Legal Question in Tax Law in District of Columbia

is an apartment lease buyout taxable as ordinary income or is it a capitol gain

Asked on 10/15/11, 9:38 am

1 Answer from Attorneys

Torrance Colvin The Colvin Law Firm

Years ago it was taxable as ordinary income to the tenant, generally reported on a 1099, and listed on Form 1040 as "other income".

In 1997, Code section 1234A was amended to apply for the first time to rights and obligations relating to interests in real property. That section now characterizes as "gain or loss from the sale of a capital asset" any "[g]ain or loss attributable to the cancellation, lapse, expiration, or other termination of . . . a right or obligation with respect to property which is (or on acquisition would be) a capital asset in the hands of the taxpayer . . . ."

Section 1234A deals with a problem that arises because the Internal Revenue Code applies favorable capital gains rates only where the gain is realized upon the "sale or exchange" of a capital asset. If a contractual right or obligation is cancelled, extinguished, or otherwise terminated upon making a payment, the courts have held in a variety of situations that the recipient of the payment does not have a capital gain because the right or obligation was "extinguished," not "sold or exchanged." Section 1234A reversed this result by providing that the gain or loss "shall be treated as gain or loss from the sale of a capital asset."

The Senate Finance Committee, as described in the committee report, specifically state that "the tax treatment of amounts received [by a landlord] to release a lessee from a requirement [in the lease] that the premise [sic] be restored on termination of the lease."

Many still don't believe that kind of payment to a landlord qualifies for capital gain treatment.

I, on the other hand, believe that the law AND Section 1234A allow for buyouts to be treated as capital gains.

Obviously, there are differences of opinion and the IRS has yet to really address it, so the smart thing is to be ready to defend your position either way.

Take into consideration that I am a litigator and not a tax lawyer, so I am likely to believe I can make any side the winning side. ;-)

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Answered on 10/29/11, 3:43 pm

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