                        128 T.C. No. 17



                   UNITED STATES TAX COURT



BAKERSFIELD ENERGY PARTNERS, LP, ROBERT SHORE, STEVEN FISHER,
GREGORY MILES AND SCOTT MCMILLAN, PARTNERS OTHER THAN THE TAX
               MATTERS PARTNER, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



  Docket No. 4204-06.                 Filed June 14, 2007.



       A Notice of Final Partnership Administrative
  Adjustment (FPAA) for the year 1998 was sent in 2005,
  determining that the basis of property sold by P was
  overstated. R contends that the overstatement of basis
  is an omission of gross income and that, therefore, the
  6-year period of limitations in sec. 6501(e)(1)(A),
  I.R.C., applies. There are no other exceptions to the
  normal 3-year period of limitations applicable to the
  individual partners.

        Held: The overstatement of basis is not an
   omission of gross income for purposes of sec.
   6501(e)(1)(A), I.R.C. Colony, Inc. v. Commissioner,
   357 U.S. 28 (1958), followed.
                                  - 2 -

       Steven Ray Mather and Elliott Hugh Kajan, for petitioners.

       Lloyd T. Silverzweig, for respondent.



                                 OPINION


       COHEN, Judge:    In a Notice of Final Partnership

Administrative Adjustment (FPAA) sent October 4, 2005, respondent

determined that Bakersfield Energy Partners, LP (BEP), had

overstated its basis in certain gas reserves sold during the

taxable year 1998, thus causing an understatement of partnership

income by more than 25 percent of the amount stated in the

return.    The issue for decision is whether, under those

circumstances, the overstatement of basis constitutes an omission

of income giving rise to an extended 6-year period of

limitations.    This issue has been presented by petitioners’

motion for summary judgment and respondent’s motion for partial

summary judgment.      Unless otherwise indicated, all section

references are to the Internal Revenue Code in effect for the

year in issue.

                               Background

       For purposes of the pending motions, the following facts

have been assumed.      The petitioning partners are all partners in

BEP.    BEP’s principal place of business was in California at the

time the petition was filed.      Prior to April 1, 1998, BEP owned

an interest in an oil and gas property with Harcor, an unrelated
                               - 3 -

company.   After a proposed sale of the oil and gas property to

another unrelated entity, Seneca Resources, fell through, the

petitioning partners decided to restructure the ownership of BEP.

To effect this new structure, on April 1, 1998, the petitioning

partners sold their partnership interests in BEP to Bakersfield

Resources, LLC (BRLLC), an entity that had been formed by the

petitioning partners.

     The petitioning partners recognized the gain from the sale

of their BEP partnership interests under the installment method.

For all tax years beginning in 1998, the petitioning partners

have reported the gain from this sale under the installment

method.

     The sale of the petitioning partners’ BEP partnership

interests caused a termination of BEP’s tax year pursuant to

section 708.   BEP made an election under section 754 to adjust

the basis of the partnership assets (the inside basis) to equal

BRLLC’s basis on its newly acquired BEP partnership interest (the

outside basis) pursuant to section 743(b).   The section 754

election and the transaction resulting in the section 743(b)

basis adjustments were disclosed in statements attached to BEP’s

partnership return for the short-year period from April 1 through

December 31, 1998 (the 9812 Form 1065).

     On the 9812 Form 1065, U.S. Partnership Return of Income,

BEP reported total income as follows:
                                  - 4 -

     1 a   Gross receipts or sales
       b   Less returns and allowances
     2     Cost of goods sold
     3     Gross profit
     4     Ordinary income (loss) from
            other partnerships . . . . . . . .     $273,262
     5     Net farm profit (loss)
     6     Net gain (loss) from Form 4797 . .     1,993,034
     7     Other income (loss)
     8     Total income (loss) . . . . . . . .    2,266,296

On Form 4797, Sales of Business Property, BEP reported sale of

the oil and gas properties in issue as follows:

     20 Gross sales price . . . . . . . . $23,898,611
     21 Cost or other basis
         plus expense of sale . . . . . . 16,515,194
     22 Depreciation (or depletion)
         allowed or allowable
     23 Adjusted basis . . . . . . . . . . 16,515,194
     24 Total gain . . . . . . . . . . . . 7,383,417

