SCOTUS Reports

Tag: Sale and Leaseback

  • Norwest Corp. & Subs. v. Commissioner, 111 T.C. 105 (1998): When Cost Allocation to Adjoining Properties is Not Permitted

    Norwest Corp. & Subs. v. Commissioner, 111 T. C. 105 (1998)

    The cost of constructing a common improvement cannot be allocated to the bases of adjoining properties unless the primary purpose was to enhance those properties to induce their sale.

    Summary

    Norwest Corporation sought to allocate the cost of constructing an Atrium to the bases of its adjoining properties, arguing that it would enhance their value. The Tax Court ruled that this allocation was not permitted because the primary purpose of the Atrium was to resolve design issues and enhance the Bank’s image, not to induce sales of the adjoining properties. The court also denied Norwest’s claim for a loss deduction under section 165(a) due to the Atrium’s alleged worthlessness and upheld the form of a sale and leaseback transaction involving the Atrium, denying Norwest’s attempt to disavow it. This decision underscores the importance of the primary purpose in determining whether cost allocations are permissible and highlights the challenges of recharacterizing transactions after they have been reported.

    Facts

    Norwest Corporation, successor to United Banks of Colorado, constructed an Atrium as part of a larger project that included office towers and other facilities. The Atrium was intended to integrate the new office tower with existing bank properties and enhance the Bank’s image. Norwest sought to allocate the Atrium’s construction costs to the bases of adjoining properties, arguing that the Atrium increased their value. However, the Atrium consistently generated operating losses, and Norwest later sold interests in the Atrium and leased it back, reporting this as a sale and leaseback transaction for tax purposes.

    Procedural History

    Norwest filed a petition with the Tax Court challenging the Commissioner’s determination of deficiencies in federal income taxes and claims for overpayments. The court consolidated several cases involving Norwest’s tax liabilities for various years. Norwest argued for the allocation of Atrium costs to adjoining properties, a loss deduction under section 165(a), and the recharacterization of a sale and leaseback transaction as a financing arrangement.

    Issue(s)

    1. Whether Norwest may allocate the cost of constructing the Atrium to the bases of adjoining properties.
    2. Whether Norwest is entitled to a loss deduction under section 165(a) for the cost of the Atrium.
    3. Whether Norwest may disavow the form of a transaction involving the Atrium.

    Holding

    1. No, because the basic purpose of the Atrium was not to enhance the adjoining properties to induce their sale, but rather to resolve design issues and enhance the Bank’s image.
    2. No, because Norwest failed to establish a loss equal to the cost of the Atrium.
    3. No, because Norwest cannot disavow the form of the transaction after reporting it as a sale and leaseback.

    Court’s Reasoning

    The court applied the ‘basic purpose test’ from the developer line of cases, determining that the primary purpose of the Atrium was not to induce sales of adjoining properties. The court found that the Atrium’s purpose was to integrate the new office tower with existing facilities and enhance the Bank’s image, despite potential value enhancement to adjoining properties. The court also noted that Norwest’s attempt to allocate costs based on fair market values was not justified by the facts. Regarding the loss deduction, the court found that Norwest did not establish the Atrium’s worthlessness as required by section 165(a). Finally, the court upheld the form of the sale and leaseback transaction, rejecting Norwest’s attempt to recharacterize it as a financing arrangement after reporting it differently on tax returns.

    Practical Implications

    This decision clarifies that cost allocations to adjoining properties are only permissible when the primary purpose of the improvement is to enhance those properties for sale. It emphasizes the importance of the ‘basic purpose test’ in tax law and the challenges of recharacterizing transactions after they have been reported. Practitioners should carefully document the primary purpose of improvements and consider the implications of transaction structures on future tax positions. This case also highlights the need for clear evidence of worthlessness when claiming loss deductions under section 165(a). Future cases may reference this decision when analyzing similar cost allocation and transaction recharacterization issues.

