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assets was. It began examining the value of the remaining water
right in December 1997. After the purchase, the LCRA recorded
$75 million as the fair market value of the assets it purchased
from petitioner and booked the entire amount to the water right.
The LCRA justified this conclusion based on the sales prices of
other water rights, inflation adjusted prices it had paid for
water rights in the past, and the cost of building a new
reservoir with capacity equivalent to petitioner’s remaining
water.
After the proposed sale to the LCRA had become public, the
city of San Antonio approached petitioner and inquired whether
petitioner would entertain a competing offer from San Antonio for
its water right. Petitioner declined and indicated that it did
not want to start a bidding war. In 2002, the LCRA entered into
a long-term water supply agreement with San Antonio, agreeing to
supply San Antonio 150,000 acre feet of water for 80 years. San
Antonio is outside the Colorado River Basin.
OPINION
I. Petitioner’s Conversion From C Corporation to S Corporation
The parties do not dispute that petitioner is subject to tax
on the built-in capital gain on its assets as of January 1, 1997.
We briefly discuss the law that subjects petitioner to such tax.
Subchapter S status entitles small, eligible corporations to
be taxed like partnerships, avoiding the corporate-level taxation
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