t c memo united_states tax_court lkf x investments llc lkf x capital corporation tax matters commissioner of internal revenue respondent partner petitioner v docket no filed date edward m robbins jr and sharyn m fisk for petitioner david w sorensen for respondent memorandum opinion marvel judge respondent issued a notice of final_partnership_administrative_adjustment fpaa for pursuant to sec_6223 to lkf x capital corp lkf cc or 1unless otherwise indicated all section references are to the internal_revenue_code code and all rule references are to continued petitioner the tax_matters_partner of lkf x investments l l c lkf a limited_liability_company classified as a partnership for federal_income_tax purposes lkf cc timely filed a petition contesting respondent’s determinations this matter is before the court on the parties’ motions for summary_judgment under rule the issues for decision are whether the court has jurisdiction in this partnership-level proceeding to decide whether lkf should be disregarded for federal_income_tax purposes and whether the partners’ outside bases are zero whether the court has jurisdiction to decide whether the accuracy-related_penalties apply and if the court has jurisdiction regarding the accuracy-related_penalties whether lkf is liable for the substantial_valuation_misstatement prong of the accuracy-related_penalty for the reasons discussed below we shall deny petitioner’s motion for summary_judgment and grant respondent’s motion for summary_judgment continued the tax_court rules_of_practice and procedure 2respondent determined in the fpaa that lkf was a sham lacked economic_substance and should be disregarded for federal_income_tax purposes our references to lkf as a partnership and to its members as partners are for convenience only lkf is not a small_partnership within the meaning of the small_partnership_exception see sec_6231 and therefore is subject_to the unified partnership audit and litigation procedures of the tax equity and fiscal responsibility act of publaw_97_248 96_stat_648 background the parties stipulated the relevant facts for purposes of our ruling on the motions we incorporate their stipulations herein by this reference no facts material to the disposition of the cross-motions remain in dispute i the market-linked deposit transactions a preliminary steps on or before date laurence k fishman mr fishman engaged the law firm of cantley and sedacca l l p cantley to prepare and file all documents necessary for the formation of lkf and lkf cc between september and date cantley prepared and sent mr fishman documents to enable mr fishman to participate in market-linked deposit transactions mld transactions cantley promoted on date lkf was formed as a limited_liability_company under the laws of delaware on the same day mr fishman executed an operating_agreement of lkf x investments l l c operating_agreement acknowledging that mr fishman contributed dollar_figure in exchange for big_number class a units of lkf upon lkf’s formation mr fishman was its only member the operating 3cantley instructed mr fishman to sign the documents but not date them mr fishman signed the documents as instructed and returned them to cantley in date 4on date lkf filed a form ss-4 application_for employer_identification_number identifying lkf as a multiple- continued agreement identified venice california as lkf’s principal office and place of business on date lkf cc was incorporated under the laws of delaware the certificate of incorporation identified edward sedacca as the incorporator on date in his capacity as the sole shareholder of lkf cc mr fishman elected himself as the sole director of lkf cc on the same day as the sole member of the board_of directors mr fishman elected himself president and secretary-treasurer and adopted the bylaws of lkf cc on date lkf opened a broker account at deutsche banc alex brown l l c at some point before date dollar_figure was deposited into lkf’s account continued member limited_liability_company and mr fishman as its manager the form ss-4 showed that los angeles county california was lkf’s principal business location 5the record indicates that as of date mr fishman had not transferred any property to lkf cc in exchange for its stock the record is not clear whether any lkf cc shares nevertheless had been issued to mr fishman at that point that would have allowed mr fishman to properly elect lkf cc’s directors on date see del code ann tit sec_107 providing generally the incorporator elects the first directors and adopts the original bylaws however the validity of mr fishman’s vote as a shareholder on date does not affect our resolution of the parties’ motions b the terms of the mld transactions on date lkf and deutsche bank ag new york deutsche bank entered into two offsetting mld transactions the terms of the mld transactions required lkf and deutsche bank to deposit the same amount big_number with each other both deposits had a maturity_date of date and fixed interest at an annual rate of percent payable at maturity along with the principal the terms of the mld transactions also provided for bonus coupons payable on date but only if pincite a m new york time on date bonus coupon fixing_date the japanese yen to u s dollar exchange rate was greater than or equal to a certain exchange rate strike_price with respect to the deposit by lkf deutsche bank was to pay lkf a big_number bonus coupon if the strike_price was greater than or equal to dollar_figure japanese yen to a u s dollar long option with respect to the deposit by deutsche bank lkf was to pay deutsche bank a 6the parties stipulated that deutsche bank was the counterparty to the transactions although deutsche bank sent the confirmations of the transactions the confirmations also indicate that deutsche bank london was the counterparty in any case for purposes of the parties’ motions it is irrelevant which deutsche bank entity entered into the transactions 7for both mld transactions deutsche bank was the calculation agent that would determine and notify the parties of the exchange rate on the bonus coupon fixing_date big_number bonus coupon if the strike_price was greater than or equal to dollar_figure japanese yen to a u s dollar short option under the terms of the mld transactions lkf was to pay deutsche bank a premium of big_number or dollar_figure million at a spot_rate of and deutsche bank was to pay lkf a premium of big_number or dollar_figure at a spot_rate of the terms of the long and short options provisions of the mld transactions are summarized below option long short net premium big_number big_number big_number strike_price per u s dollar dollar_figure dollar_figure bonus coupon big_number big_number big_number 1the u s dollar equivalent of the net premium was dollar_figure at the exchange rate of dollar_figure u s dollar per euro the parties agreed to pay the premiums on date but neither lkf nor deutsche bank transferred the deposit amounts or the premiums to the other party on date lkf wired a dollar_figure net premium to deutsche bank under the bonus coupon provisions of the mld transactions three scenarios were possible if on the bonus coupon fixing_date the exchange rate was below dollar_figure japanese yen to a u s dollar neither lkf nor deutsche bank would be entitled to a premium interest payment if the exchange rate was dollar_figure or 8the parties incorrectly stipulated that the premium for the long option was payable on date instead of date dollar_figure japanese yen to a u s dollar lkf would be entitled to a big_number bonus coupon and would have no obligation to pay a bonus coupon to deutsche bank if the exchange rate was at or above dollar_figure japanese yen to a u s dollar both lkf and deutsche bank would be entitled to receive and would be required to pay bonus coupons meaning that lkf would be entitled to a net bonus coupon of dollar_figure c events after date on date mr fishman entered into an agreement with cf advisors xvi l l c cf advisors according to which cf advisors was to advise mr fishman on investment strategies using long and short foreign_currency and foreign_currency derivatives on date mr fishman in his capacities as the sole member of lkf and the president of lkf cc executed an assignment of membership units and joinder agreement assignment agreement transferring his entire_interest in lkf to lkf cc mr fishman treated the transaction as a nontaxable_exchange under sec_351 in which mr fishman contributed to 9the parties’ stipulation of fact incorrectly shows this amount as big_number 10the potential net bonus coupon is calculated as the difference between the bonus coupons payable or big_number minus big_number 11the parties incorrectly stipulated the name of the cf advisors entity we disregard the stipulation on this point as being inconsistent with the record lkf cc property with a dollar_figure basis in exchange for lkf cc sharesdollar_figure on date cf advisors became a member of lkf when lkf cc and cf advisors executed an amended and restated operating_agreement of lkf x investments l l c amended agreement in the amended agreement lkf cc and cf advisors acknowledged that lkf cc contributed dollar_figure in exchange for big_number class a units and cf advisors contributed dollar_figure out of service fees described below in exchange for big_number class b units the members agreed that lkf would be classified as a partnership for federal_income_tax purposes see sec_301_7701-3 and b proced admin regs on the form_1065 u s return of partnership income the parties reported the transaction as a 12although the parties stipulated that mr fishman received big_number lkf cc shares in exchange for interest in lkf a document