               *    *    *    *      *    *   *

     28 If sec. 1254 property:
       a Intangible drilling and
          development costs, expenditures
          for development of mines and
          other natural deposits, and
          mining exploration costs . . . . 1,993,034
        b Enter the smaller of
           line 24 or 28a . . . . . . . . 1,993,034

               *    *    *    *      *    *   *

     30 Total gains for all properties . . 7,383,417
     31 [From line 28] . . . . . . . . . . 1,993,034
     32 Subtract line 31 from line 30 . . 5,390,383

Attached to BEP’s 9812 Form 1065 was a Statement Regarding a

Partnership Technical Termination as follows:

     Pursuant to IRC Sec. 708(b)(1)(B) and the regulations
     thereunder, Bakersfield Energy Partners, LP terminated
     on April 1, 1998. On that date, certain partners sold
     over a 50% ownership interest in the partnership’s
     capital and profits to Bakersfield Resources, LLC
                               - 5 -

     * * *. On April 7, 1998, Bakersfield Resources, LLC
     acquired additional partnership interests through
     purchases. These transactions resulted in a new
     partnership for federal income tax purposes (the “new”
     partnership retains the same federal employer
     identification number).

     As reflected within the capital accounts, the
     partnership books were restated to reflect the value of
     the assets as required in the regulations under IRC
     704. As reflected within this return, in the event of
     a sale of these assets, proper adjustments have been
     made to reflect the tax basis and the proper taxable
     gain.

Also attached was a Section 754 Election Statement as follows:

     The partnership hereby elects, pursuant to IRC Section
     754, to adjust the basis of partnership property as a
     result of a distribution of property or a sale or
     exchange of a partnership interest as provided in IRC
     Sections 734(b) and 743(b).

     The FPAA in this case was sent October 4, 2005.   The notice

adjusted BEP’s ordinary income as follows:

     a.   Portfolio income (loss) interest

          (1) Adjustment                    $0
          (2) As reported              381,998
          (3) Corrected                381,998

     b.   Net gain (loss) under sec. 1231 not casualty/theft

          (1) Adjustment            16,515,194
          (2) As reported            5,390,383
          (3) Corrected             21,905,577

The adjustment was explained as follows:

     Bakersfield Energy Partners, LP has failed to establish
     that it had a basis greater than $0 in the gas reserves
     it sold during the taxable year 1998. It has been
     determined that any optional basis adjustment under
     section 743(b) was the result of a sham transaction, a
     transaction lacking economic substance that had no
     business purpose and no economic effect and/or was
                               - 6 -

     availed for tax avoidance purpose and should not be
     respected for tax purposes.

     Petitioners filed a motion for summary judgment on the

ground that the FPAA was issued after the applicable period of

limitations had expired.   Petitioners contend that overstatement

of basis is not an omission from gross income for purposes of the

extended period of limitations under section 6501(e)(1)(A) or, in

the alternative, that the amount omitted was “disclosed in the

return, or in a statement attached to the return, in a manner

adequate to apprise the Secretary of the nature and amount of

such item.”   Sec. 6501(e)(1)(A)(ii).    Respondent has moved for

partial summary judgment, agreeing that the material facts

necessary to determine whether the overstatement of basis is an

omission from gross income are not in dispute.     Respondent

contends, however, that the question of adequate disclosure on

the return involves a dispute as to material facts.

     The parties have now stipulated facts as to each partner in

the partnership, to the effect that they are unaware of any

exception to the normal 3-year period of limitations on

assessment other than the issue addressed in this Opinion.

                            Discussion

     Under the general rule set forth in section 6501, the

Internal Revenue Service is required to assess tax (or send a

notice of deficiency) within 3 years after a Federal income tax

return is filed.   See sec. 6501(a).    For this purpose, the
                                 - 7 -

“return” does not include a return of a person, such as a

partnership, from whom the taxpayer (i.e., a partner) has

received an item of income, gain, loss, deduction, or credit.

Id.   In the case of a tax imposed on partnership items, section

6229 sets forth special rules to extend the period of limitations

prescribed by section 6501 with respect to partnership items or

affected items.    See sec. 6501(n)(2); Rhone-Poulenc Surfactants &

Specialties, L.P. v. Commissioner, 114 T.C. 533, 540-543 (2000).

