Our Understanding of the Facts:

Samantha owns a nonresidential commercial building. Prior to 2008, the building had been used as office space. In 2008, she leased the entire building to HRV Corporation under a ten-year lease. HRV intended to use the building as an audio and video production studio. The lease specified that at the end of the lease term (2018), HRV had to restore the building to its original condition if any modification were made. During the lease term HRV had made substantial modifications to the interior of the building so that HRV could use the building as an audio and video production studio. Those modification cost HRV approximately $975,000.

At the end of the lease, HRV approached Samantha in an attempt to have the restoration clause nullified. HRV argued that the improvements made to the building enhanced the buildings value by at least $300,000. Samantha disagreed as the modification were specific to HRVs usage of the building and potential tenants might not find them useful. After some negotiations, Samantha agreed that HRV could pay her $200,000 to be released from the restoration requirement. Samantha has come to you as her tax advisor to determine the Federal Income Tax treatment of accepting HRVs $200,000 payment.

Assignment

In a properly structured tax research memorandum, document the advice you will be giving Samantha regarding the tax treatment related to HRVs payment of $200,000. Your analysis should include a discussion regarding the amount, if any, that should be included in Samanthas 2018 gross income, any basis adjustment, etc.

Hint: In your memo, you should cite only primary sources such as the Internal Revenue Code, Regulations, Court Cases, etc. Keeping that in mind, the following would be good places to start your research:

Editorial Sources Found in Checkpoint:

Checkpoint Federal Tax Coordinator Analysis (RIA): J-2250 IntroductionImprovements to Leased Property by Lessee.

Also, keep in the mind the concepts of Gross Income covered in Chapter 5 of the Textbook: General Definition of Gross Income found in IRC 61, as well as the Economic Benefit, Realization and Recognition Principles.

Primary Sources:

Internal Revenue Code 61 especially IRC 61(a)(5)

IRC 109 Improvements by lessee on lessor's property.

Reg 1.109-1. Exclusion from gross income of lessor of real property of value of improvements erected by lessee.

Other Potential Authorities:

Boston Fish Market Corp. 57 TC 884 (1972)

Sirbo Holdings Inc v. CIR, 31 AFTR 2d 73-10005, 73-1 USTC 9312 (2^nd Cir., 1973)