entitled sec_1_351-3 statement for shareholder tax_year attached to mr fishman’ sec_2001 form_1040 u s individual_income_tax_return indicates that mr fishman received big_number voting common shares of lkf cc lkf cc’s certificate of incorporation indicates however that only big_number common shares were authorized when lkf cc was incorporated the discrepancies in the record as to the number of lkf cc shares that mr fishman received in a sec_351 transaction do not affect our disposition of the motions 13the long option and dollar_figure were assets lkf held when it was a single-member limited_liability_company and therefore technically lkf cc contributed both cash and the long option to the newly created partnership with cf advisors as stipulation states and as reported on lkf’s form_1065 u s return of partnership income however for reasons that are not explained in the record the amended agreement does not mention the long option as a capital_contribution by lkf cc contribution to lkf of dollar_figure consisting of dollar_figure cash and dollar_figure million of mld transactions and by cf advisors of dollar_figure lkf cc’s capital_contribution item of dollar_figure million represented the big_number premium converted to u s dollars at the spot_rate of that lkf was to pay deutsche bank under the terms of the long option the parties did not reduce the basis in lkf to reflect the obligations under the short option taking a position that those obligations were not liabilities for purposes of sec_752 the amended agreement also provided that cf advisors would provide services as an investment adviser and foreign_currency and foreign_currency derivatives specialist the amended agreement provided for quarterly compensation of cf advisors for such services calculated on the basis of lkf’s net asset value and all income and gains with respect to however the parties agreed cf advisors would receive a one-time dollar_figure service feedollar_figure on date lkf wired dollar_figure to cf advisors’ account in partial payment of the service fee for between november and lkf entered into four separate european digital currency option transactions with 14the stipulation of facts contains conflicting information regarding the amount of the service fee on the one hand stipulated exhibit 21-j states that the fee was dollar_figure and we so find on the other hand the parties stipulated in par g that the fee was dollar_figure in any event the amount of the fee is not determinative deutsche bank involving euro japanese yen british pounds and canadian dollars digital options for a premium of dollar_figure each on date lkf sold the japanese yen digital option for dollar_figure on date lkf wired an dollar_figure payment for the digital options premiums to deutsche bank the three remaining digital options expired with the euro and canadian dollar digital options expiring out of the money and the british pound digital option paying dollar_figure the aggregate net_loss to lkf with respect to the digital options was dollar_figure on date lkf authorized a purchase of canadian dollars for dollar_figure canadian currency position at the spot_rate on date the mld transactions matured neither lkf nor deutsche bank repaid each other the principal or fixed interestdollar_figure d lkf’s deemed liquidation on date cf advisors withdrew as a member of lkf by selling its interest to lkf cc for dollar_figure lkf cc became lkf’s sole member after the sale because lkf had elected to be treated as a partnership for federal tax purposes the sale of cf advisors’ interest resulted in a deemed liquidation of lkf for 15the record does not reflect what exchange rate the calculation agent reported on the bonus coupon fixing_date but the parties stipulated that the new york federal reserve bank reported the exchange rate of dollar_figure japanese yen per u s dollar the record does not reflect that the parties paid each other bonus coupons or that deutsche bank paid a net bonus coupon to lkf federal_income_tax purposes see sec_708 45_tc_588 revrul_99_6 1999_1_cb_432 on date lkf’s assets consisted of dollar_figure cash and the canadian currency position under sec_732 lkf cc claimed a basis in the canadian currency position equal to its basis in lkf or dollar_figure on or about date lkf sold the canadian currency position for dollar_figuredollar_figure ii federal_income_tax reporting a cantley opinion in date cantley mailed mr fishman a 100-page opinion letter regarding the mld transactions the opinion concluded inter alia that it was more_likely_than_not that the obligations under the short option would not be treated as liabilities for purposes of sec_752 when mr fishman contributed his interest in lkf to lkf cc his basis in lkf cc was equal to the premium due from lkf for the long option feature of the mld transaction plus any cash held by lkf and lkf cc’s purchase of cf advisors’ interest resulted in a deemed liquidation of lkf for federal tax purposes under sec_708 and lkf cc took lkf’s remaining assets other than cash and marketable_securities with an adjusted_basis equal to 16the parties stipulated that lkf sold the canadian currency position lkf cc’s adjusted_basis in lkf immediately before the deemed_distribution reduced by any cash and marketable_securities deemed received see sec_732 b lkf’s form_1065 lkf timely filed its form_1065 on schedules k-1 partner’s share of income credits deductions etc lkf reported capital contributions by lkf cc of dollar_figure consisting of dollar_figure cash and dollar_figure million of mld transactions and contributions by cf advisors of dollar_figure lkf cc’s contribution of dollar_figure million represented a big_number premium converted to u s dollars at the spot_rate of that lkf was required to pay deutsche bank under the terms of the long option lkf cc and lkf did not treat the obligations under the short option as liabilities under sec_752 and did not reduce lkf cc’s basis in the partnership_interest by the short option premium on the form_1065 lkf reported the following separately_stated partnership items item interest_income interest_expense dividend income net_loss on digital options guaranteed payments to cf advisors wire fees nondeductible expenses total amount dollar_figure big_number big_number big_number big_number all separately_stated partnership items were allocated to lkf cc lkf also reported distributions to its partners of dollar_figure cash and the canadian currency position to lkf cc and dollar_figure to cf advisorsdollar_figure under sec_732 lkf cc allocated its remaining basis in lkf partnership_interest to the canadian currency position as the only partnership asset other than cash accordingly lkf assigned the canadian currency position an adjusted_basis of dollar_figure c mr fishman’ sec_2001 return on hi sec_2001 form_1040 mr fishman included lkf cc as an s_corporation mr fishman reported a nonpassive loss from lkf’s schedule_k-1 of dollar_figure the loss represented lkf cc’s loss on the sale of the canadian currency position that lkf cc received in a deemed_distribution in the lkf liquidation the canadian currency position was sold for dollar_figure with the substituted_basis of dollar_figure mr fishman combined this nonpassive loss from lkf with other income of dollar_figure primarily related to mr fishman’s business trident labs inc and reported total partnership and s_corporation income of dollar_figure 17the parties incorrectly stipulated the amount of distribution to cf advisors but the exact amount is irrelevant for purposes of deciding the parties’ motions iii fpaa and the parties’ stipulations of settled issues respondent examined lkf’ sec_2001 form_1065 and on date mailed an fpaa to lkf cc as tax matters partnerdollar_figure in the fpaa respondent adjusted partnership items as follows item portfolio_income interest portfolio_income dividends other portfolio_income loss guaranteed payments to partner deductions related to portfolio_income interest_expense investment_income investment_expenses net_earnings_from_self-employment nondeductible expenses distributions--money distributions--property other than money as reported dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number as corrected -0- -0- -0- dollar_figure -0- -0- -0- -0- big_number -0- big_number -0- in exhibit a explanation of items explanation of items attached to the fpaa respondent provided the following explanations for the adjustments to lkf’s form_1065 lkf was not a partnership as a matter of fact even if lkf was a partnership in fact it was formed solely for tax_avoidance purposes and various transactions had no business_purpose lacked economic_substance constituted an economic sham and were abusive under sec_1_701-2 income_tax regs and lkf 18although on its form_1065 lkf checked off that it is not subject_to secs it also designated a tax_matters_partner 19the explanation of items is attached hereto as an appendix should be disregarded and all transactions should be treated as entered into by lkf’s purported partners respondent also explained that the obligations under the short option provision of the mld transactions constituted liabilities under sec_752 the assumption of which by lkf should reduce the partners’ outside bases although the fpaa did not adjust the partners’ outside bases to zero in the explanation of items respondent determined that the partners failed to establish that the partners’ bases in the long option were greater than zero and accordingly the partners failed to establish that the adjusted bases in their respective partnership interests were greater than zero in paragraph of the explanation of items respondent determined that penalties under sec_6662 