Discussion:Leasehold improvements
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Discussion Forum Index --> Tax Questions --> Leasehold improvements
| 21 July 2006 | |
| I can't figure out anything this morning. What happens when an S-corp/lessee effectively terminates a building lease with a related party LLC/lessor due to sale of the business and liquidation, where there are significant leasehold improvements on the lessee's books because they were purchased by the lessee? There's still substantial basis remaining in the improvements - generally the lessee can write-off the remaining basis when they don't retain the improvements. But does the lessor now have income because they continue to have space to rent with the improvements they never paid for? Or do related party rules somehow change everything? | |
| 21 July 2006 | |
| Distribution of leasehold improvements to shareholder would be at fair market value. Where is the loss? | |
| July 21, 2006 | |
| The lessee has a loss, Dennis, walking away from the LI's. His question is whether the landlord/lessor has income to the extent that he receives those LI's without any expenditure. (In my experience, unless this is a rehab'd old building or something, most landlords tear out the build out anyway so that the next guy can build it as he likes. So there's no value to the landlord...but I've never seen this brought up before.) | |
| 21 July 2006 | |
| There is a significant difference between walking away, which would be the case if an unrelated party got the improvements, and a liquidation distribution, which is what is happening here. You can't abandon property you are keeping. If subsequent tenant wants the improvements out you can probably expense demolition cost but distribution value would be an addition to basis. | |
| July 21, 2006 | |
| Forgot about the related party thing, and the 'effectively' terminates... | |
| 21 July 2006 | |
| MSTguy, the value of LHI acquired by a lessor as a result of the abandonment by the lessee is excluded from gross income under Sec. 109. I see no income to the lessor if the improvements were made by the lessee without the anticipation of the cancellation of the lease. | |
| 21 July 2006 | |
| I don't see the without the anticipation argument when lessee and lessor are related parties, and 1.167(a)-8(a)(4) makes loss recognition doubtful.
4) Where an asset is retired by actual physical abandonment (as, for example, in the case of a building condemned as unfit for further occupancy or other use), loss will be recognized measured by the amount of the adjusted basis of the asset abandoned at the time of such abandonment. In order to qualify for the recognition of loss from physical abandonment, the intent of the taxpayer must be irrevocably to discard the asset so that it will neither be used again by him nor retrieved by him for sale, exchange, or other disposition. | |
| 21 July 2006 | |
| The Section 109 nonrecognition rules trump the Section 301 distribution rules when the LHI were made by the lessee in his capacity as lessee as opposed to its capacity as corporation/shareholder. Thus, I would agree that an abandoned improvement, which was custom made by the lessee on behalf of the lessor, would be fall within the scope of Section 301, rather than Section 109, I see nothing in the fact pattern that would cause me to believe that Sec. 301 trumps Sec. 109 in the original post. | |
| 22 July 2006 | |
| I agree that it doesn't seem right that the lessee should get a deduction when the lessor doesn't have to pick up the income; however, the statute appears to treat these as two unrelated issues. | |
| 22 July 2006 | |
| Everything depends on facts and circumstance. To me the key words are " In order to qualify for the recognition of loss from physical abandonment, the intent of the taxpayer must be irrevocably to discard the asset so that it will neither be used again by him nor retrieved by him for sale, exchange, or other disposition."
I can see loss recognition if the improvements are a nuisance that has to be removed to rent to the next tenant. See Wolan v Commissioner -- or a California case (Hubacher). | |
| 22 July 2006 | |
| The deductibility to the lessee of the abandonment loss (or lack thereof) should have no bearing on the lessor's exclusion under Sec. 109. | |
| 23 July 2006 | |
| As lessor, no, but as shareholder? Putting some feathers on this turkey, sole shareholder leases vacant land from single member LLC.(same person) He builds a warehouse for 500K. Operates an import business for 5 years. Sells business. Buyer has his own warehouse. Liquidates corp. Warehouse (basis 440K, fmv 900K) goes to LLC or to shareholder? My point is absent abandonment the asset has to go somewhere on liquidation. | |
| 23 July 2006 | |
| Thanks for all the feedback, guys. All are very good points. The more I thought about it, I have to agree that taking a loss on termination of the lease can't be the right way to go, especially when there's $150k in remaining basis that, if deductible, could offset capital gain on sale of goodwill, after which either shareholder or lessor retain the improvements, which would likely be unchanged when leasing to next tenant. I found a similar case where a liquidating lessee corporation transferred lease interest and improvements to lessor corp (transferee). The lessor continued to depreciate the remaining basis of the improvements, and upon its own liquidation and distribution of LHI to shareholders, shareholders also had to continue depreciating original basis (after being so ordered by the court - originally shareholders had tried to write off unamortized basis). I'm amazed, however, at the lack of information I was able to dig up in researching this. I'm surpised I did not find more - that's why I appreciate the support in this forum. | |
| 24 July 2006 | |
| Aha. Basis was going to be the next item on the agenda. The citation would be helpful. ♫ | |
| 24 July 2006 | |
| Dennis - this isn't the exact same case, but it is also pretty much on point:
(cited from RIA - Action Distributing Co v. Commissioner) Where a taxpayer liquidates and, in effect, transfers its leasehold to the taxpayer's sole shareholder, the benefits of the leasehold improvements are not ended, whether the sole shareholder continues the taxpayer's business or whether he leases the buildings to new lessees, as was done here. Thus, there was no real change of interest to warrant the acceleration of deductions for the cost of lease improvements. The Tax Court dismissed as a distinction without a difference the taxpayer's argument that this case was distinguishable from Wolan, and Cooper Foundation since the leases in this case were not distributed in kind to its shareholder in the course of a complete liquidation but were terminated by mutual consent. The Sixth Circuit affirmed the Tax Court's disallowance of the deduction for leasehold improvements on the grounds that a lessee may not accelerate amortization or depreciation of capital expenses incurred with respect to a lease when it assigns its leasehold interest to a related lessor. It ruled that the focus of inquiry is the relationship between the lessor and lessee, and not whether there was a liquidating distribution. | |
| 24 July 2006 | |
| This was my original point, but your comment on court mandated liquidation distribution at basis puzzles me. The possibility of gain on distribution has to be there, but I suppose, as Riley noted above, that specific facts are going to determine. | |
