Section 754 Bogus Optional Basis transactions
What about BOB?
Taxpayers are continuing to use partnership entities to structure abusive tax avoidance transactions. The Pass-Through Entity Program has examined many types of bogus optional basis transactions (BOB Transactions) in which a partnership uses an Internal Revenue Code (IRC) Section 754 election to inappropriately increase the basis of its property. In some cases, the basis of assets is increased before their disposition. In other cases, taxpayers are using the additional basis to claim increased depreciation or amortization deductions. Although each type of BOB transaction may be structured in various ways, the ultimate objective is to avoid gain on asset dispositions, or to create deductions that offset income.
We have observed several methods used to artificially increase partnership property basis:
- A transaction in which a partner is redeemed out of the partnership for a redemption note, followed by a related party transfer of partnership interests.
- A transaction that uses related party installment sales of partnership interests for promissory notes or annuities.
- A transaction using the rules of IRC Section 734 to shift basis from a high basis asset to a low basis asset.
We are closely scrutinizing IRC Section 754 BOB transactions. Depending upon the facts and circumstances, the transaction may be disregarded or recast to properly reflect California income, or the basis step-up might be disallowed based on one or more of these positions:
- The transactions are a sham for tax purposes.
- The substance of the transactions does not represent the form.
- Intermediate steps should be disregarded under the step transaction doctrine.
- The transactions can be recast under the partnership anti-abuse regulations of IRC Section 701.
- The redemption note is not a valid liability for tax purposes.
- The gain or loss can be recomputed under IRC Section 446 or 269.
- The relevant tax laws were not applied properly.
We may add substantial penalties to any additional tax due, depending on the facts and circumstances. For example, the 40 percent non-economic substance transaction penalty, the 100 percent interest based penalty, or the accuracy related penalty might be applicable. The California eight-year statute of limitations rule may apply to the transactions.
Taxpayers who are reconsidering their use of tax avoidance schemes to understate their tax liabilities have asked us about their options. Your clients can amend their state income tax returns at any time to restate their proper tax liability. Their self-assessed tax and appropriate interest is due, and must be paid when they file their amended return.
Substantial penalties might apply to an abusive tax scheme; however your client may avoid certain penalties by filing an amended return. If any of your clients are interested in filing an amended return, please use the address below. To ensure proper handling, write BOB TS on the top right margin of the first page.
ATTN: 341: MS F-150
Franchise Tax Board
PO Box 942867
Sacramento CA 94267-0001