applied lkf cc as lkf’s tax_matters_partner timely filed a petition contesting respondent’s determinations on date the parties filed a stipulation of settled issues stipulation the parties stipulated that all of the disputed partnership items should be adjusted in accordance with the fpaa except the partnership_item distributions--property other than money dollar_figure petitioner also stipulated 20for distributions--property other than money the parties stipulated dollar_figure instead of dollar_figure as lkf reported on the form_1065 or zero as respondent determined in the fpaa if the court determines that it has jurisdiction in this case petitioner stipulates that he does not intend to call any witnesses or offer any evidence in this proceeding or otherwise contest the determinations made in the fpaa other than the determination that the valuation_misstatement_penalty imposed by sec_6662 b e and h applies to any underpayment resulting from the adjustments to partnership items in the recitals part of the stipulation petitioner contends that the court lacks jurisdiction over certain issues addressed in the fpaa and that any underpayment attributable to the adjustments in the fpaa would not be subject_to the valuation misstatement prong of the accuracy-related_penalty under sec_6662 b e and h the recitals part of the stipulation also states the following whereas if the court determines that it has jurisdiction in this case petitioner does not intend to contest any of the issues raised in the fpaa other than the issue of whether the valuation_misstatement_penalty would apply in this case and whether respondent has the burden of production for any sec_6662 penalty under sec_7491 whereas aside from the stipulation of facts to be prepared and submitted the petitioner does not intend to offer any witnesses or further evidence on the valuation_misstatement_penalty issue respondent asserts that summary_judgment is appropriate because petitioner stipulated the adjustments in the fpaa and does not contest the determinations made in the fpaa other than the determination that the valuation misstatement prong of the accuracy-related_penalty under sec_6662 b e and h applies respondent argues that the gross_valuation_misstatement prong of the penalty applies because the determinations in the fpaa which petitioner conceded caused the partners’ bases in lkf to be reduced to zero which in turn resulted in a reduction in the basis of the canadian currency position lkf cc received in lkf’s deemed liquidation petitioner filed a motion for summary_judgment asserting that it had stipulated the numerical adjustments in the fpaa and that the court lacks jurisdiction over nonnumerical determinations in the explanation of items because such determinations purport to eliminate lkf’s partners’ outside bases in lkf petitioner argues the court lacks jurisdiction over outside_basis adjustments petitioner also argues that respondent’s determinations of sham economic_substance and tax_avoidance are not partnership items and cannot be litigated in a partnership-level proceeding this case is ripe for summary_judgment because the parties do not dispute the facts and we may render a decision as a matter of law i summary_judgment discussion summary_judgment is designed to expedite litigation and avoid unnecessary time-consuming and expensive trials fla peach corp v commissioner 90_tc_678 summary_judgment may be granted with respect to all or any part of the legal issues presented if the pleadings answers to interrogatories depositions admissions and any other acceptable materials together with the affidavits if any show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law rule b 98_tc_518 affd 17_f3d_965 7th cir the moving party bears the burden of proving that there is no genuine issue of material fact and factual inferences will be drawn in a manner most favorable to the party opposing summary_judgment 85_tc_812 79_tc_340 the nonmoving party however cannot rest upon the allegations or denials in his pleadings but must set forth specific facts showing that there is a genuine issue for trial rule d dahlstrom v commissioner supra pincite ii respondent’s determinations regarding nonpenalty issues a general tefra procedures for federal_income_tax purposes partnerships are not taxable entities but they are required to file annual information returns reporting items of gross_income and deductions and other information as the secretary may prescribe sec_701 sec_6031 each partner then is required to report all partnership items on his federal_income_tax return consistently with the schedule_k-1 received from the partnership sec_701 sec_702 sec_703 and sec_704 congress enacted the unified_audit and litigation procedures of the tax equity and fiscal responsibility act of tefra publaw_97_248 96_stat_648 to provide consistent treatment of partnership items among partners of the same partnership and to lessen the administrative and judicial burdens that arose from duplicative audits and litigation see 64_f3d_101 2d cir h conf rept pincite 1982_2_cb_600 a partnership_item is any item the secretary has determined is more appropriately determined at the partnership level than at the partner level sec_6231 sec_301_6231_a_3_-1 proced admin regs the term partnership_item includes not only items of income gain loss deduction or credit of the partnership see sec_301_6231_a_3_-1 proced admin regs but also legal and factual determinations that underlie the determination of the amount timing and characterization of items of income credit gain loss deduction etc see sec_301_6231_a_3_-1 proced admin regs a nonpartnership item is an item that is not a partnership_item its tax treatment is determined at the partner level sec_6231 the proper tax treatment of any partnership_item must be determined in a single partnership-level proceeding sec_6221 and the result of such proceeding then applies to each individual partner’s tax_return 94_tc_853 after a final partnership-level adjustment has been made to a partnership_item in a unified partnership proceeding the commissioner may assess a corresponding computational adjustment to a partner’s tax_liability without issuing a notice_of_deficiency sec_6225 a n c f energy partners v commissio89_tc_741 sec_301_6231_a_6_-1 proced admin regs sec_301_6231_a_6_-1t a temporary proced admin regs fed reg date however if an increased liability stemming from an affected_item requires a factual determination at the partner level normal deficiency procedures under sec_6212 and sec_6213 apply to such adjustment to a partner’s tax_liability other than penalties additions to tax and additional_amounts that relate to adjustments to partnership items see sec a a i 129_tc_11 the commissioner must issue an affected items notice_of_deficiency to the partner in order to assess tax attributable to the affected_item see sec a a i sec_301_6231_a_6_-1 proced admin regs sec_301_6231_a_6_-1t a temporary proced admin regs supra b whether lkf should be disregarded for tax purposes petitioner contends the term partnership_item includes only accounting items and does not refer to judicial doctrines of sham or lack of economic_substance petitioner argues that we lack jurisdiction in this partnership-level proceeding to consider such issues as well as the question of outside_basis which is an affected itemdollar_figure this court is a court of limited jurisdiction and we may exercise our jurisdiction only to the extent provided by congress see sec_7442 114_tc_519 in a partnership-level proceeding our jurisdiction is limited to determining partnership items of the partnership for the taxable_year to which the fpaa relates the proper allocation of such items among the partners and the applicability of any penalty addition_to_tax or additional_amount with respect to an adjustment to a partnership_item sec_6226 the determinations in the explanation of items in this case are similar to those contained in exhibit a to the fpaa in 21petitioner also points out that in the stipulation of settled issues respondent allowed three partnership items guaranteed payments net_earnings_from_self-employment and distributions of money although petitioner argues that those allowances are inconsistent with allegations of sham and disregarding partnership we do not believe that the settlement of adjustments between parties operates to prevent the parties or this court from addressing and resolving other issues that have not been settled and are properly before the court petaluma fx partners llc v commissioner t c ___ in which we addressed arguments similar to petitioner’s in petaluma we held that a determination whether a partnership is a sham lacks economic_substance or otherwise should be disregarded for tax purposes is a partnership_item and that we have jurisdiction over such determinations id at ___ slip op pincite see also 491_f3d_732 8th cir although we recognized that in some situations a partner’s outside_basis in a partnership_interest may be an affected_item more appropriately determined at the partner level see domulewicz v commissioner supra pincite 127_tc_75 95_tc_1 we held that when a partnership is disregarded for federal_income_tax purposes the court has jurisdiction in a partnership-level proceeding to determine that there can be no outside bases in the partnership petaluma fx partners llc v commissioner supra at ___ slip op pincite we see no reason to revisit our holding in petaluma and we conclude that we have jurisdiction over the determinations at issue 22petaluma fx partners llc v commissioner t c ___ is currently on appeal to the court_of_appeals for the d c circuit which is the venue for appeal in this case also as discussed