      Section 6229 provides in pertinent part:

      SEC. 6229.   PERIOD OF LIMITATIONS FOR MAKING
                   ASSESSMENTS.

           (a) General Rule.–-Except as otherwise provided in
      this section, the period for assessing any tax imposed
      by subtitle A with respect to any person which is
      attributable to any partnership item (or affected item)
      for a partnership taxable year shall not expire before
      the date which is 3 years after the later of--

                (1) the date on which the partnership return
           for such taxable year was filed, or

                (2) the last day for filing such return for
           such year (determined without regard to
           extensions).

                   *    *    *    *      *   *   *

           (c) Special Rule in Case of Fraud, Etc.--

                   *    *    *    *      *   *   *

                (2) Substantial omission of income.–-If any
           partnership omits from gross income an amount
           properly includible therein which is in excess of
           25 percent of the amount of gross income stated in
           its return, subsection (a) shall be applied by
           substituting “6 years” for “3 years”.
                                 - 8 -

In drafting section 6229, Congress did not create a completely

separate statute of limitations for assessments attributable to

partnership items.    See AD Global Fund, LLC v. United States, 481

F.2d 1351 (Fed. Cir. 2007); Rhone-Poulenc Surfactants &

Specialties, L.P. v. Commissioner, supra at 545.     Instead,

section 6229 merely supplements section 6501.

     In Rhone-Poulenc Surfactants & Specialties, L.P. v.

Commissioner, supra at 539, the Court analyzed sections 6229 and

6501 as applicable to an FPAA.    The Court stated in pertinent

part:

          The Internal Revenue Code prescribes no period
     during which TEFRA partnership-level proceedings, which
     begin with the mailing of the notice of final
     partnership administrative adjustment, must be
     commenced. However, if partnership-level proceedings
     are commenced after the time for assessing tax against
     the partners has expired, the proceedings will be of no
     avail because the expiration of the period for
     assessing tax against the partners, if properly raised,
     will bar any assessments attributable to partnership
     items. [Id. at 534-535.]

                  *     *    *    *      *   *   *

          * * * Any income tax attributable to partnership
     items is assessed at the partner level. Thus, any
     statute of limitations provisions that limit the time
     period within which assessment can be made are
     restrictions on the assessment of a partner’s tax.
     [Id. at 539.]


See AD Global Fund, LLC v. United States, 481 F.2d 1351 (Fed.

Cir. 2007); G-5 Inv. Pship. v. Commissioner, 128 T.C. ___

(May 30, 2007).
                               - 9 -

     If respondent’s position in this proceeding is correct, the

FPAA was sent within the 6-year period of limitations, and the

FPAA, by reason of section 6229(d), would suspend the period of

limitations applicable to assessment of the liabilities of the

partners.   If we adopt petitioners’ position in this case, the

applicability of the period of limitations requires analysis of

the situation of each partner, i.e., whether the partner’s tax

year is open to assessment.   If the period of limitations is open

with respect to any partner in the partnership, the adjustments

made in the FPAA in issue would have to be examined on the

merits.   However, the parties have stipulated that they know of

no other exceptions to the normal 3-year period with respect to

the individual partners, and respondent has conceded that, if the

Court determines that petitioners’ failure to include net gain

from the sale of property does not constitute an omission from

gross income, the Court should grant petitioners’ motion for

summary judgment.

     Although section 6229 does not repeat all of the terms and

provisions already set forth in section 6501, the precedents

interpreting section 6501(e)(1)(A)(ii) have been held equally

applicable to section 6229(c)(2), and that principle is not

disputed here.   In this case, however, respondent implies that an

interpretation under the Internal Revenue Code of 1939 should not

apply to the current Code provisions.
                              - 10 -

     In Colony, Inc. v. Commissioner, 357 U.S. 28, 37 (1958), the

Supreme Court, interpreting section 275(c), I.R.C. 1939, the

predecessor of section 6501(e), specifically stated that the

result that it reached is in harmony with the language of section

6501(e)(1)(A):

          We think that in enacting section 275(c) Congress
     manifested no broader purpose than to give the
     Commissioner an additional two years [now three] to
     investigate tax returns in cases where, because of a
     taxpayer’s omission to report some taxable item, the
     Commissioner is at a special disadvantage in detecting
     errors. In such instances the return on its face
     provides no clue to the existence of the omitted item.
     On the other hand, when, as here, the understatement of
     a tax arises from an error in reporting an item
     disclosed on the face of the return the Commissioner is
     at no such disadvantage. * * * [Id. at 36.]

