## Facts

- Related partnerships and partners sought to claim over $100 million in capital losses on their 1997 returns to offset trading gains.
- A promoter designed a transaction using lease-and-sublease arrangements (CHIPS/TRIPS) that generated preferred stock with a claimed tax basis far exceeding its market value.
- The intermediary entity obtained preferred stock by exchanging packages of lease obligations that included “stripped” income elements, producing an asserted basis roughly 100 times the market value of the underlying economics.
- The preferred stock was contributed to a partnership and then sold soon after for about $1 million.
- Despite the low sale proceeds, the partnership reported an approximately $100 million basis in the stock and claimed a corresponding capital loss (allocated to partners).
- The taxpayers obtained a legal opinion letter concluding the intended loss treatment “should” be respected for federal income tax purposes.
- The IRS disallowed most of the claimed loss and imposed accuracy-related penalties under I.R.C. § 6662.
- The taxpayers brought an action for readjustment of partnership items and challenged both the disallowance and the penalties in a bench trial.

## Issues

1. Whether the transaction should be disregarded under the economic substance doctrine because it lacked objective economic effects and a non-tax business purpose, thereby eliminating the claimed capital losses.
2. Whether accuracy-related penalties under I.R.C. § 6662 applied, and whether the taxpayers qualified for the I.R.C. § 6664(c)(1) reasonable-cause and good-faith exception based on reliance on professional advice.

## Decision

- The court held the transaction lacked economic substance and a genuine non-tax business purpose and therefore was disregarded for tax purposes.
- The court upheld the IRS’s disallowance of the claimed capital losses.
- The court sustained the accuracy-related penalties under I.R.C. § 6662.
- The court rejected the taxpayers’ reasonable-cause and good-faith defense, concluding reliance on the opinion letter was not reasonable under the circumstances.

## Legal Principles

- A transaction may be disregarded for federal tax purposes when, viewed as a whole, it lacks objective economic substance (meaningful pre-tax profit potential) and lacks a genuine non-tax business purpose.
- Basis claims that bear no reasonable relationship to fair market value, and that arise from prearranged steps aimed at producing tax attributes, support a finding of no economic substance.
- For I.R.C. § 6662 penalties, taxpayers may avoid liability only by showing reasonable cause and good faith under I.R.C. § 6664(c)(1).
- Reliance on professional tax advice is not reasonable cause when the taxpayer knew or should have known the advice rested on unrealistic assumptions, did not address economic reality, or functioned primarily to support a preselected tax result.

## Conclusion

The court treated the partnership’s lease-strip/basis-inflation structure as a tax-motivated arrangement lacking meaningful economic effects and a bona fide business purpose, disallowed the resulting capital losses, and upheld accuracy-related penalties because the taxpayers’ opinion-letter reliance was not reasonable or in good faith.


Long Term Cap. Holdings v. United States, 330 F. Supp. 2d 122 (D. Conn. 2004)