infra petitioner’s counsel is counsel for the taxpayer in petaluma and the parties’ briefs are very similar like the partner in petaluma petitioner stipulated that it would not contest the determination that the relevant entity here lkf should be disregarded other than on jurisdictional grounds when a party states that it does not intend to contest an issue we have found it appropriate to deem the issue conceded see id at ___ slip op pincite see also decaprio v commissioner tcmemo_1996_367 accordingly we hold that lkf should be disregarded for tax purposes and the partners have no outside bases in a disregarded partnership see petaluma fx partners llc v commissioner supra at ___ slip op pincite iii penalties a the parties’ stipulation on penalties respondent stated in paragraph of the explanation of items that the adjustments in the fpaa were attributable to a tax_shelter for which lkf had no substantial_authority or reasonable_cause respondent determined that the entire underpayment_of_tax resulting from those adjustments is attributable to gross or substantial_valuation_misstatement under sec_6662 b e and h negligence or disregard of rules or regulations under sec_6662 b and c or substantial understatements of income_tax under sec_6662 b and d petitioner stipulated that it is contesting only the applicability of the valuation misstatement prong of the accuracy-related_penalty valuation_misstatement_penalty we treat this stipulation as conclusive and binding on petitioner and deem issues with respect to the negligence and substantial_understatement prongs of the sec_6662 accuracy-related_penalty conceded see rule e petaluma fx partners llc v commissioner supra at ___ slip op pincite 87_tc_1451 accordingly we consider only the applicability of the valuation misstatement penaltydollar_figure b jurisdiction over valuation_misstatement_penalty determination sec_6662 imposes a 20-percent accuracy-related_penalty on the portion of an underpayment_of_tax attributable to items set forth in sec_6662 sec_6662 specifies as one such item a substantial_valuation_misstatement a substantial_valuation_misstatement occurs if the value or the adjusted_basis of any property claimed on any return is percent or more of the correct amount sec_6662 the penalty is increased to percent if the underpayment_of_tax results from a gross_valuation_misstatement which occurs if the 23the commissioner may not stack or compound parts of the accuracy-related_penalty to impose a penalty in excess of percent on any given portion of an underpayment or percent if such portion is attributable to a gross_valuation_misstatement sec_1_6662-2 income_tax regs value or adjusted_basis of any property claimed on a return is percent or more of the correct amount sec_6662 sec_6221 provides that the applicability of any penalty addition_to_tax or additional_amount which relates to an adjustment to a partnership_item is determined at the partnership level see also sec_6226 sec_301_6221-1 proced admin regs sec_301_6221-1t c temporary proced admin regs fed reg date if a penalty was imposed at the partnership level during the tefra proceeding the commissioner may assess that amount without issuing a notice_of_deficiency sec a sec_301_6231_a_6_-1 proced admin regs sec_301_6231_a_6_-1t a temporary proced admin regs supra the determination under the fpaa or under the decision of a court regarding the applicability of any penalty relating to an adjustment to a partnership_item is deemed conclusive sec c but a partner may file a claim_for_refund and assert any partner-level defenses that may apply or challenge the amount of the computational adjustment sec_301_6221-1 and d proced admin regs sec_301 1t c and d temporary proced admin regs fed reg date see also new millennium trading l l c v commissioner t c ___ upholding the validity of sec_301_6221-1t c and d temporary proced admin regs supra accordingly in a partnership-level proceeding we may not consider partner-level defenses to any penalty addition_to_tax or additional_amount that relate to an adjustment to a partnership_item sec_301_6221-1 and d proced admin regs sec_301_6221-1t c and d temporary proced admin regs supra see also new millennium trading l l c v commissioner supra at ___ slip op pincite petitioner argues that the court does not have jurisdiction to determine a penalty with respect to an adjustment to an affected_item such as outside_basis we held in petaluma fx partners llc v commissioner t c at ___ slip op pincite that if a partnership is disregarded for tax purposes and the partners’ collective basis in the partnership is zero the court has jurisdiction to determine the applicability of accuracy- related penalties that result from the determination as in petaluma we hold that lkf should be disregarded for federal tax purposes and the partners cannot have outside bases in a disregarded_entity accordingly we may determine the applicability of the valuation_misstatement_penalty c burden of production sec_7491 places the initial burden of production in any court_proceeding on the commissioner with respect to the liability of any individual for any penalty addition_to_tax or additional_amounts imposed by the code the burden_of_proof however remains on the taxpayer 116_tc_438 petitioner argues that sec_7491 applies because respondent asserts penalties against partners and that respondent failed to carry his burden of production under sec_7491 respondent contends that he does not have the burden of production because the penalty determination is made at the partnership level and sec_7491 applies only when the taxpayer is an individual respondent asserts that even if sec_7491 applies he has met his burden of production we do not need to resolve the disagreement because even if the burden of production under sec_7491 lies with respondent he satisfied the threshold requirement supporting his determination that the gross_valuation_misstatement penalty is appropriate d the valuation_misstatement_penalty respondent argues that the partners’ collective basis in lkf should be zero instead of the amount claimed respondent also contends the valuation_misstatement_penalty applies because the inflated basis in the canadian currency position originates in the partnership’s misstatement of mr fishman’s contribution amount and his resulting basis in the partnership_interest petitioner argues the valuation_misstatement_penalty is inappropriate because the record does not support a factual determination of sham or lack of economic_substance petitioner believes that by carving out the right to contest the valuation_misstatement_penalty it preserved the right to argue that the transactions had a business_purpose we disagree the parties’ stipulation clearly states that if the court finds it has jurisdiction petitioner does not intend to contest the determinations made in the fpaa other than the valuation_misstatement_penalty stipulations are conclusive and binding on the parties unless otherwise permitted by the court rule e stamos v commissioner t c pincite5 in petaluma fx partners llc v commissioner supra at ___ slip op pincite the parties’ stipulations were substantially_similar to the stipulation in this case we construed the language to preclude the taxpayer’s challenge of the penalty on the merits and did not allow the taxpayer to qualify or change the stipulation see also decaprio v commissioner tcmemo_1996_367 we take a similar approach here and conclude that petitioner waived its right to argue that the underlying transactions had economic_substance as a defense to the valuation_misstatement_penalty petitioner argues the valuation_misstatement_penalty is inapplicable as a matter of law because the underpayment_of_tax is not attributable to erroneous valuation but rather to disregard of a partnership in support petitioner relies on among other cases 472_fsupp2d_885 e d tex affd in part vacated in part and remanded on a different issue 568_f3d_537 5th cir a partnership-level case in which the u s district_court for the eastern district of texas held that a certain tax_shelter lacked economic_substance in klamath the government argued that the gross valuation penalty applied because the taxpayers’ basis in euro distributed by a partnership exceeded the true basis and the 400-percent threshold was met id pincite the taxpayers argued the gross valuation penalty does not apply when the commissioner totally disallows a deduction or credit and the case was similar to disallowance of a deduction or credit id pincite the court agreed with the taxpayer and stated that under the law in the fifth circuit if the court disregarded transactions for lack of economic_substance the underpayment_of_tax was not attributable to gross valuation but rather to the disregard of the transaction id citing 902_f2d_380 5th cir revg t c memo relying on 389_f3d_152 5th cir petitioner also contends that because respondent advanced 24petitioner cites 440_fsupp2d_608 e d tex addressing on the parties’ motions for summary_judgment whether certain loans were contingent obligations under sec_752 and whether sec_1_752-6 income_tax regs was valid we assume that petitioner intended to rely on 472_fsupp2d_885 e d tex considering the transactions on merits and refusing to apply the gross valuation penalty affd in part vacated in part and remanded 568_f3d_537 5th cir several alternative theories for adjusting partnership items it is impossible to determine whether the partners’ underpayments are attributable to a valuation_overstatement petitioner also suggests that under 893_f2d_225 9th cir affg tcmemo_1988_416 and 862_f2d_540 5th cir affg 89_tc_912 the valuation_misstatement_penalty does not apply when the deduction