The precise holding of the Supreme Court in Colony, Inc. v.

Commissioner, supra, was that the extended period of limitations

applies to situations where specific income receipts have been

“left out” in the computation of gross income and not when an

understatement of gross income resulted from an overstatement of

basis.   The Supreme Court stated:

          In determining the correct interpretation of sec.
     275(c) [now sec. 6501(e)] we start with the critical
     statutory language, “omits from gross income an amount
     properly includible therein.” The Commissioner states
     that the draftsman’s use of the word “amount” (instead
     of, for example, “item”) suggests a concentration on
     the quantitative aspect of the error–-that is, whether
     or not gross income was understated by as much as 25%.
     This view is somewhat reinforced if, in reading the
     above-quoted phrase, one touches lightly on the word
     “omits” and bears down hard on the words “gross
     income,” for where a cost item is overstated, as in the
     case before us, gross income is affected to the same
                             - 11 -

     degree as when a gross-receipt item of the same amount
     is completely omitted from a tax return.

          On the other hand, the taxpayer contends that the
     Commissioner’s reading fails to take full account of
     the word “omits,” which Congress selected when it could
     have chosen another verb such as “reduces” or
     “understates,” either of which would have pointed
     significantly in the Commissioner’s direction. The
     taxpayer also points out that normally “statutory words
     are presumed to be used in their ordinary and usual
     sense, and with the meaning commonly attributable to
     them.” De Ganay v. Lederer, 250 U.S. 376, 381. “Omit”
     is defined in Webster’s New International Dictionary
     (2d ed. 1939) as “To leave out or unmentioned; not to
     insert, include, or name,” and the Court of Appeals for
     the Sixth Circuit has elsewhere similarly defined the
     word. Ewald v. Commissioner, 141 F.2d 750, 753.
     Relying on this definition, the taxpayer says that the
     statute is limited to situations in which specific
     receipts or accruals of income items are left out of
     the computation of gross income. For reasons stated
     below we agree with the taxpayer’s position. [Id. at
     32-33.]

Although the numbering of the sections as part of recodifications

of the Internal Revenue Code has changed, we see little change in

the rationale of the applicable statute.   Thus, the Supreme Court

holding would apply equally to BEP’s return.

     Respondent’s memorandum brief in support of motion for

partial summary judgment maintains that BEP:

     properly reported the gross sales price of $23,898,611
     on the Form 4797, but that it only reported $5,390,383
     of the related net gain under I.R.C. sec. 1231
     (understating the net gain by $16,515,194). * * * On
     its return for the 1998 Taxable Year, * * * [BEP]
     reported gross income totaling $8,038,677, including
     the reported net I.R.C. sec. 1231 gain of $5,390,383,
     portfolio (interest) income of $381,998, and trade or
     business income of $2,266,296. * * * Therefore, the
     amount of gross income omitted by * * * [BEP] which was
     properly includible therein (i.e. $16,515,194) exceeded
                             - 12 -

     the amount of income stated in the return (i.e.
     $8,038,677) by 205 percent.

Respondent argues:

          Overstating deductions is not considered an
     omission of gross income for purposes of I.R.C. secs.
     6229(c)(2) and 6501(e)(1)(A). However, overstating the
     basis resulting in underreporting net I.R.C. sec. 1231
     gain is not considered overstating deductions. Rather,
     the underreporting (or omitting) of I.R.C. sec. 1231
     gain is the omission of gross income regardless of
     whether the gross sales price is underreported (or
     omitted) or the basis is overstated. The relevant
     issue is not whether an income item was completely
     omitted from the return, but whether, for purposes of
     I.R.C. secs. 6229(c)(2) and 6501(e)(1)(A), gross income
     is omitted when a taxpayer underreports the gain from
     the sale of property used in a trade or business as the
     result of overstating the cost or other basis of such
     property. [Emphasis added.]

