be relevant by the iraqis and the court essentially what they're asking this court to do is draw economic lines in a very complicated area of tax policy when previously every regulation every court every revenue ruling has looked at the fundamental principles of what is going on which is do you still fundamental aspect of what's going on and i suggest to you that the fundamental aspect of what's going on is somebody who has his whole asset value tied up in one stock who wants to change it to a diversified portfolio and goes to do banks and gets one hundred ninety four million dollars so he can do that and you want us to say there's no gain when he does and that's been blessed explicitly by the i r s the two thousand revenue in two thousand time that's the first contract they've lasted why they did that i don't know that's that's their problem they did it you know on again now we have a new transaction of a swap for a second contract with a new valuation day we disagree that it is a new transaction we think it is the same open a second transaction let's not call it new then let's call it second to the first right you  this is unprecedented anybody ever done this before and achieve the result you want we think this is entirely analogous to a short sale i understand is analogous but has anyone ever done this maneuver of extending valuation days on a variable price forward and not been charged with a taxable we're not aware of any precedent in one way or the other to say to them oh they're doing something wholly new is really no better an argument than to say you're trying to do something wholly new and we have to decide who is going to win this unusual things but again respectfully your honor we think the president that we cite in our brief all points to the view that when you change a valuation date a calculation it because really in any forward contract the date of settlement of a contract can can be viewed as key to the ultimate valuation so any extension of forward contract the irish could be making the same arguments they don't because the i r s has to date and courts today have said when you have an open transaction and you have certain and you keep that same uncertainty going you don't stop and value things that as of a given date you wait until there is certainty there is the same serve and they would say it's a different answer because it has a different day we think that argument proves too much we just think that argument proves too much because again from mr mcalpin standpoint when he extends that hollywood proves that you lose the fair enough your honor we think it's a dangerous precedent is that because when mr mckenzie extended this he didn't know whether that would ultimately reduces his cost of satisfy his obligation or increase he both he and the bank have to have some notion of what the change in settlement and  reasonable for him to think now what this stock has gone down from thirty two to seventeen in the first ten months of this contract i believe in this company i think the stock is going to rise back up i don't want to deliver my stock in two months i want to keep my transaction open i want to let it ride in hopes that the stock is going to rise back up and i'll be able to realize the appreciated value of that stuff you kept that possibility open volatility is recognized in the black shuls formula and i gather that the creators of the formula won the nobel prize for developing a way of pricing options that includes volatility and and such things a settlement date that we're discussing and you have an offer and a different kind of analysis for the valuation that people trade in these contracts so where we're left with a whit open you know no one knows and yet people are in fact valuing them and trading on them it's not just a question of valuation that is untrue it's also the character of what's going to happen because if mr mccarthy ultimately settled his b p s use by delivering stock which is what happened here and that needs to be treated as a sale of the stock delivered for whatever his basis in the stock the government's position on short term capital gains that the replacement of the new the p f c from the original of the p of c with the new represented a other an exchange of property or a reduction in his  obligations and so in that that is a short term thing kind of transaction you're just describing is what ultimately happens with respect to long term capital gains and how much is realized is not right too different to different  that same trend same underlying transaction open because one would have realized gain an artificially midstream when he still hasn't yet decided whether he's going to deliver the shares and isn't that the nature of  of a derivative contract needs to be deemed a realization of instead where there is continuing uncertainty one waits until you know the nature and amount of whatever gain or loss you have and i think that uncertainty tax we think it's favorable and obviously we said in our brief a number of precedents that we think actually support our position quite strongly in that courts have repeatedly said we can best short sale example is is we think perhaps the best one and that is cream for two has a short sale it's remains open i don't actually said it's a supreme court i don't believe that that was right i think that's from the tax court but short sales are considered open transactions a short sale can be viewed in a way it's every day you're changing the expected value of settling that transaction irises never said no court has ever said that every day you have to revalue that determine whether you or you are changing or you mean the market is changing the market market is what you are not negotiating for a new strike price now every day that one keeps a short sale it's changing that's a different kind of change from the change here but every day that you and your counter party decide not to settle that short sale or your counter party decides not to demand delivery on the short sale the expected cost of satisfying your obligation is changing every single day every day it's kept open there's further chords is faced with with trying to draw off analogies but i think the life insurance example is actually quite helpful to us in that that would be analogous here if mr mchale we had changed the stock that was referred to in the v p se because then the transaction would be done it would be no possibility that he would often only have to deliver six point five million shares of monster stock here he kept open that same very real possibility that these going to settle on shares of stock or with cash there is no realization there is a continued uncertainty because that is not in our view a fundamental change or more relevant heater or away from his liability  one o nine has been in place since one thousand nine hundred ninety and it's long been understood to to to to set forth what you know the fundamental or material change rule that a taxpayer who changes the terms of their financial instrument in a fundamental material way is treated for tax purposes as having ended the old contract and turned into a new contract and if that contract is property then that's an exchange or property is taxed as an exchange of property under section one thousand and one and then this case presents a new scenario where if it's not property and we believe that it was but if it's not you still have terminated the obligations that's never come up before but but it's it's in it's it's a necessary implication of the fundamental change and the resulting determination an entry into a new contract you've terminated   it's appropriate to to to do that when there's been a new contract whether whether in fact or as having been deemed on the property if you in the case x court said it was not property or said it was not crime of the exchange at the time of the exchange you think the question of whether it's property should be answered at the time of the exchange you're at that time the proper use of what we think it should be at the the time robert he was acquired at least in the time it's acquired it is property because yes yes and anyway the tax court said it wasn't property is to view it later when there was only an obligation left that's correct that's correct and when you're talking if if the date is the time of acquisition of the item why don't you call it an asset that modes or the item in question then the tax code would have been wrong in its first step namely that it's not property that's correct that's the commissioner's position that's that's our position that at least in the case we're talking about a bilateral financial instrument we're motherwell out on the other side of the case the constructive sale side is there any area any case any situation in tax law where a property would be valued for tax purposes pending on whether he's price was so low that it could realistically go above great price or any other situation outside of a constructive sale any other situation where you would say well this is so low and so you percent probability that it will ever reach this and and probability analysis that's right that's right and it really it's a it's a sort of a basic substance over form question deep my friend the other side wants you to to focus on what was the form of the contract and inform yes there was a theoretical possibility that that there could be a amount of property other than six point five million shares that would be delivered to those if the company realistic monster but if a company had various assets and provide for making adjustments recognizing that construction is constructive sale is not a sale that actually happens the actual sale happens later the code does provide for just means to be made at the later at the time of the actual sale and more generally because we're talking about realisation and it's a timing issue the game that was realized that that was realized at the time of these contract modifications would be stepped up basis correct yes that that's correct so in this instance it wouldn't a subsequent rise in the value wouldn't vale the taxpayer or his estate an