n-00-44.pdf

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Part III - Administrative, Procedural, and Miscellaneous
Tax Avoidance Using Artificially High Basis
Notice 2000-44
In Notice 99-59, 1999-52 I.R.B. 761, the Internal Revenue Service and the
Treasury Department described certain transactions that were being marketed to
taxpayers for the purpose of generating artificial tax losses. This notice concerns other
similar transactions that purport to generate tax losses for taxpayers.
As stated in Notice 99-59, a loss is allowable as a deduction for federal income
tax purposes only if it is bona fide and reflects actual economic consequences. An
artificial loss lacking economic substance is not allowable. See ACM Partnership v.
Commissioner, 157 F.3d 231, 252 (3d Cir. 1998), cert. denied, 526 U.S. 1017 (1999)
("Tax losses such as these . . . which do not correspond to any actual economic losses,
do not constitute the type of 'bona fide' losses that are deductible under the Internal
Revenue Code and regulations."); Scully v. United States, 840 F.2d 478, 486 (7th Cir.
1988) (to be deductible, a loss must be a "genuine economic loss"); Shoenberg v.
Commissioner, 77 F.2d 446, 448 (8th Cir. 1935) (to be deductible, a loss must be
"actual and real"); § 1.165-1(b) of the Income Tax Regulations ("Only a bona fide loss is
allowable. Substance and not mere form shall govern in determining a deductible
loss.").
Notice 99-59 describes an arrangement that purported to give rise to deductible
losses on disposition of stock by applying the rules relating to distributions of
encumbered property to shareholders in order to create artificially high basis in the

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stock. The Service and the Treasury have become aware of similar arrangements that
have been designed to produce noneconomic tax losses on the disposition of
partnership interests. These arrangements purport to give taxpayers artificially high
basis in partnership interests and thereby give rise to deductible losses on disposition of
those partnership interests.
One variation involves a taxpayer’s borrowing at a premium and a partnership’s
subsequent assumption of that indebtedness. As an example of this variation, a
taxpayer may receive $3,000X in cash from a lender under a loan agreement that
provides for an inflated stated rate of interest and a stated principal amount of only
$2,000X. The taxpayer contributes the $3,000X to a partnership, and the partnership
assumes the indebtedness. The partnership thereafter engages in investment
activities. At a later time, the taxpayer sells the partnership interest.
Under the position advanced by the promoters of this arrangement, the taxpayer
claims that only the stated principal amount of the indebtedness, $2,000X in this
example, is considered a liability assumed by the partnership that is treated as a
distribution of money to the taxpayer that reduces the basis of the taxpayer’s
partnership interest under § 752 of the Internal Revenue Code. Therefore, disregarding
any additional amounts the taxpayer may contribute to the partnership, transaction
costs, and any income realized or expenses incurred at the partnership level, the
taxpayer purports to have a basis in the partnership interest equal to the excess of the
cash contributed over the stated principal amount of the indebtedness, even though the
taxpayer's net economic outlay to acquire the partnership interest and the value of the
partnership interest are nominal or zero. In this example, the taxpayer purports to have

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a basis in the partnership interest of $1,000X (the excess of the cash contributed
($3,000X) over the stated principal amount of the indebtedness ($2,000X)). On
disposition of the partnership interest, the taxpayer claims a tax loss with respect to that
basis amount, even though the taxpayer has incurred no corresponding economic loss.
In another variation, a taxpayer purchases and writes options and purports to
create substantial positive basis in a partnership interest by transferring those option
positions to a partnership. For example, a taxpayer might purchase call options for a
cost of $1,000X and simultaneously write offsetting call options, with a slightly higher
strike price but the same expiration date, for a premium of slightly less than $1,000X.
Those option positions are then transferred to a partnership which, using additional
amounts contributed to the partnership, may engage in investment activities.
Under the position advanced by the promoters of this arrangement, the taxpayer
claims that the basis in the taxpayer's partnership interest is increased by the cost of
the purchased call options but is not reduced under § 752 as a result of the
partnership’s assumption of the taxpayer’s obligation with respect to the written call
options. Therefore, disregarding additional amounts contributed to the partnership,
transaction costs, and any income realized and expenses incurred at the partnership
level, the taxpayer purports to have a basis in the partnership interest equal to the cost
of the purchased call options ($1,000X in this example), even though the taxpayer's net
economic outlay to acquire the partnership interest and the value of the partnership
interest are nominal or zero. On the disposition of the partnership interest, the taxpayer
claims a tax loss ($1,000X in this example), even though the taxpayer has incurred no
corresponding economic loss.

