Issues
William owns a building and leases it out to Lester’s Machine Shop. Lester recommends that William rewire the building in preparation for the procurement of new equipment. The wiring would cost around $4,000, but as it is only used in conjunction with the specialized equipment, it would not raise the building’s value. In exchange for Lester paying for the wiring, William agrees to forgo one month’s $1,000 rent rather than lose Lester as a renter. Lester agrees as he does not want to move. As William’s CPA, can you tell him whether he needs to include any money in his gross income?
Analysis
William’s lessee, Lester, has expressed interest in rewiring the facility so that it may accommodate additional pieces of machinery. William is willing to let Lester cover the expense of rewiring the apartment in exchange for one month’s rent, and Lester has offered to do so. Since William will not be paying his rent for the upcoming month, it is essential to determine how much William should report as his gross income. An analysis of rules and regulations made at the federal level reveals that William is required to count $1,000 against the total of his gross income.
When a lessor leases a real estate property from a lessee, disagreements may arise over who counts particular renovations as gross income for tax intentions. In this matter that involves William, the lessor, and Lester, the lessee shall choose who shall include the renovations on Lester’s Machine Shop in his gross revenue (Bogataj et al., 2020). Income is other than rent is not included in gross revenue, according to Code Section 109 (“11 U.S. Code § 109 – Who may be a debtor”, n.d.). At the end of a lease, a lessor of real estate will calculate this value, which is the portion of the property’s value attributable to buildings built or other improvements made by the lessee. Additionally, Regulation Section 1.109-1 states that the gross income exclusion only pertains to the income received by the lessor (“26 CFR § 1.109-1 – Exclusion from gross income of lessor of real property of the value of improvements erected by lessee.” n.d.). In this scenario, upon the expiration or termination of the lease and does not apply to any payment, if any, in the form of rent that a lessor may derive throughout the term of the lease and that is attributable to structures constructed or other improvements made by the lessee.
In the case of Commissioner v. Cunningham, it was agreed that there would be no rent payments; however, the lessee would be liable for paying any property taxes that occurred during the lease. Following the conclusion reached by the Tax Court, the structure was not constructed with the expectation that it would be used to replace rent; as a result, the intention was irrelevant (“Commissioner of Internal Revenue, Petitioner, v. Grace H. Cunningham, Eugene F. Cunningham and Grace H. Cunningham, Respondents, 258 F.2d 231 (9th Cir. 1958)”, n.d.). This ruling runs contrary to what the Commissioner had asserted: that the construction of a structure counted as rent because it was an improvement.
Summary
After examining the information in our 2011 Federal Income Tax textbook and the online code sections and cases, I concluded that William should include $1,000 for gross income. William and Lester agreed they would forego paying rent for one month to save money for the rewiring. Lester can rewire the building if he decides to pay a cost of one thousand dollars in place of monthly rent. As a result of this arrangement, William is required to count $1,000 toward his total income for tax purposes.
References
11 U.S. Code § 109 – Who may be a debtor? LII / Legal Information Institute. Web.
26 CFR § 1.109-1 – Exclusion from gross income of lessor of real property of the value of improvements erected by the lessee. LII / Legal Information Institute. Web.
Bogataj, M., Bogataj, D., & Drobne, S. (2020). Real estate taxes and other fiscal policies as regulators of growth in aging regions. IFAC-Papersonline, 53(2), 16908-16913.