Respondent relies on cases defining “gross income” for general

purposes of section 6501(e) by reference to section 61.

Respondent cites section 6501(e)(1)(A)(i), which defines gross

income in the context of sale of goods or services, and argues:

          Any uncertainty in analyzing the sales of business
     property under I.R.C. sec. 6501(e)(1)(A) results only
     from trying to apply statements in Colony, Inc. v.
     Commissioner, 357 U.S. 28 (1958), concerning the
     extended period for omissions in the I.R.C. of 1939 to
     the revised provision of the I.R.C., and from taking
     statements about equating gross receipts with gross
     income in the case of a trade or business out of
     context. * * *

Respondent continues:

     In Colony, Inc., the taxpayer understated the gross
     profits on the sales of certain lots of land for
     residential purposes as a result of having overstated
     the basis of such lots by erroneously including in
     their cost certain unallowable items of development
     expense. Colony, Inc., 357 U.S. at 30. Respondent
     acknowledges that Colony, Inc. suggests that an
                             - 13 -

     overstated basis, in contrast to the omission of sales
     proceeds, provides something for the Service to
     check.4/ However, in Colony, Inc., the Supreme Court
     had before it a case of a sale of goods or services, as
     the taxpayer’s principal business was the development
     and sale of lots in a subdivision. See Colony, Inc. v.
     Commissioner, 26 T.C. 30, 31 (1956), aff’d, 244 F.2d 75
     (6th Cir. 1957), rev’d, 357 U.S. 28 (1958). In cases
     not concerning a sale of goods or services, Colony,
     Inc.’s approach would conflict with I.R.C. sec.
     6501(e)(1)(A). See CC&F Western Operations L.P., 273
     F.3d at 406, in which the First Circuit questions
     whether Colony’s main holding carries over from the
     1939 Internal Revenue Code for land sales in general
     (“Gross income on land sales is normally computed as
     net gain after subtracting basis. 26 U.S.C. secs.
     61(a)(3), 1001(a); 26 C.F.R. sec. 1.61-6 (2001).”).

          Accordingly, respondent maintains that Colony,
     Inc. does not provide any authority for treating gross
     receipt as gross income for the sale of land or other
     property; rather, under the current I.R.C., that
     treatment depends on whether the property sold is a
     good or service. The sale of business property
     reported on Form 4797 is not the sale of a good or
     service; rather it is the sale of an item that is used
     by a business to sell goods or services.
     __________________________
     4 Petitioner notes that although the Supreme Court
     applied the 1939 I.R.C., it stated “that the conclusion
     is in harmony with the unambiguous language of sec.
     6501(e)(1)(A).” Colony, Inc., 357 U.S. at 37. The
     Supreme Court did not purport to explain how an
     interpretation under the I.R.C. 1954 should incorporate
     its analysis. It appears that this observation was
     only made because each party had looked to the I.R.C.
     1954 Code for support as indicated by the following
     phrase which prefaces the observation: “And without
     doing more than noting the speculative debate between
     the parties as to whether Congress manifested an
     intention to clarify or to change the 1939 Code,
     * * *.” Colony, Inc., 357 U.S. at 37.

     We are unpersuaded by respondent’s attempt to distinguish

and diminish the Supreme Court’s holding in Colony, Inc. v.

Commissioner, 357 U.S. 28 (1958).   We do not believe that either
                                - 14 -

the language or the rationale of Colony, Inc. can be limited to

the sale of goods or services by a trade or business.   As

petitioners point out, the Supreme Court held that “omits” means

something “left out” and not something put in and overstated.

     We apply the holding of Colony, Inc. v. Commissioner, supra,

to this case and conclude that the 6-year period of limitations

set forth in section 6501(e) does not apply.   Thus, we need not

determine whether the amounts in dispute were disclosed on the

return in a manner adequate to apprise the Secretary of the

nature and amount of the omitted item.

     Because of the stipulation that no other exception to the

normal 3-year period applies to any of the individual partners

and to reflect the foregoing,


                                     An order and decision will be

                                entered granting petitioners’

                                motion for summary judgment and

                                denying respondent’s motion for

                                partial summary judgment.