  • Friendship Dairies, Inc. v. Commissioner, 90 T.C. 1054 (1988): The Investment Tax Credit and Economic Substance Doctrine

    Friendship Dairies, Inc. v. Commissioner, 90 T. C. 1054 (1988)

    The investment tax credit cannot be considered as a substitute for or component of economic profit in determining the economic substance of a transaction for tax purposes.

    Summary

    Friendship Dairies, Inc. engaged in a prearranged transaction to purchase and lease back computer equipment through intermediaries, aiming to claim investment tax credits. The U. S. Tax Court ruled that the transaction lacked economic substance because it could not yield a profit without the tax credit, and thus, the tax benefits were disallowed. The court emphasized that the investment tax credit was not intended to transform unprofitable transactions into profitable ones, and upheld the application of increased interest rates for tax-motivated transactions under section 6621(c).

    Facts

    Friendship Dairies, Inc. purchased IBM computer equipment from O. P. M. Leasing Services, Inc. through an intermediary, Starfire Leasing Corp. , on September 26, 1980. The equipment was immediately leased back to O. P. M. , who then subleased it to R. L. Polk & Co. , Inc. for 48 months. Friendship Dairies expected to generate a profit solely through the investment tax credit, as the transaction’s cash flows did not promise any economic profit without it. The company’s president relied on assumptions about the equipment’s residual value, which were based on biased and outdated information.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in Friendship Dairies’ income tax and disallowed the claimed investment tax credit. Friendship Dairies petitioned the U. S. Tax Court, which upheld the Commissioner’s determination on May 23, 1988, ruling that the transaction lacked economic substance and was thus not recognized for tax purposes.

    Issue(s)

    1. Whether Friendship Dairies’ purchase and leaseback of the computer equipment had economic substance to be respected for federal income tax purposes?
    2. Whether the investment tax credit should be considered in determining the economic substance of the transaction?
    3. Whether the increased rate of interest under section 6621(c) applies to the underpayment?

    Holding

    1. No, because the transaction had no economic substance; it was motivated solely by tax benefits and could not yield a profit without the investment tax credit.
    2. No, because the investment tax credit is not a substitute for economic profit and was not intended to transform unprofitable transactions into profitable ones.
    3. Yes, because the transaction was tax-motivated and resulted in a substantial underpayment, triggering the increased interest rate under section 6621(c).

    Court’s Reasoning

    The court applied the two-pronged test from Frank Lyon Co. v. United States to determine economic substance, focusing on whether the transaction was motivated by non-tax business purposes and whether it had a reasonable possibility of profit. Friendship Dairies failed both prongs. The court examined legislative history to conclude that the investment tax credit, part of the Revenue Act of 1962, was not intended to be a substitute for economic profit but rather an incentive for capital investment. The court rejected Friendship Dairies’ argument that the tax credit should reduce the cost basis of the equipment for economic substance analysis, citing that such an approach would distort congressional intent. The court also upheld the application of the increased interest rate under section 6621(c) due to the tax-motivated nature of the transaction.

    Practical Implications

    This decision reinforces the importance of economic substance in tax planning, particularly in sale and leaseback transactions. Taxpayers cannot rely on tax credits to create economic substance where none exists. It highlights the need for transactions to have a genuine business purpose and potential for economic profit independent of tax benefits. The ruling may deter similar tax-motivated transactions and could lead to increased scrutiny of transactions involving investment tax credits. Subsequent cases, such as ACM Partnership v. Commissioner, have cited this decision in upholding the economic substance doctrine. Practitioners must ensure that clients understand the risks of engaging in transactions lacking economic substance, as such transactions may not be respected for tax purposes and could result in penalties and increased interest rates.

  • Gregory Hotel Florence Corp. v. Commissioner, 73 T.C. 193 (1979): Determining Principal Purpose of Corporate Acquisitions for Tax Avoidance

    Gregory Hotel Florence Corp. v. Commissioner, 73 T. C. 193 (1979)

    The principal purpose for acquiring control of a corporation must be assessed at the time of acquisition to determine if it was for tax avoidance under Section 269(a).

