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Can a dispute over an asset's basis result in a tax controversy?

Readers likely know that capital gain must be reported to applicable authorities, such as to state revenue agents or on a federal income tax return filed with the Internal Revenue Service at the federal level. However, tax disputes can arise over the basis used in calculating such gains.

In a recent celebrity example, actor Rob Low found himself in a tax controversy against state taxing authorities over the capital gain he reported on the sale of his $25 million home. Specifically, the local franchise tax board claimed that Lowe should have used a basis that was $6 million lower, around $7 million instead of the $13.5 million Lowe had used. The lower basis would have resulted in over $714,000 in additional capital gains tax. 

The actor and his wife had allegedly put thousands of dollars into improvements, landscaping and construction costs above and beyond the home's purchase price. The project had begun in 1998. Unfortunately, many original records were no longer available, forcing the parties to rely on estimates. Lowe claimed that many of the records were destroyed when a former accountant’s computer crashed.

Although not every state tax dispute may involve millions of dollars, a dispute over an asset’s basis can be very expensive. In addition, a dispute may also result in potential penalties and interest. In this case, for example, state authorities had also slapped a $178,671 penalty against the actor. Fortunately, the parties were able to reach a settlement, agreeing to set the basis at $11.36 million. The penalty was also dropped pursuant to the settlement agreement. 

Source: Bloomberg, “Rob Lowe Grinds Out Tax Win Over $25 Million Home Sale,” Laura Mahoney, Nov. 18, 2015

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