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Congress Doubles Time for IRS to Audit Certain Returns

Christopher Kirk

Taxpayers be aware: if you overstate your basis in property when reporting a sale, the IRS may have six years, instead of the usual three, to audit you.

The default rule for audits is that the IRS has three years from the date the return is due or filed, whichever is later, to assess additional tax. An important exception to this is that, if a taxpayer omits an item of income from their return, amounting to 25% or more of the gross income stated on the return, the statute of limitations on assessment is six years, not three. Generally, this was understood to apply only to complete omissions, not misstatements - if you included an item of income, but misstated the amount, it was not considered omitted from the return.  If you bought a painting at a garage sale for $10, and it was sold for $100,000 after discovering it was an undiscovered work by Jasper Johns, only the three-year statute of limitations applied if you reported the sale but claimed your basis was $90,000.

For many years, the IRS argued against this understanding, and brought assessments against taxpayers after the three-year period had run, claiming that an overstatement of basis constituted an omission of income and thus brought the case within the ambit of the exception. For many years, the IRS lost the argument. In 2012, the Supreme Court finally weighed in on the matter, affirming its earlier decision that an overstatement of basis did not constitute an omission of an item of income, and throwing out IRS regulations interpreting the statute of limitations the other way. The Court found that the language of the statute had not changed since its earlier decision, so there was no reason to change how it should be applied.

What the IRS could not win through litigation, it has won through legislation. On July 31, 2015, President Obama signed into law the Surface Transportation and Veterans Health Care Choice Improvement Act. Attached to that act was a provision that included an overstatement of basis as an omission of an item of income. 

The takeaway from this is that even if the IRS loses the battle, it may end up winning the war.