    Summary

    In Gregory Hotel Florence Corp. v. Commissioner, the court addressed whether the acquisition of Hotel Florence by Gregory Hotel was primarily for tax avoidance under Section 269(a) and whether a subsequent sale and leaseback transaction was a valid business move or a tax evasion scheme. The court found that Gregory Hotel’s acquisition was driven by business motives, not tax avoidance, and the sale and leaseback of Hotel Florence’s assets had valid business purposes, allowing the deduction of net operating losses. The decision underscores the importance of examining the intent at the time of acquisition and validates business restructuring moves if supported by legitimate business motives.

    Facts

    Gregory Hotel Florence Corp. (petitioner) acquired 56% of Hotel Florence’s stock from Mercantile in one transaction, which did not give it enough control to file a consolidated return with Hotel Florence. Hotel Florence had sustained losses in 1965 and 1966, and continued to do so in 1967 after the acquisition, but losses reduced in 1968. Petitioner later acquired 80% of the stock, liquidated Hotel Florence, and sold the hotel property in 1972. A sale and leaseback transaction was executed with Glacier, a related corporation, resulting in a claimed loss by Hotel Florence.

    Procedural History

    The Commissioner disallowed petitioner’s deduction for net operating losses of Hotel Florence, asserting the acquisition was for tax avoidance under Section 269(a). The Tax Court reviewed the case, focusing on the intent at the time of acquisition and the validity of the sale and leaseback transaction, ultimately ruling in favor of the petitioner.

    Issue(s)

    1. Whether the principal purpose for petitioner’s acquisition of 56% of Hotel Florence’s stock was to evade or avoid federal income tax under Section 269(a)?
    2. Whether Hotel Florence substantially changed its business after petitioner’s acquisition, affecting the applicability of Section 382(a)?
    3. Whether the sale and leaseback transaction between Hotel Florence and Glacier was a valid business move or a tax evasion scheme?

    Holding

    1. No, because the evidence showed that the principal purpose for the acquisition was not tax avoidance but was driven by valid business motives.
    2. No, because Hotel Florence did not substantially change its business after the acquisition, so Section 382(a) did not apply to disallow the net operating loss carryovers.
    3. The sale and leaseback transaction was valid and not a tax evasion scheme, allowing the deduction of the loss incurred by Hotel Florence.

    Court’s Reasoning

    The court’s analysis focused on the intent at the time of the acquisition of Hotel Florence. It relied on the Hawaiian Trust Co. v. United States decision, emphasizing that the intent at acquisition is crucial, not subsequent actions. The court found that the testimony of John Hayden, who recommended the acquisition, was significant in demonstrating business motives rather than tax motives. The court rejected the Commissioner’s arguments, citing the lack of evidence that tax avoidance was the principal purpose at the time of the 56% stock acquisition. For Section 382(a), the court found no substantial change in Hotel Florence’s business, as it continued to operate as a hotel. Regarding the sale and leaseback, the court recognized valid business reasons presented by John Hayden and rejected the Commissioner’s arguments that it lacked substance or was a like-kind exchange under Section 1031.

    Practical Implications

    This case provides guidance on how courts assess the principal purpose of corporate acquisitions under Section 269(a), emphasizing the importance of examining the intent at the time of acquisition. It reinforces that business restructuring, such as sale and leaseback transactions, can be upheld if supported by valid business motives, not merely as tax avoidance schemes. Legal practitioners should focus on documenting and proving business motives at the time of acquisitions to support their clients’ positions in similar tax cases. This decision also highlights the relevance of jurisdiction-specific precedents, as the court adhered to Ninth Circuit rulings. Subsequent cases may refer to this decision when analyzing corporate acquisitions and related tax implications, particularly in distinguishing between business and tax motives.

