Printer Friendly
The Free Library
22,728,043 articles and books

Lease termination payments not deductible.



The IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws.  has ruled in Letter Ruling 9607016 that a payment in connection with the termination of a lease was not deductible and will be treated as a capital expenditure under Sec. 263(a). The taxpayer was in the sixth year of a 15-year lease when it entered into an agreement with an unrelated party for the acquisition of a parcel of land for its new site. The taxpayer had executed letters of intent for the development of the new site and construction of a new office facility to be owned and occupied by the taxpayer. It was also stipulated that, in the event the taxpayer could not obtain a timely release of its obligations on its current lease, the agreement could be terminated. In the negotiations with its landlord, the taxpayer's lease would be terminated as of the date that construction of the new office space was expected to be completed and on payment of the sum in question. The Service ruled that this payment should be capitalized as part of the cost of the new property because of the interrelationship in·ter·re·late  
tr. & intr.v. in·ter·re·lat·ed, in·ter·re·lat·ing, in·ter·re·lates
To place in or come into mutual relationship.



in
 between the lease termination and the property acquisition.

Not surprisingly, the IRS relied on INDOPCO, Inc., 503 US 79 (1992), in which the Supreme Court stated that deductions are exceptions to the norm of capitalization. According to according to
prep.
1. As stated or indicated by; on the authority of: according to historians.

2. In keeping with: according to instructions.

3.
 Sec. 162 and the underlying regulations, current deductions are specifically listed; therefore, expenditures not found specifically within the law become subject to disallowance dis·al·low  
tr.v. dis·al·lowed, dis·al·low·ing, dis·al·lows
1. To refuse to allow: "[The government]
. Sec. 263, relating to relating to relate prepconcernant

relating to relate prepbezüglich +gen, mit Bezug auf +acc 
 capitalization, however, does not provide such detail; rather, it contains a general discussion on distinguishing capital items from current expenses. Thus, INDOPCO stated that deductions are strictly construed and allowed only when there is a clear provision therefor there·for  
adv.
For that: ordering goods and enclosing payment therefor.

Adv. 1. therefor
. The Court also noted that realization of benefits beyond the year in which the expenditure is incurred is undeniably important in determining whether the appropriate tax treatment is a current deduction or a capital expenditure. An important determination that must be made is whether or not the expenditure is for an asset or an income-producing item that extends beyond the current tax year. If payment for an item that benefits more than merely the current year is deducted, it would obviously cause a distortion of income in the current period. Applying this rationale to the lease termination payment, the Service reasoned that the payment related to the acquisition of the new property and benefited periods beyond the current year.

By contrast, in similar situations, courts have generally allowed deductions for payments made to reduce expenses or eliminate unproductive income-producing activities, and specifically, lease termination payments. In Cassatt, 137 F2d 745 (3d Cir. 1943), the taxpayer made a payment for the cancellation of certain leases. The court allowed the payment as a current deduction because the payment was in the form of damages to allow the taxpayer to be released from an unprofitable contract. Also, in Rev. Rul. 69-511, the IRS ruled that a lessee One who rents real property or Personal Property from another.

A lessee of land is a tenant. Cross-references

Landlord and Tenant.


lessee n. the person renting property under a written lease from the owner (lessor).
 was allowed a deduction for a lump-sum payment made to be relieved from a lease for the purpose of reducing expenses.

Payments made to terminate a lease have not, however, always been allowed as a current deduction. In Pig & Whistle Co., 9 BTA (Business Technology Association, Kansas City, MO, www.bta.org). A membership association of manufacturers, dealers, distributors and service companies in the business equipment and systems industries, founded in 1994.  668 (1927), a payment made to extinguish Extinguish

Retire or pay off debt.
 an original lease was held to be part of the cost of acquiring a new lease on the same premises and was required to be amortized over the life of the new lease. Lease termination payments made by lessors are generally capitalizable due to the fact that the expenditure represents an effort to acquire possession of the property. The taxpayer in Letter Ruling 9607016 made a lumpsum payment to be relieved from a lease. Somewhat like a lessor One who rents real property or Personal Property to another.

A lessor of land is a landlord. Cross-references

Landlord and Tenant.


lessor n. the owner of real property who rents it to a lessee pursuant to a written lease.
, it did so for the purpose of acquiring property; it was not done to reduce expenses or for damages. By terminating its lease, the taxpayer acquired a right to use and enjoy its newly purchased property. Since the two events were interrelated in·ter·re·late  
tr. & intr.v. in·ter·re·lat·ed, in·ter·re·lat·ing, in·ter·re·lates
To place in or come into mutual relationship.



in
 (one was contingent on Adj. 1. contingent on - determined by conditions or circumstances that follow; "arms sales contingent on the approval of congress"
contingent upon, dependant on, dependant upon, dependent on, dependent upon, depending on, contingent
 the other), it was all part of one single overall plan. The interrelation between the lease termination and the acquisition of the new site led to the conclusion that the payment is properly treated as a cost of acquiring the new property and thus capitalizable.

In planning for a payment such as that described here, in order to achieve the best tax treatment, taxpayers should structure their agreements so as not to be linked with other transactions or activities as part of an overall plan. Also, they should analyze the facts closely to be sure to obtain deductibility if in fact they are entitled to do so--based on all the circumstances of the transaction or situation.
COPYRIGHT 1996 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1996, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

 Reader Opinion

Title:

Comment:



 

Article Details
Printer friendly Cite/link Email Feedback
Author:Brown, Robert R., Jr.
Publication:The Tax Adviser
Date:Aug 1, 1996
Words:778
Previous Article:Charitable deductions and flowthrough entity basis limitations.
Next Article:Complexities of the sec. 179 deduction.
Topics:



Related Articles
No alimony after death of payee spouse.
Notice 96-7: request for comments on further capitalization guidance.
Deduction of early years' divorce payments.
Acquisition-related compensation not capitalized under INDOPCO.
Downsizing costs.
Lease negotiations are a matter of tax.
"Bailout" payments made by bank to its proprietary mutual funds must be capitalized.
The business auto decision.
Purchasing, leasing and developing software.
Deductibility of pre-demolition payments to tenants.

Terms of use | Copyright © 2014 Farlex, Inc. | Feedback | For webmasters