Problem Description
Kim leased an office building to USA Corporation under a ten-year lease specifying that at the end of the lease USA had to return the building to its original condition if any modifications were made. USA changed the interior of the building, and at the end of the lease USA paid Kim 30,000 instead of making the required repairs. Does Kim have to include the payment in gross income?
Problem Solution
Gross income does not include the value of real property due to structures erected or other improvements made by a lessee after a lease, as stated in Section 109. A lessee must include in their gross income any rent they receive from a lessor. Gross revenue does not include any amounts used to improve the property or rent received (Berdon, 1946). In the given scenario, the question that will be depicted is whether or not the thirty thousand dollars that the United States of America Corporation paid Kim should be included in her gross income. According to Section 109 of the Internal Revenue Code, rental income is a payment the lessee makes to the lessor (Berdon, 1946). The amount of rent now owed is the price that must be paid to have the right to occupy the property.
The case I choose to discuss is Boston Fish Market Corp., where one of the tenants should decide whether or not to pay the petitioner in 1968 to meet the tenant’s obligation to return certain leased premises to the original, preleased condition (United States Tax Court, n.d.). This decision is part of the tenants’ commitment to restoring the premises to the preleased condition (United States Tax Court, n.d.). If this were the case, it would be subject to the gross income requirements of Section 109 or the taxable amount corresponding to the amount obtained through the sale.
Now, in the case of Sirbo Holdings Inc. v. CIR, 31 AFTR 2d 73-1005, 73-1 USTC 9312 (2nd Cir., 1973), the question that needs to be answered is whether or not the tenant’s fee to its landlord of $125,000 in fulfillment of the tenant’s commitment to reinstate leased premises to their prelease condition is entitled. In whole or in part, to long-term capital gains treatment under Section 1231 of the Internal Revenue Code (US Court of Appeals for the Second Circuit, n.d.). As a result, the commissioner concluded that the petitioner’s amount should be treated as regular taxable income. In 1944, Sirbo leased one of its buildings to CBS.
Following the expiration of that lease, Sirbo awarded CBS a new lease for the theater they were renting at the time. By 1968, the Sirbo lease had required that CBS bring all of the properties back to the condition they had been in 1947. A settlement was signed on January 31, 1964, but it ended up dating back to December 31, 1963, that stated CBS had given Sirbo $125,000 for the release of any claims, harm, or damage. This was done in exchange for releasing any claims, injury, or damage (US Court of Appeals for the Second Circuit, n.d.). With time, CBS made additional theater changes so it could be used as a television studio. They were obligated to include the payment of $125,000 in their total gross income due to Sirbo’s acceptance of the money.
There are certain similarities between the Kim case and the Sirbo case. Both of them deal with the process of leasing their building to a business and, at the end of the lease, having any modifications made to the structure reverted to its initial state. This is a problem for both of them. Because Kim and Sirbo accepted cash payments from their lessees before making improvements to the property and did not return it to its former condition, they are exempt from the requirements of Section 109. This provision does not apply to them.
In conclusion, Section 109 of the Internal Revenue Code provides that a lessor of property is not allowed to include in their gross income any revenue that is received from sources other than rent upon the expiration of their lease. Excluding cash transfers from gross income was not intended to be a purposeful application of this rule. Consequently, Kim would be required to include it in the total gross revenue.
References
Berdon, S. S. (1946). Give Section 109 a Transfusion.Taxes, 24, 649. Web.
United States Tax Court. (n.d.). Boston Fish Market Corpor | 57 T.C. 884 (1972) | cntc8841850 | Leagle.com. Leagle. Web.
US Court of Appeals for the Second Circuit. (n.d.). Sirbo Holdings, Inc., Appellant, v. Commissioner of Internal Revenue, Appellee, 509 F.2d 1220 (2d Cir. 1975) :: Justia. Justia Law. Web.