I am not going to get into this fight, except to point out that under the tax code, all income is assumed to be taxable unless proven otherwise.
I will also note that the statute of limitations is three years from the date the tax return is filed. If a required return is not filed, the clock on the statute of limitations never starts running, and the taxpayer can be audited and penalized at any indefinite time in the future.
For the taxpayer, the important point is going to be to document exactly how each property transfer occurred in order to document the basis. The basis of the property will be the same regardless of whether any paperwork is filed. The issue of the missing gift tax return will only come up if the taxpayer is audited regarding the reporting of the capital gains. The taxpayer should keep all of the documents and proofs that they gather and use to determine the basis for at least six years after the sale.
