Maribel is your client. You will be meeting Maribel to discuss her 2021 real estate transactions, including the renegotiated lease with Highland Consultants ("Highland"). In preparation for the meeting, you will research the tax implications of the renegotiated lease as described in "Our Understanding of the Facts." You will document your findings in a properly structured internal research memo.

Our Understanding of the Facts:

Maribel owns a four-story office building. The building consisted of a mixed-use first floor for retail shops and restaurants and three floors of office space.

Originally, Highland Consultants ("Highland") leased the top three floors as office space. This original lease was entered into on October 1, 2019 and ends on September 30, 2029. The rental payment on the lease was $60,000 per month.

As part of the lease agreement, Highland made substantial leasehold renovations to the building, costing $440,000. The Highland improvements included first floor improvements of $200,000 to upgrade the building entrance and elevators and $240,000 spent on the second, third and fourth-floor office space. These improvements would revert to Maribel at the end of the lease. In addition, Maribel also spent $375,000 improving the building exterior and the first-floor common, retail, and restaurant spaces.

As a result of the pandemic, Highland decided they no longer needed the second and third floors for offices and would like to lease only the fourth floor. Therefore, in January 2021, Highland and Maribel entered a new lease that contained the following terms:

• The new lease starts January 1, 2021, and ends on September 30, 2029.
• Commencing September 30, 2021, and ending September 30, 2029, Highland would pay Maribel rent of $28,500 per month to use the fourth floor.
• As of January 1, 2021, Highland relinquished all rights to the leasehold improvement made on the first, second, and third floors to Maribel.
• From January 1, 2021, to September 30, 2021, Highland could use the fourth-floor rent-free. This rent holiday was in exchange for Highland's relinquishing all rights to the leasehold improvement made on the first, second, and third floors.

Assignment

In a properly structured tax research memorandum, document the advice you will be giving your client, Maribel. The guidance will cover the tax treatment of the renegotiated lease with Highland, including the amount, if any, that should be included in Maribel's 2021 gross income.