  • Estate of Franklin v. Commissioner, 64 T.C. 752 (1975): When a Sale and Leaseback Agreement Constitutes an Option Rather Than Indebtedness

    Estate of Franklin v. Commissioner, 64 T. C. 752 (1975)

    A transaction structured as a sale and leaseback of property may be treated as an option to purchase rather than an enforceable sale if the buyer’s obligations are too contingent and indefinite to constitute indebtedness or a cost basis for depreciation.

    Summary

    Charles T. Franklin’s estate and his widow claimed deductions for their share of losses from a limited partnership that purported to purchase a motel and lease it back to the sellers. The Tax Court held that the partnership’s obligations under the sales agreement were not sufficiently definite to constitute indebtedness or provide a cost basis for depreciation. The agreement, when read with the contemporaneous lease, was deemed an option to purchase the property at a future date rather than a completed sale. The court found that the partnership had no enforceable obligation to buy the motel and no real economic investment in the property, thus disallowing the claimed deductions.

    Facts

    Charles T. Franklin, deceased, was a limited partner in Twenty-Fourth Property Associates, which entered into a sales agreement to purchase the Thunderbird Inn motel from Wayne L. and Joan E. Romney for $1,224,000. Concurrently, the partnership leased the motel back to the Romneys for 10 years with rent payments offsetting the purchase price. The partnership paid $75,000 as prepaid interest, but no actual payments were made under the sales agreement or lease, only bookkeeping entries. The Romneys retained possession and control of the motel, including the right to make improvements and additions.

    Procedural History

    The Commissioner of Internal Revenue determined deficiencies in the Franklins’ federal income tax due to disallowed deductions for their distributive share of partnership losses. The Franklins petitioned the Tax Court, which held that the partnership’s obligations did not constitute indebtedness or a cost basis for depreciation, thus disallowing the claimed deductions.

    Issue(s)

    1. Whether the partnership’s obligations under the sales agreement were sufficiently definite and unconditional to constitute indebtedness for the purpose of interest deductions under section 163(a)?
    2. Whether the partnership’s obligations under the sales agreement provided a cost basis for depreciation deductions under section 167(g)?

    Holding

    1. No, because the partnership’s obligations were too contingent and indefinite to constitute indebtedness.
    2. No, because the partnership’s obligations did not provide a cost basis for depreciation.

    Court’s Reasoning

    The court examined the totality of the circumstances surrounding the transaction, including the sales agreement and lease. The court found that the partnership had no enforceable obligation to purchase the motel, as it could choose to complete the transaction or walk away at the end of the 10-year period. The sales price was to be computed by a formula based on the outstanding mortgages and a balloon payment, rather than the stated purchase price of $1,224,000. The partnership had no funds to make the required payments, and the Romneys retained possession and control of the property. The court concluded that the transaction was, in substance, an option to purchase the motel at a future date rather than a completed sale. The court distinguished cases involving nonrecourse obligations, noting that those cases did not involve similar contingencies and lack of economic investment. The court quoted from Russell v. Golden Rule Mining Co. , stating that an agreement is only a contract of sale if the purchaser is bound to pay the purchase price.

    Practical Implications

    This decision emphasizes the importance of substance over form in tax transactions. Taxpayers must demonstrate a genuine economic investment and enforceable obligations to claim deductions for interest and depreciation. Practitioners should carefully structure sale and leaseback agreements to ensure that the buyer has a real economic stake in the property and an unconditional obligation to purchase. The decision also highlights the need for credible evidence of property value to support claimed deductions. Subsequent cases have applied this ruling to similar transactions, disallowing deductions where the buyer’s obligations are too contingent or the transaction lacks economic substance.

  • Leslie Co. v. Commissioner, 64 T.C. 247 (1975): When a Sale and Leaseback Transaction Does Not Qualify as a Like-Kind Exchange

    Leslie Co. v. Commissioner, 64 T. C. 247 (1975)

    A sale and leaseback transaction does not qualify as a like-kind exchange under Section 1031 if the leasehold lacks separate capital value and the transaction is a bona fide sale.

