Boston Fish Market Corp. v. Commissioner, 57 T. C. 884, 1972 U. S. Tax Ct. LEXIS 154 (1972)

Cash payments received by a lessor in lieu of leasehold improvements are taxable as capital gain, not excludable under IRC Section 109.

Summary

In Boston Fish Market Corp. v. Commissioner, the Tax Court ruled that a $47,500 payment received by the lessor from a tenant in lieu of restoring leased premises to their original condition was not excludable from gross income under IRC Section 109. The court held that this cash payment, made upon lease termination, should be treated as capital gain to the extent it exceeded the basis of the leasehold improvements. The decision clarified that Section 109 applies only to the value of physical improvements, not cash, and reinforced the tax treatment of such payments as akin to sales or exchanges of property.

Facts

Boston Fish Market Corp. leased property on the Boston Fish Pier to First National Stores, Inc. under various agreements from 1947 to 1967. These leases required First National to restore the premises to their original condition upon termination. In 1968, First National notified Boston Fish Market of its intent to terminate the lease and vacate the premises. Boston Fish Market elected to have the premises restored, but instead, First National paid $47,500 in lieu of performing the restorations. Boston Fish Market did not report this payment as income, instead reducing the basis of certain unrelated leasehold improvements by this amount.

Procedural History

The Commissioner of Internal Revenue determined deficiencies in Boston Fish Market’s income tax for 1966 and 1968, asserting that the $47,500 payment should be included in gross income. Boston Fish Market petitioned the U. S. Tax Court, which heard the case and issued a decision that the payment was taxable as capital gain to the extent it exceeded the basis of the leasehold improvements related to the terminated lease.

Issue(s)

1. Whether the $47,500 payment received by Boston Fish Market in lieu of leasehold restoration is excludable from gross income under IRC Section 109?
2. If not, how should the payment be treated for tax purposes?

Holding

1. No, because the payment does not constitute “income attributable to buildings erected or other improvements made by the lessee” under Section 109, which applies only to physical improvements, not cash payments.
2. The payment should be treated as capital gain to the extent it exceeds the basis of the leasehold improvements related to the terminated lease.

Court’s Reasoning

The court emphasized that IRC Section 109 was enacted to address the tax implications of improvements left on leased property at termination, as seen in the Helvering v. Bruun case. The statute’s language and legislative history clearly intended to exclude only the value of physical improvements from gross income, not cash payments. The court distinguished cash payments as liquid assets, not subject to the same tax concerns as fixed improvements. The court also rejected Boston Fish Market’s attempt to apply the payment to reduce the basis of unrelated leasehold improvements, instead allocating a portion of the pre-1953 leasehold improvements’ basis to the six stores in question. The court cited prior cases treating similar cash payments as proceeds from a sale or exchange, taxable as capital gain when exceeding the property’s basis.

Practical Implications

This decision clarifies that cash payments received by lessors in lieu of leasehold restorations are taxable as capital gain, not excludable under Section 109. Attorneys should advise clients to report such payments on their tax returns and calculate any capital gain based on the basis of the specific leasehold improvements affected. The ruling may influence lease negotiations, as tenants may seek to limit their restoration obligations or negotiate lower cash settlements to minimize the lessor’s tax liability. Future cases involving similar payments will likely follow this precedent, treating them as akin to sales or exchanges of property rather than excluded income.