or credit is disallowed in total for reasons other than the fact that the basis of the property was inflated see also 556_f3d_1056 9th cir stating that the court_of_appeals for the ninth circuit adheres to gainer v commissioner supra and does not uphold a penalty for overvaluing an asset when a deduction is disallowed in total affg in part and revg in part tcmemo_2006_131 we disagree that gainer controls our decision because in gainer we disallowed a tax_credit where the asset had not been placed_in_service and the case is distinguishable see gainer v commissioner tcmemo_1988_416 in 54_tc_742 affd 445_f2d_985 10th cir we held that we follow a decision of the court_of_appeals to which an appeal from our disposition of a case lies when that decision is squarely on point and a failure to follow that decision would result in an inevitable reversal because of the clearly established position of the court_of_appeals see also 99_tc_490 sec_7482 provides that in the case of a petition under sec_6226 a decision by this court may be reviewed by the u s court_of_appeals for the circuit in which the partnership has its principal_place_of_business appellate venue under sec_7482 is determined as of the time the petition is filed with the court sec_7482 if no subparagraph of sec_7482 applies the decision may be reviewed by the court_of_appeals for the district of columbia circuit id respondent argues that when the petition was filed lkf had no principal_place_of_business petitioner states in its petition that lkf’s legal residence was california when it filed the petition however petitioner then stipulated that lkf filed it sec_2001 form_1065 as a final return in date lkf distributed its assets to the partners and the partnership was deemed liquidated for federal_income_tax purposes accordingly we conclude that lkf did not have a principal_place_of_business when the petition was filed and this case may be appealable to the court_of_appeals for the district of columbia circuit see petaluma fx partners llc v commissioner t c at ___ slip op pincite the court_of_appeals for the district of columbia circuit has yet to consider the issue of whether the valuation_misstatement_penalty applies to underpayments attributable to overstated basis in property where the transaction is found to be a sham or lacking economic_substance accordingly we may give effect to our own views see golsen v commissioner supra pincite in petaluma we held that if a partnership is disregarded for tax purposes the gross_valuation_misstatement penalty applies petaluma fx partners llc v commissioner supra at ___ slip op pincite in so holding this court has followed the approach adopted by the courts of appeals for the second third fourth sixth and eighth circuits 196_f3d_147 3d cir affg tcmemo_1997_385 118_f3d_184 4th cir affg tcmemo_1996_167 982_f2d_163 6th cir affg tcmemo_1991_449 933_f2d_143 2d cir affg tcmemo_1989_684 supplemented by tcmemo_1990_205 876_f2d_616 8th cir affg tcmemo_1988_427 we agree with these courts of appeals and see no reason to revisit our holding in petaluma fx partners llc v commissioner supra accordingly we conclude that the gross_valuation_misstatement penalty applies e partnership-level defenses when considering penalties at the partnership level we may consider defenses of the partnership such as the reasonable_cause exception see sec_6664 new millennium trading l l c v commissioner t c at ___ slip op pincite whitehouse hotel ltd pship v commissioner t c ___ ___ slip op pincite santa monica pictures llc v commissioner tcmemo_2005_104 reasonable_cause requires that the taxpayer have exercised ordinary business care and prudence as to the disputed item see 115_tc_43 affd 299_f3d_221 3d cir the determination of whether a taxpayer acted with reasonable_cause and in good_faith is made on a case-by-case basis taking into account all pertinent facts and circumstances sec_1_6664-4 income_tax regs the most important factor is the extent of the taxpayer’s effort to assess the taxpayer’s proper tax_liability taking into account the experience knowledge and education of the taxpayer id in its petition petitioner claimed that assuming some or all of the commissioner’s adjustments are correct there was reasonable_cause for petitioner’s positions and the petitioner acted in good_faith in the stipulation of settled issues petitioner stipulated that it did not intend to offer any witnesses or further evidence on the valuation misstatement issuedollar_figure in its opposition to respondent’s motion for summary 25although the parties stipulated the cantley opinion as a joint exhibit petitioner is not arguing in its briefs that lkf continued judgment petitioner does not argue that lkf had any partnership- level defenses to the valuation_misstatement_penalty does not state which facts would support a finding that reasonable_cause existed and does not claim there is a genuine issue as to a material fact with respect to any partnership-level defenses accordingly we conclude there is no genuine issue as to any material fact regarding potential partnership-level defenses see rule b 78_tc_646 iv conclusion on the basis of the foregoing we shall deny petitioner’s motion for summary_judgment and grant respondent’s motion for summary_judgment we have considered the parties’ remaining arguments and to the extent not discussed above we conclude those arguments are irrelevant moot or without merit to reflect the foregoing an appropriate order and decision will be entered continued relied on an opinion of a professional tax adviser exhibit a - explanation of items appendix it is determined that neither lkf x investments l l c nor its purported partners have established the existence of lkf x investments l l c as a partnership as a matter of fact even if lkf x investments l l c existed as a partnership the purported partnership was formed and availed of solely for purposes of tax_avoidance by artificially overstating basis in the partnership interests of its purported partners the formation of lkf x investments l l c the acquisition of any interest in the purported partnership by the purported partner the purchase of offsetting positions on market-linked deposits the transfer of offsetting positions held by lkf x investments l l c to lkf capital x corp the purchase of assets by the partnership and the distribution of those assets to the purported partners in complete_liquidation of the partnership interests and the subsequent sale of those assets to generate a loss all within a period of less than months had no business_purpose other than tax_avoidance lacked economic_substance and in fact and substance constitutes an economic sham for federal_income_tax purposes accordingly the partnership and the transactions described above shall be disregarded in full and any purported losses resulting from these transactions are not allowable as deductions for federal_income_tax purposes it is determined that lkf x investments l l c was a sham lacked economic_substance and under sec_1_701-2 of the income_tax regulations was formed and availed of in connection with a transaction or transactions in taxable_year a principal purpose of which was to reduce substantially the present_value of its partners’ aggregate federal tax_liability in a manner that is inconsistent with the intent of subchapter_k of the internal_revenue_code it is consequently determined that a lkf x investments l l c is disregarded and all transactions engaged in by lkf x investments l l c are treated as engaged in directly by its purported partners this includes the determination that the assets purportedly acquired by lkf x investments l l c including but not limited to foreign_currency options were acquired directly by the purported partners b c d the positions in market-linked deports sic purportedly acquired by or assumed by lkf x investments l l c are treated as never having been acquired by or assumed by said partnership and any gains or losses purportedly realized by lkf x investments l l c on the positions in market-linked deposits are treated as having been realized by its partners the purported partners of lkf x investments l l c should be treated as not being partners in lkf x investments l l c acquisitions by lkf x investments l l c will be adjusted to reflect clearly the partnership’s or purported partners’ income it is determined that the obligations under the short positions on market-linked deposits sold are liabilities within the meaning of sec_752 of the internal_revenue_code the assumption of which by lkf x investments l l c shall reduce the purported partners’ bases in lkf x investments l l c in the amount of dollar_figure for lkf x capital corp but not below the fair_market_value of the purported partnership_interest it is determined that neither lkf x investments l l c nor its purported partners entered into the positions on market-linked deposits or purchased the foreign_currency or stock with a profit_motive for purposes of sec_165 of the internal_revenue_code it is determined that even if the positions on market- linked deposits are treated as having been contributed to lkf investments l l c the amount treated as contributed by the partners under sec_722 of the internal_revenue_code is reduced by the amounts received by the contributing_partner s from the contemporaneous sales of the offsetting_position to the same counter-party thus the basis of the contributed position is reduced both in the hands of the contributing partners and lkf x investments l l c consequently any corresponding claimed increases in the outside_basis in lkf x investments l l c resulting from the acquisitions or contributions of the positions on market-linked deposits