ABC Beverage Corporation (“ABC”) determined its lease payments under a 40-year lease of a bottling plant in Hazelwood, Missouri were in excess of market rates and therefore exercised a right-to-buy option under the lease. Appraisals obtained by ABC placed the value of the property without the lease at $2.75 million. ABC determined that the value of the property with the 40-year lease to be at least $9 million, and negotiated a purchase price in excess of $9 million. ABC deducted the $6.25 million difference calling it a lease termination fee. The IRS disallowed the deduction and concluded the $6.25 million should be capitalized under IRC 167(c)(2), which states that “no portion of the adjusted basis
[of property subject to lease] shall be allocated to the leasehold interest, and the entire adjusted basis shall be taken into account in determining the depreciation deduction.” The 6th Circuit Court found for the taxpayer and allowed the $6.25 million deduction, noting that ABC had proven that the lease terms were onerous and that the fair market value of the property without the lease was $2.75 million. The 6th Circuit Court rejected the IRS argument under IRC 167(c)(2), noting that the lease terminated when ABC bought the underlying property, and therefore the property wasn’t “subject to a lease” upon acquisition. To read the entire case, click here.