    Summary

    Leslie Co. constructed a new facility and entered into a sale and leaseback agreement with Prudential. The agreement set a maximum sale price of $2. 4 million, which was the property’s fair market value upon completion. Leslie Co. incurred construction costs of $3. 187 million but sold the property for $2. 4 million, claiming a loss. The court held that this was a bona fide sale and not a like-kind exchange under Section 1031 because the leasehold did not have separate capital value. The decision emphasized the necessity of an exchange for Section 1031 to apply and clarified that the leasehold’s value to Leslie Co. did not transform the transaction into an exchange. This ruling impacts how similar transactions should be analyzed for tax purposes.

    Facts

    Leslie Co. , a New Jersey corporation, decided to move its operations from Lyndhurst to Parsippany and purchased land for a new facility in 1967. Unable to secure traditional financing, Leslie Co. entered into a sale and leaseback agreement with Prudential Insurance Co. of America. The agreement stipulated that upon completion of the facility, Leslie Co. would sell the property to Prudential for $2. 4 million, the lower of the actual cost or this amount, and lease it back for 30 years at a net rental of $190,560 annually. The facility was completed in 1968 at a total cost of $3. 187 million, and Leslie Co. sold it to Prudential for $2. 4 million, claiming a loss of $787,414 on its tax return.

    Procedural History

    The Commissioner of Internal Revenue disallowed Leslie Co. ‘s claimed loss, treating it as a cost of obtaining the lease to be amortized over 30 years. Leslie Co. petitioned the United States Tax Court, which ruled in favor of Leslie Co. , holding that the transaction was a bona fide sale and not a like-kind exchange under Section 1031.

    Issue(s)

    1. Whether the sale and leaseback of the property by Leslie Co. constituted an exchange of property of a like kind within the meaning of Section 1031(a).

    Holding

    1. No, because the transaction was a bona fide sale and not an exchange under Section 1031. The leasehold did not have separate capital value, and the sale price and lease rental were for fair value, indicating no exchange occurred.

    Court’s Reasoning

    The court found that for Section 1031 to apply, an exchange must occur, defined as a reciprocal transfer of property, not merely a sale for cash. Leslie Co. sold the property to Prudential for $2. 4 million, which was the fair market value, and the leasehold did not have separate capital value. The court noted that the leaseback was integral to the transaction but did not constitute part of the consideration for the sale. The court also highlighted that the lease rental was comparable to the fair rental value of similar properties, further supporting the conclusion that the leasehold had no capital value. The court rejected the Commissioner’s argument that the difference between the cost and sale price should be attributed to the leasehold’s value, emphasizing that the leasehold’s value to Leslie Co. did not transform the transaction into an exchange. Dissenting opinions argued that the transaction should be viewed as an integrated whole, with the excess costs attributed to the leasehold interest, but the majority held firm on the distinction between a sale and an exchange.

    Practical Implications

    This decision clarifies that a sale and leaseback transaction will not be treated as a like-kind exchange under Section 1031 if the leasehold lacks separate capital value. Practitioners must carefully evaluate whether a leasehold in a sale and leaseback has independent value to determine if Section 1031 applies. The ruling impacts how businesses structure financing arrangements and report losses for tax purposes. It also underscores the importance of distinguishing between sales and exchanges, influencing how similar cases are analyzed. Subsequent cases, such as Jordan Marsh Co. v. Commissioner, have further explored this distinction, though Leslie Co. remains a key precedent in this area of tax law.

  • Century Electric Co. v. Commissioner, 15 T.C. 581 (1950): Tax Implications of Sale and Leaseback Transactions

    15 T.C. 581 (1950)

    A sale and leaseback of real property, where the lease is for a term of 30 years or more, is considered an exchange of like-kind property under Section 112(b)(1) of the Internal Revenue Code, precluding recognition of a loss on the sale.