are disallowed also any corresponding claimed increases in basis in lkf x capital corp resulting from the contribution by taxpayer of his interest in lkf x investments to lkf x capital corp are disallowed it is determined that the adjusted bases of the long position s on market-linked deposits and other contributions purportedly acquired by the lkf x investments l l c and contributed to lkf x capital corp has not been established under sec_723 of the internal_revenue_code it is consequently determined that the partners of lkf x investments l l c have not established adjusted bases in their respective partnership interests in an amount greater than zero it is further determined that in the case of a sale exchange or liquidation of lkf x investments l l c partners’ partnership interests neither the purported partnership nor its purported partners have established that the bases of the partners’ partnership interests were greater than zero for purposes of determining gain_or_loss to such partners from the sale exchange or liquidation of such partnership_interest accuracy-related_penalties it is determined that the adjustments of partnership items of lkf x investments l l c are attributable to a tax_shelter for which no substantial_authority has been established for the position taken and for which there was no showing of reasonable belief by the partnership or its partners that the position taken was more_likely_than_not the correct treatment of the tax_shelter and related transactions in addition all of the underpayments of tax resulting from those adjustments of partnership items are attributable to at a minimum substantial understatements of income_tax gross_valuation_misstatement s or negligence or disregarded rules or regulations there has not been a showing by the partnership or any of its partners that there was reasonable_cause for any of the resulting underpayments that the partnership or any of its partners acted in good_faith or that any other exceptions to the penalty apply it is therefore determined that at a minimum the accuracy-related_penalty under sec_6662 of the internal_revenue_code applies to all underpayments of tax attributable to adjustments of partnership items of lkf x investments l l c the penalty shall be imposed on the components of underpayment as follows a b c d a percent penalty shall be imposed on the portion of any underpayment attributable to the gross_valuation_misstatement as provided by sec_6662 sec_6662 sec_6662 and sec_6662 of the internal_revenue_code a percent penalty shall be imposed on the portion of the underpayment attributable to negligence or disregard of rules and regulations as provided by sec_6662 sec_6662 sec_6662 of the internal_revenue_code a percent penalty shall be imposed on the underpayment attributable to the substantial_understatement_of_income_tax as provided by sec_6662 sec_6662 and sec_6662 of the internal_revenue_code a percent penalty shall be imposed on the underpayment attributable to the substantial_valuation_misstatement as provided by sec_6662 sec_6662 and sec_6662 of the internal_revenue_code it should not be inferred by the determination of the accuracy-related_penalty in this notice that fraud penalties will not be sought on any portion of an underpayment subsequently determined to be attributable to fraud or that prosecution for criminal offenses will not be sought under sec_7201 or sec_7206 of the internal_revenue_code or other provisions of federal_law if determined to be appropriate


department of the treasury int ernal revenue service washington d c o f f i c e o f c h i e f c o u n s e l date number release date cc psi cam-107509-01 uilc internal_revenue_service national_office chief_counsel_advice memorandum for industry director financial services lmsb f from susan j reaman chief branch office of associate chief_counsel passthroughs and special industries cc psi subject denial of consent for change in method_of_accounting in accordance with section a of revproc_2001_1 2001_1_irb_1 this chief_counsel_advice advises you that consent for a change in accounting_method has been denied to a taxpayer within your jurisdiction pursuant to sec_6110 of the internal_revenue_code this chief_counsel_advice is not to be cited as precedent legend taxpayer bank bank predecessor thrift b c d e cam-107509-01 f g taxpayer filed a form_3115 application_for change in accounting_method to request permission to change its treatment of a regulatory intangible asset supervisory goodwill from a non-depreciable asset to a depreciable asset beginning with the taxable_year beginning b year_of_change on c taxpayer acquired bank which previously had acquired bank previously known as predecessor on d on e predecessor acquired thrift the acquisition through a supervisory merger the acquisition was a transaction actively encouraged and approved by the federal home and loan banking board fhlbb due to thrift’s troubled financial condition the fhlbb’s approval was the equivalent of assistance pursuant to sec_406 of the national housing act as a part of the contract between predecessor and the government in f predecessor received a regulatory intangible asset which represented the right to include such asset in the calculation of the regulatory capital ratios of predecessor for financial_accounting purposes the acquisition of predecessor was accounted for under the purchase_method of accounting the fair value allocated to the regulatory intangible asset was determined by taxpayer to be dollar_figureg the regulatory intangible asset was referred to as goodwill on the financial statements of taxpayer although the regulatory intangible asset was amortized for book purposes it was never amortized for federal_income_tax purposes under the proposed method taxpayer will depreciate under sec_167 of the internal_revenue_code the tax basis of the regulatory intangible asset acquired during the acquisition over the useful_life of such asset law and analysis taxpayer takes the position that the contractual right to use the purchase_method of accounting along with the resultant purchased goodwill results in an asset on its books properly identified as supervisory goodwill taxpayer believes that this supervisory goodwill qualifies as other_property for purposes of sec_597 of the code and is a form of financial assistance provided by the federal savings and loan insurance corporation fslic under sec_406 of the national housing act and as such the asset was properly excluded from income pursuant to sec_597 relying on 507_us_546 taxpayer further believes that it as a result of the application of sec_597 has an ascertainable tax basis in its supervisory goodwill and that this asset with the enactment of the financial institutions reform recovery and enforcement act of firrea had a limited useful_life we cannot accept this view based on our analysis as set forth below cam-107509-01 issue whether supervisory goodwill qualifies as money or other_property for purposes of sec_597 of the code supervisory goodwill is a creature of regulatory accounting principles although it bears a nexus to the generally_accepted_accounting_principles gaap asset of purchased goodwill that results under the purchase_method of accounting upon the acquisition of one corporation by another for federal_income_tax purposes predecessor's acquisition of the failing thrift qualified and was accounted for as a tax-free reorganization under sec_368 of the code thus predecessor took a carryover_basis in the assets and liabilities from the acquired institution at their financial book basis and recognized no gain_or_loss on the acquisition as a general matter for federal_income_tax purposes purchased goodwill is not an acquired asset in a tax-free reorganization the value otherwise ascribed to purchased goodwill under gaap the excess of purchase_price including liabilities assumed over the fair_market_value of the assets acquired is already reflected in the book basis of the assets and liabilities acquired from the failing thrift predecessor at the time of its acquisition of the failing thrift correctly did not recognize a separate intangible asset for federal_income_tax purposes comparable to its regulatory asset of supervisory goodwill that was booked on its acquisition of the failing thrift as that regulatory asset was derived from the gaap asset of purchased goodwill moreover even where goodwill is recognized as a tax asset it is not subject_to recovery by depreciation or amortization see 518_us_839 at n quoting 507_us_546 and winstar supra pincite n as discussed more fully in winstar supra during the time predecessor acquired the failing thrift the savings and loan industry was in crisis and the fslic lacked the funds necessary to liquidate all of the failing thrifts accordingly the fslic arranged mergers between healthy thrifts and failing thrifts as an inducement for these mergers the fslic allowed the acquiring thrifts to count supervisory goodwill toward regulatory capital reserve requirements set forth in c f_r dollar_figure and to amortize the goodwill over as much a sec_40 years in congress enacted firrea which impacted a thrift's ability to count supervisory goodwill towards satisfaction of its capital reserve requirements at the time predecessor acquired the failing thrift sec_597 of the code as added by sec_244 of the economic_recovery_tax_act_of_1981 publaw_97_34 date the act provided that the gross_income of a domestic_building_and_loan_association did not include any amount of money or other_property received from the fslic pursuant to sec_406 of the national housing act u s c f regardless of whether any note or other instrument was issued in exchange further sec_597 