Lease Termination Payment Related to Property Acquisition May Be Deducted
June 19, 2014
Federal income tax law requires taxpayers to capitalize expenses incurred to acquire property. When a lease is terminated as part of a transaction to purchase a piece of property, case law generally requires taxpayers to capitalize the lease termination payment as part of the purchase price of the property. However, a recent case from the U.S. Court of Appeals for the 6th Circuit treated the amount paid in excess of the appraised value of the acquired building as a deductible lease termination payment.
In ABC Beverage Corporation v. U.S., the taxpayer entered into a lease for a bottling plant. After concluding that the rent under the current lease agreement was too high, the taxpayer exercised a purchase option on the plant. Both the taxpayer and the property owner secured appraisals on the property. The taxpayer’s appraisal valued the property at $2.75 million, and the property owner’s appraisal valued the property at $14.8 million. The taxpayer and the property owner ultimately agreed upon a purchase price of $11 million.
The primary issue decided in the case was whether the additional amount paid, ultimately $8.25 million, by the taxpayer for the property that it valued at $2.75 million represented a currently deductible expense or a capitalizable cost of purchasing the building. The court held that the amount of purchase price paid in excess of the property’s appraised value was deductible as a lease termination payment.
Taxpayers in similar situations still should proceed with caution when deducting lease termination payments. The taxpayer succeeded in this case because it was able to differentiate its fact pattern from several other cases where lease termination payments were required to be capitalized. The taxpayer also had the support of multiple appraisals to establish the fair market value at $2.75 million. Taxpayers who believe they might be in a similar position should closely analyze their fact pattern in light of this decision.
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