    Summary

    Century Electric Co. sold its foundry property to a college and simultaneously leased it back for 95 years. The company claimed a loss on the sale, arguing it was a distinct transaction from the leaseback. The Tax Court held that the sale and leaseback were a single, integrated transaction amounting to an exchange of like-kind property (real estate for a leasehold of 30 years or more). Consequently, the loss was not recognizable under Section 112(b)(1) of the Internal Revenue Code. The court also determined the basis for depreciation of the leasehold.

    Facts

    • Century Electric Co. owned foundry property with an adjusted basis of $531,710.97.
    • On December 1, 1943, Century Electric conveyed the property to the Trustees of William Jewell College for $150,000 in cash.
    • Simultaneously, Century Electric leased the same property back from the college for a term of 95 years, divided into eight periods with the lessee having the power to terminate the lease at the end of any one of the eight periods.
    • The company continued to use the property for its foundry operations and would not have sold the property without the leaseback.

    Procedural History

    • Century Electric Co. claimed a deductible loss of $381,710.97 on its 1943 tax return.
    • The Commissioner of Internal Revenue disallowed the loss, arguing the transaction was an exchange of like-kind property.
    • Century Electric Co. petitioned the Tax Court for review.

    Issue(s)

    1. Whether the sale of foundry property and its immediate leaseback for 95 years constitutes a sale or an exchange of like-kind property under Section 112(b)(1) of the Internal Revenue Code.
    2. If the transaction is an exchange and the loss is disallowed, whether Century Electric is entitled to depreciation on the foundry building or the lease after December 1, 1943, and in what amount.

    Holding

    1. Yes, because the sale and leaseback were integrated parts of a single transaction, and a leasehold of 30 years or more is considered like-kind property to real estate under Treasury Regulations.
    2. Yes, Century Electric is entitled to depreciation on the leasehold, not the building, over the 95-year term of the lease, with a basis equal to the adjusted basis of the property exchanged less the cash received.

    Court’s Reasoning

    • The court reasoned that Century Electric would not have sold the property without the leaseback, making the two actions interdependent.
    • It rejected the argument that the transaction was a sale with a leasehold reserved, noting that Century Electric conveyed a fee simple estate and then received a lease from the college.
    • The court found no requirement in the statute or regulations that the leasehold had to be in existence before the exchange; the key factor was the reciprocal nature of the transfers.
    • The court relied on Treasury Regulations defining a leasehold of 30 years or more as like-kind property to real estate and noted that this administrative construction had been consistently applied and given the force of law through the reenactment of the relevant statutory provisions.
    • The court distinguished cases cited by Century Electric, such as Pembroke v. Helvering, noting that the facts were dissimilar and did not support the argument that the conveyance of the fee should be regarded as mere payment of rental.
    • Regarding depreciation, the court cited Weiss v. Wiener, holding that as a lessee, Century Electric was not entitled to depreciation on the building, but was entitled to depreciation on the leasehold itself, using the adjusted basis of the exchanged property less the cash received, depreciated over the term of the lease.
    • The court stated: “We think that the test of an exchange is not whether the transfers are simultaneous but whether they are reciprocal.”

    Practical Implications

    • This case establishes that a sale and leaseback transaction involving a lease term of 30 years or more will likely be treated as a like-kind exchange for tax purposes, preventing the recognition of a loss at the time of the sale.
    • Taxpayers contemplating such transactions should be aware that they will not be able to immediately deduct a loss, but they will be able to depreciate the basis of the leasehold over its term.
    • This ruling encourages careful structuring of sale and leaseback agreements, particularly concerning the lease term, if the goal is to recognize an immediate loss. Shorter lease terms might allow for loss recognition, but could also trigger scrutiny from the IRS under the step-transaction doctrine.
    • Later cases have cited this case to support the like-kind exchange treatment of sale-leaseback transactions, reinforcing the importance of considering the overall economic substance of the arrangement rather than its form.