provided that no reduction in the basis of assets of a domestic cam-107509-01 building and loan association shall be made on account of such money or other_property received sec_246 of the act made sec_597 of the code applicable to payments made on or after date the use of the word payments in sec_246 of the act along with the statutory language of sec_597 of the code and sec_406 of the national housing act clearly indicates the congressional intent to limit sec_597 to forms of financial assistance provided by the fslic although the legislative_history to sec_244 of the act is somewhat sparse what legislative_history there is also supports a conclusion that sec_597 of the code covers only financial assistance provided by the fslic sec_597 as enacted appears to have been first added in the version of h_r that was passed by the house on date see cong rec at h5259 and h5279 daily ed date the legislative_history also indicates that this tax provision was initially agreed to in the senate as a floor amendment captioned section fslic financial assistance on date see cong rec at s8287 daily ed date in support of the senate amendment the congressional record reflects that the amendment would facilitate the infusion of capital to a failing savings and loan or the merger of a savings and loan with another financial_institution by clarifying that these transactions are nontaxable events id at s8288 further the use of terms such as payment capital infusion and repayment during the legislative process are further indications of a congressional intent to limit sec_597 of the code solely to forms of financial assistance see eg letter from richard t pratt then- chairman of the fhlbb cong rec at s8288 the conference_report moreover indicates that this amendment was intended to resolve the question of whether financial assistance from the fslic was to be included in income or treated as a non-shareholder contribution_to_capital with a consequential reduction in the tax basis of assets by the taxpayer h_r conf_rep no 97th cong 1st sess see also staff of the joint_committee on taxation 97th cong 1st sess general explanation of the economic_recovery_tax_act_of_1981 h_r 97th cong pub_l_no pincite to facilitate providing of financial assistance by the fslic and referring to the fslic's financial assistance program and the proper treatment under prior_law of such assistance payments from the fslic the fslic was created in with the passage of the national housing act chiefly to insure deposits made by the public see winstar u s pincite in addition to providing deposit insurance the fslic generally was authorized to make loans to to make deposits in to purchase the assets or securities of to assume the liabilities of or to make contributions to any insured institution see sec_406 of the national housing act u s c f as a result supervisory goodwill does not resemble any type of financial assistance listed in sec_406 of the national housing act rather the concept of supervisory goodwill was merely part of an accounting regime designed to induce healthy thrifts cam-107509-01 to acquire failing thrifts see winstar u s pincite the nature of supervisory goodwill is one of regulatory forbearance rather than financial assistance further based on the types of assistance that the fslic was authorized to render under sec_406 of the national housing act the fslic assistance given under this provision was intended to increase the capital of an institution so that the institution could meet its obligations to depositors supervisory goodwill does not enhance the capital of an institution rather it is the antithesis of capital as it relieves the institution and its shareholders of their obligations to meet otherwise applicable capital requirements nothing in the legislative_history to sec_597 of the code indicates it was intended to apply to forms of assistance other than financial assistance under these circumstances supervisory goodwill is not assistance within the meaning of sec_597 moreover both the statutory language and the legislative_history of sec_597 of the code limit application of sec_597 to financial assistance provided by the fslic under title of the united_states_code the regulatory forbearance that taxpayer claims created supervisory goodwill was not provided by the fslic generally the clear meaning of a statute will control its application unless it is established that congressional intent would require a different result congress clearly differentiated between the fhlbb and the fslic for purposes of applying various contemporaneously enacted provisions of the internal_revenue_code compare sec_243 and sec_244 of the act in which congress spoke only to actions by the fslic with sec_241 of the act in which congress spoke to actions by either the fhlbb or the fslic the fslic although working with the fhlbb in such matters was a separate corporation for tax purposes see 319_us_436 further the fslic had no authority to allow supervisory goodwill to be counted toward regulatory capital requirements under the rules of the fhlbb given the clear statutory reference in sec_597 of the code we cannot expand the meaning of the fslic to encompass actions of the fhlbb we do not agree that because the fslic and the fhlbb have been treated as indistinguishable for purposes of determining a breach of contract with respect to the use of supervisory goodwill to meet regulatory capital requirements the same result applies here we note that the supreme court in winstar supra did not hold that supervisory goodwill was provided by the fslic under sec_406 of the national housing act within the meaning of sec_597 of the code we also do not agree that sec_597 of the code extends to the right to use supervisory goodwill to meet regulatory capital requirements and that the fslic on predecessor’s behalf obtained that right from the fhlbb and then conveyed it to predecessor in connection with the acquisition of the failing thrift for the reasons set forth above we conclude that the right to use supervisory goodwill is not assistance provided by the fslic under sec_597 cam-107509-01 issue whether taxpayer properly established a tax basis in the book asset identified as supervisory goodwill for federal_income_tax purposes a taxpayer’s basis in property is generally established by reference to the taxpayer’s cost see sec_1012 of the code the taxpayer's cost is usually measured by the amount the taxpayer paid in cash or kind for the property see sec_1_1012-1 of the regulations when a taxpayer incurs no cost in connection with the acquisition of the property the taxpayer's basis in that property may be established under other provisions of the code however absent the application of a special provision that provides for the tax-free receipt of property a taxpayer generally must include the fair_market_value of the property received in income in order to obtain a tax basis in such property see eg sec_1 d of the regulations 91_tc_627 thus generally when a taxpayer acquires property without incurring any cost the amount of the taxpayer's basis in that property is equal to the amount included in income that is the property's fair_market_value taxpayer has no tax basis in supervisory goodwill for federal_income_tax purposes predecessor's acquisition of the failing thrift qualified as a tax-free reorganization under sec_368 of the code special basis rules apply in connection with assets and liabilities acquired by means of a tax-free reorganization under these rules for federal_income_tax purposes a taxpayer such as predecessor generally steps into the shoes of the transferor_corporation such as the failing thrift acquired by predecessor with respect to basis see sec_362 because supervisory goodwill was not a pre-existing asset on the books of the failing thrift acquired by predecessor predecessor could not obtain a carryover_basis in that asset see also sec_357 and sec_1032 as predecessor could not obtain a carryover_basis for supervisory goodwill under sec_362 of the code taxpayer must identify a fresh source from which basis can be obtained taxpayer takes the position that sec_597 applies to provide a tax-free source_of_income from which this fresh basis can be said to derive for the reasons set forth above under issue sec_597 is not applicable to the acquisition of supervisory goodwill by predecessor consequently predecessor was not entitled to exclude the value of supervisory goodwill from gross_income under sec_597 as predecessor did not separately pay for the purported asset and did not include the fair_market_value of that asset in gross_income taxpayer cannot now claim that predecessor had a tax basis in that asset see sec_1_61-2 of the regulations strong v commissioner supra taxpayer has no tax basis in the right to use goodwill even assuming that predecessor received an asset from the regulators that is recognizable for federal_income_tax purposes this asset can only be the right to use purchased goodwill to meet regulatory capital requirements further for cam-107509-01 federal_income_tax purposes this right is considered other_property and any_tax basis attributable to the acquisition of this right would be determined under rules applicable to the receipt of property see sec_1012 of the code as a general matter the creation of rights under governmental regulatory and licensing arrangements property rights will usually not result in the recognition of gross_income to the recipient of those property rights see eg revrul_92_16 1992_1_cb_15 holding that the issuance of emission allowance by the environmental protection agency does not result in gross_income to the taxpayer a utility that receives it moreover not even the excess