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credits. The parties further stipulated that in 1982 the
recyclers were not properly valued at $1,750,000 each but instead
had a maximum value of only $30,000 to $50,000 each. On its
1982, 1983, and 1984 tax returns, Hamilton reported net ordinary
losses of $713,291, $36,205, and $16,720, respectively. The
losses and credits reported by Hamilton on its tax returns were
passed through to Hamilton’s limited partners. The portions
attributable to petitioners, respectively, were included on
Schedules K-1 (Form 1120S), Partners Share of Income, Credits,
Deductions, Inc., issued to them and filed with Hamilton’s tax
returns.
B. The Private Offering Memorandum
Generally, Hamilton distributed a private offering
memorandum to potential investors. The offering memorandum
informed investors that Hamilton’s business would be conducted in
accordance with the transaction described above. The offering
memorandum also warned potential investors of significant
business and tax risks associated with investing in Hamilton.
Specifically, the offering memorandum warned potential
investors that: (1) There was a substantial likelihood of an
audit by the Internal Revenue Service (IRS); (2) “On audit, the
purchase price of the Sentinel EPS Recyclers to be paid by F&G to
ECI may be challenged by the * * * [IRS] as being in excess of
the fair market value thereof, a practice followed by * * * [the
IRS] in transactions it deems to be tax shelters”; (3) the
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