  • Century Electric Co. v. Commissioner, 15 T.C. 581 (1950): Like-Kind Exchange Includes Leaseback of Real Property

    15 T.C. 581 (1950)

    A sale and leaseback of real property, when part of an integrated transaction, constitutes a like-kind exchange under Section 112(b)(1) of the Internal Revenue Code, precluding recognition of loss if the lease has a term of 30 years or more.

    Summary

    Century Electric Co. sold its foundry property to William Jewell College for $150,000 and simultaneously leased the property back for 95 years, with options to cancel after 25 years and every 10 years thereafter. Century claimed a loss on the sale, arguing it was a separate transaction from the leaseback. The Tax Court held that the sale and leaseback were an integrated transaction, constituting a like-kind exchange. Therefore, no loss was recognizable under Section 112(b)(1) and 112(e) of the Internal Revenue Code, but Century was entitled to depreciation on the leasehold over the 95-year term.

    Facts

    Century Electric owned and operated a foundry building and land with an adjusted basis of $531,710.97. The foundry was essential to Century’s business. Facing pressure to improve its cash position, Century agreed to sell the foundry to William Jewell College for $150,000. As a condition of the sale, Century simultaneously leased the property back from the College for a term of 95 years, subject to cancellation options after 25 years and every 10 years thereafter. The lease required Century to pay rent, insurance, repairs, and assessments, but exempted the College from general state, city, and school taxes due to its charter. Century claimed a loss of $381,710.97 on the sale.

    Procedural History

    The Commissioner of Internal Revenue disallowed Century’s claimed loss. Century Electric petitioned the Tax Court for review of the Commissioner’s determination.

    Issue(s)

    1. Whether the sale and leaseback of the foundry property constitutes a like-kind exchange under Section 112(b)(1) and 112(e) of the Internal Revenue Code, precluding recognition of loss.

    2. If the claimed loss is not allowed, whether Century is entitled to depreciation on the foundry building or on the lease after December 1, 1943, and in what amount for 1943.

    Holding

    1. No, because the sale and leaseback were interdependent steps in a single, integrated transaction, constituting an exchange of real property for cash and a leasehold with a term exceeding 30 years.

    2. Century is not entitled to depreciation on the foundry building, but is entitled to depreciation on the leasehold, calculated over the 95-year term of the lease.

    Court’s Reasoning

    The court reasoned that the sale and leaseback were not separate transactions but were interdependent steps in a single, integrated transaction designed to improve Century’s financial position while allowing it to continue operating its foundry. The court emphasized that Century would not have sold the property without simultaneously securing a leaseback. Because the lease term was for 95 years, it qualified as a leasehold of a fee with 30 years or more to run, which Regulation 111, Section 29.112(b)(1)-1 treats as “like kind” property to real estate. The court rejected Century’s argument that a fee simple and a leasehold in the same property could not be like-kind, noting that prior cases implicitly rejected such a requirement. The court also cited longstanding administrative construction of Section 112(b)(1), given force of law by reenactment of the statutory provision without material change. The court held that while Century could not depreciate the building it no longer owned, it could depreciate the basis of the leasehold, calculated as the adjusted basis of the property exchanged ($531,710.97) less the cash received ($150,000), over the 95-year term of the lease.

    Practical Implications

    This case clarifies that a sale and leaseback can be treated as a single, integrated transaction qualifying as a like-kind exchange under Section 1031 (formerly Section 112) of the Internal Revenue Code. It highlights the importance of examining the substance of a transaction over its form. Attorneys should advise clients that a sale and leaseback, especially when interdependent, may not result in a recognized loss for tax purposes if the lease term is 30 years or more. Later cases applying this ruling often focus on whether the transactions are truly integrated and whether the lease term meets the statutory threshold. This decision impacts tax planning for businesses seeking to free up capital without relinquishing operational control of their real estate.