of the fair_market_value of the property right over the cost of acquisition of that right will be income see eg revrul_67_135 1967_1_cb_20 holding that the excess of the fair_market_value over the cost of a lease obtained by a taxpayer in a lottery conducted by the united_states bureau of land management is not includable in gross_income even where a tax basis in such a property right is properly determined under sec_1012 of the code that basis is generally limited to the taxpayer's cost of acquiring the property right not the fair_market_value of the right itself the service's position with respect to the proper determination of any_tax basis to be accorded to the acquisition of these types of property rights has been implicitly adopted by a number of courts in cases holding that taxpayers' bases in similar_property rights were the respective taxpayers' costs of obtaining those rights see eg 191_f2d_934 5th cir 79_tc_109 aff'd per curiam 722_f2d_324 6th cir 31_tc_803 thus as predecessor incurred no additional cost in order to obtain the right to use purchased goodwill for regulatory purposes its cost_basis in such an asset would be zero issue whether taxpayer is entitled to claim a deduction for depreciation of supervisory goodwill under sec_167 of the code sec_167 of the code provides as a depreciation deduction a reasonable allowance for the exhaustion wear_and_tear and obsolescence of property used in a trade_or_business or of property_held_for_the_production_of_income sec_167 of the code generally provides that the basis on which exhaustion wear_and_tear and obsolescence are allowed shall be the adjusted_basis provided in sec_1011 for the purpose of determining the gain on the sale_or_other_disposition of the property sec_1_167_g_-1 of the regulations provides that the basis upon which the allowance for depreciation is computed with respect to any property shall be the adjusted_basis provided in sec_1011 for the purpose of determining gain on the sale_or_other_disposition of the property sec_1_1011-1 provides the adjusted_basis for determining gain_or_loss from the disposition of property is the cost or other basis prescribed in sec_1012 or other applicable provisions of subtitle a of the code cam-107509-01 sec_1_167_a_-1 of the regulations provides that the allowance for the exhaustion wear_and_tear and obsolescence of property used in a trade_or_business or held_for_the_production_of_income is that amount which should be set_aside for the taxable_year in accordance with a reasonably consistent plan so that the aggregate of the amounts set_aside will at the end of the estimated_useful_life of the depreciable_property equal the cost or other basis of that property the allowance shall not reflect amounts representing a mere reduction in market_value sec_1_167_a_-1 of the regulations provides that the estimated_useful_life of an asset is not necessarily the useful_life inherent in the asset but the period over which the asset may reasonably be expected to be useful to the taxpayer in its trade_or_business or in the production of the taxpayer’s income this period shall be determined by reference to the taxpayer’s experience with similar_property taking into account present conditions and probable future developments sec_1_167_a_-3 of the regulations provides that an intangible asset that is known from experience or other factors to be of use in the business or the production_of_income for only a limited period the length of which can be estimated with reasonable accuracy may be the subject of a depreciation allowance an intangible asset the useful_life of which is not limited is not subject_to the allowance for depreciation no allowance for depreciation will be permitted merely because in the unsupported opinion of the taxpayer the intangible asset has a limited useful_life no deduction for depreciation is allowable with respect to goodwill sec_1_167_a_-10 of the regulations provides that the period for depreciation shall begin when the asset is placed_in_service and shall end when the asset is retired from service in order to claim a depreciation deduction under sec_167 of the code a taxpayer is required to have a determinable tax basis in the asset use the asset in the taxpayer’s trade_or_business or hold the asset for the production_of_income and have a useful_life determinable with reasonable accuracy for the reasons set forth above under issue taxpayer does not have a tax basis in the claimed intangible asset regardless of whether that asset is considered to be the regulatory asset of supervisory goodwill or merely the right to use such supervisory goodwill to meet regulatory capital requirements without a tax basis in that intangible asset even if we were to conclude that such asset was a depreciable asset taxpayer's depreciable basis would be zero pursuant to sec_167 of the code and sec_1_167_g_-1 of the regulations thus the amount of the depreciation deduction that would be allowable in any taxable_year would be zero even assuming that taxpayer had established a tax basis in the claimed intangible asset regardless of whether that asset is considered to be the regulatory asset of supervisory goodwill or merely the right to use such supervisory goodwill to meet cam-107509-01 regulatory capital requirements that asset is not depreciable under sec_167 of the code for gaap predecessor’s acquisition of the failing thrift was accounted for under the purchase_method for business combinations the amount by which the fair_market_value of the liabilities assumed by predecessor the acquisition price exceeded the fair_market_value of the assets received by predecessor as a result of the acquisition was recognized on predecessor's books as purchased goodwill for regulatory purposes this purchased goodwill corresponded to predecessor's regulatory asset identified as supervisory goodwill if the acquisition of the failing thrift created tax basis as taxpayer alleges then the calculation of the excess acquisition costs would be consistent with the residual_method of determining tax_accounting goodwill see eg 84_tc_476 aff'd 815_f2d_75 6th cir in order to be depreciable an identified asset requires a determination of value basis and a reasonably determinable useful_life 507_us_546 these two requirements are to be met based on information available as of the transaction date see banc one supra at most predecessor received a right to use supervisory goodwill to meet regulatory capital requirements even assuming that such a right resulted in a recognizable asset for federal_income_tax purposes at the time of acquisition this right is not clearly severable from the residual tax asset of goodwill the mere fact that enactment of firrea eliminated predecessor’s right to use its supervisory goodwill for regulatory purposes does not establish that its tax asset now also has a separately ascertainable value and a reasonably determinable useful_life taxpayer has failed to substantiate that the fair_market_value of the right to use supervisory goodwill is equal to the residual amount likewise the remaining useful_life determined by the taxpayer is for the right to use and not necessarily for the residual amount therefore taxpayer has failed to distinguish the right to use supervisory goodwill from nondepreciable goodwill further most of the value assigned to the regulatory book asset of supervisory goodwill was likely derived from loans and other assets that had declined in value because of rising interest rates see winstar u s pincite for federal_income_tax purposes because predecessor took the loans and other assets from which the regulatory book asset of supervisory goodwill was derived at their historic that is unreduced book values tax basis was properly reflected directly in these loans and other assets rather than indirectly in a separately booked tax asset comparable to supervisory goodwill even if taxpayer had tax basis in supervisory goodwill such basis would be the fair_market_value of the right to use the supervisory goodwill toward regulatory capital requirements not the full amount of the regulatory forbearance claimed by taxpayer while supervisory goodwill was used to meet regulatory capital requirements the value is not equivalent to its capital cost and does not have a dollar for dollar value see 43_fedclaims_445 aff’d in part and vacated in part 245_f3d_1342 thus taxpayer has failed to substantiate the basis in its right to use supervisory goodwill cam-107509-01 consequently taxpayer has not met its burden of separately identifying valuing and lifing the right to use as required by the supreme court in newark morning ledger supra in order for such right to be subject_to a depreciation deduction under sec_167 of the code even assuming that the asset recognizable for federal_income_tax purposes is the regulatory asset of supervisory goodwill taxpayer also has not met its burden of separately valuing and lifing such asset as required by the supreme court in newark morning ledger supra therefore the claimed intangible asset regardless of whether that asset is considered to be the regulatory asset of supervisory goodwill or merely the right to use such supervisory goodwill to meet regulatory capital requirements is not depreciable under sec_167 and taxpayer is not entitled to a deduction for depreciation or amortization under sec_167 for this asset conclusion for the reasons set forth above taxpayer’s requested change in method_of_accounting with respect to its supervisory goodwill regulatory intangible asset has been denied if you have any questions on this matter do not hesitate to call susan j reaman j v office of the associate chief_counsel passthroughs special industries cc