IRS Will Not Let Investors off the Hook in Overvaluing Assets
- Steven L. Walker PLC
- Apr 10, 2013
- 2 min read
Updated: Aug 16, 2025
Individuals should exercise prudence in evaluating transactions designed to generate paper losses on federal income tax returns—so-called tax shelters. And in particular, taxpayers should focus on the value of the underlying asset reported on the return and ask whether that valuation makes sense. In an unusual move, the U.S. Tax Court recently overturned its precedent to side with the IRS and hold that an investor is not off the hook for steep penalties if valuation is wrong.
Valuation plays a key role in tax shelter cases, as valuation is one of the major devices used in abusive tax shelters (McCrary, 92 T.C. 827, 863 (1989), (Gerber, J., dissenting)). Courts look at the fair market value of an asset claimed on a tax return to determine whether a business transaction has economic substance and will be respected for tax purposes. As explained by the Ninth Circuit, “[a] fundamental issue in tax shelter cases is whether the property has been ‘acquired’ at an artificially high price, having little relation to its fair market value” (Estate of Franklin, 544 F.2d 1045, 1046 n. 1 (9th Cir. 1976), aff’g 64 T.C 752 (1975)).
Recently, the IRS, federal courts, and even Congress have become more aggressive about penalties in tax shelter cases. In 2010, Congress amended the Code to impose a new strict liability penalty for transactions lacking in economic substance that applies to transactions entered into after March 30, 2010 (Sec. 6662(b)(6)). There is no reasonable cause exception for this new penalty (Sec. 6664(c)(2)).
Significantly, a recent opinion by the Tax Court, in adopting the majority view of the U.S. courts of appeals, has made it more difficult for taxpayers to avoid the gross valuation misstatement penalty short of trial. The opinion represents a victory for the IRS in a battle stemming back over 25 years. (See AHG Investments, LLC, 140 T.C. No. 7 (2013).) This decision follows other recent government victories in the federal courts of appeals in tax shelter cases. In Alpha I, L.P., 682 F.3d 1009 (Fed. Cir. 2012), the Federal Circuit reversed a Court of Federal Claims ruling that the gross valuation misstatement penalty did not apply when a taxpayer conceded the adjustments on grounds other than basis or valuation. In Gustashaw, 696 F.3d 1124 (11th Cir. 2012), the Eleventh Circuit affirmed a Tax Court decision that held the taxpayers liable for the gross valuation misstatement penalty.
For more information, please see the article, below.
