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S Corporation on September 16, 2000 (the 1999 return). The 1999
return reported a built-in gains tax of $9,636,736 on the sale of
petitioner’s water right. The built-in gains tax amount reported
by petitioner was based on a valuation of $31,410,000 as of
January 1, 1997 (valuation date) for the water right and the
investment portfolio.
Respondent determined a deficiency in petitioner’s 1999
Federal income tax of $15,819,650, based on a valuation of
$76,609,000 for the water right and the investment portfolio.
1. Petitioner’s Irrigation Business
The State of Texas owns the water in its public waterways.
The right to divert and use or sell water from a waterway is
known as a “water right”. The Texas Commission on Environmental
Quality, formerly known as the Texas Natural Resources
Conservation Commission (hereinafter, the TNRCC), is a State
agency that regulates the water rights in Texas and controls the
transfer and use of such rights. The TNRCC formally recognized a
water right by issuing to the holder a Certificate of
Adjudication, which contained the limits of that right, its
priority date, and any special or unique conditions associated
with its use.
On June 28, 1989, the TNRCC formally recognized petitioner’s
water right and issued to it Certificate of Adjudication No. 14-
5434 (certificate). Petitioner’s certificate allowed it to
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