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The purported losses resulting from the transactions described above do not
represent bona fide losses reflecting actual economic consequences as required for
purposes of § 165. The purported losses from these transactions (and from any similar
arrangements designed to produce noneconomic tax losses by artificially overstating
basis in partnership interests) are not allowable as deductions for federal income tax
purposes. The purported tax benefits from these transactions may also be subject to
disallowance under other provisions of the Code and regulations. In particular, the
transactions may be subject to challenge under § 752, or under § 1.701-2 or other anti-
abuse rules. In addition, in the case of individuals, these transactions may be subject
to challenge under § 165(c)(2). See Fox v. Commissioner, 82 T.C. 1001 (1984).
Furthermore, tax losses from similar transactions designed to produce noneconomic tax
losses by artificially overstating basis in corporate stock or other property are not
allowable as deductions for federal income tax purposes.
Appropriate penalties may be imposed on participants in these transactions or,
as applicable, on persons who participate in the promotion or reporting of these
transactions, including the accuracy-related penalty under § 6662, the return preparer
penalty under § 6694, the promoter penalty under § 6700, and the aiding and abetting
penalty under § 6701.
Transactions that are the same as or substantially similar to the transactions
described in this Notice 2000-44 are identified as "listed transactions" for the purposes
of § 1.6011-4T(b)(2) of the Temporary Income Tax Regulations and § 301.6111-
2T(b)(2) of the Temporary Procedure and Administration Regulations. See also
§ 301.6112-1T, A-4. It should be noted that, independent of their classification as

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“listed transactions” for purposes of §§ 1.6011-4T(b)(2) and 301.6111-2T(b)(2), the
transactions described in this Notice 2000-44 may already be subject to the tax shelter
registration and list maintenance requirements of §§ 6111 and 6112 under the
regulations issued in February 2000 (§§ 301.6111-2T and 301.6112-1T, A-4), as well
as the regulations issued in 1984 and amended in 1986 (§§ 301.6111-1T and
301.6112-1T, A-3). Persons required to register these tax shelters who have failed to
register the shelters may be subject to the penalty under § 6707(a) and to the penalty
under § 6708(a) if the requirements of § 6112 are not satisfied.
In addition, the Service and the Treasury have learned that certain persons who
have promoted participation in transactions described in this notice have encouraged
individual taxpayers to participate in such transactions in a manner designed to avoid
the reporting of large capital gains from unrelated transactions on their individual
income tax returns (Form 1040). Certain promoters have recommended that taxpayers
participate in these transactions through grantor trusts and use the same grantor trusts
as vehicles to realize the capital gains. Further, although each separate capital gain
and loss attributable to a portion of a trust that is treated as owned by a grantor under
the grantor trust provisions of the Code (§ 671 and following) is properly reported as a
separate item on the grantor’s individual income tax return (see § 1.671-2(c) and the
Instructions to Form 1041, U.S. Income Tax Return for Estates and Trusts), the Service
and the Treasury understand that these promoters have advised that the capital gains
and losses from these transactions may be netted, so that only a small net capital gain
or loss is reported on the taxpayer’s individual income tax return. In addition to other
penalties, any person who willfully conceals the amount of capital gains and losses in

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this manner, or who willfully counsels or advises such concealment, may be guilty of a
criminal offense under §§ 7201, 7203, 7206, or 7212(a) or other provisions of federal
law.
The principal authors of this notice are David A. Shulman of the Office of
Associate Chief Counsel (Passthroughs and Special Industries) and Victoria S. Balacek
of the Office of Associate Chief Counsel (Financial Instruments and Products). For
further information regarding this notice, contact Mr. Shulman at (202) 622-3080 or Ms.
Balacek at (202) 622-3930 (not toll free calls).