Lease as Capital Asset

  • Thread starter Stuart A. Bronstein
  • Start date

S

Stuart A. Bronstein

A question just came up that I haven't faced before. The small
amount of research I have done so far hasn't come up with anything,
and I'm wondering what you all think.

The situation is that the client has a rent controlled apartment in
San Francisco, and has lived there more than two years. The
landlord wants to sell the building to a developer, and the sale
will be more likely to happen (or he will make more money) if it is
sold vacant. So the landlord wants to buy out the tenant.

Leases are capital assets - I've found cases that specify that.
But my question is whether this lease as a capital asset can
qualify for the homeowner's exclusion under section 121. It says
that property (and a lease is property) qualifies if,

"during the 5-year period ending on the date of the sale or
exchange, such property has been owned and used by the taxpayer as
the taxpayer’s principal residence for periods aggregating 2 years
or more."

Sure sounds like it qualifies to me. Am I off base?
 
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A

Alan

A question just came up that I haven't faced before. The small
amount of research I have done so far hasn't come up with anything,
and I'm wondering what you all think.

The situation is that the client has a rent controlled apartment in
San Francisco, and has lived there more than two years. The
landlord wants to sell the building to a developer, and the sale
will be more likely to happen (or he will make more money) if it is
sold vacant. So the landlord wants to buy out the tenant.

Leases are capital assets - I've found cases that specify that.
But my question is whether this lease as a capital asset can
qualify for the homeowner's exclusion under section 121. It says
that property (and a lease is property) qualifies if,

"during the 5-year period ending on the date of the sale or
exchange, such property has been owned and used by the taxpayer as
the taxpayer’s principal residence for periods aggregating 2 years
or more."

Sure sounds like it qualifies to me. Am I off base?
Yes. The tenant is not selling a home that he owns. He is selling a
lease. The landlord owns the home.
 
S

Stuart A. Bronstein

Alan said:
Yes. The tenant is not selling a home that he owns. He is
selling a lease. The landlord owns the home.
But the tenant owns the lease, which is the right to occupy and use
the property. He has most of the rights of the "owner" except that
his rights are temporary. It is still property, and he still owns
it.

Are you aware of any regulations or rulings on this point?

Thanks.
 
A

Alan

But the tenant owns the lease, which is the right to occupy and use
the property. He has most of the rights of the "owner" except that
his rights are temporary. It is still property, and he still owns
it.

Are you aware of any regulations or rulings on this point?

Thanks.
Just the plain language of the code and regs and every case I ever read
that discussed ownership and the exclusion. Someone who rents is not the
owner of his primary residence. Every rental lease is an asset. Using
your logic anyone who sells his lease can take the exclusion.
 
S

Stuart A. Bronstein

Alan said:
Just the plain language of the code and regs and every case I
ever read that discussed ownership and the exclusion. Someone
who rents is not the owner of his primary residence. Every
rental lease is an asset. Using your logic anyone who sells his
lease can take the exclusion.
Not exactly. Leases are generally for a year at a time. So you
only own one year at a time. To me that is an impediment to the
exclusion under section 121, since the lease may have been "owned"
by the tenant, but temporarily.

With the rent control ordinance, as long as the tenant complies
with the lease terms (primarily pays rent on time) it's his as long
as he wants to stay there, lease or not. So from that standpoint
it's similar to regular concepts of "ownership."

The first hudle for me was to determine that a lease (or right to
rent property, at any rate) is a capital asset, and if the right to
live in/use the property is long enough, its sale can be a long
term capital gain.

Based on that, it seems to me to lead to the conclusion that, if
that property has been the person's primary residence for two
years, it would qualify under section 121.
 
P

Pico Rico

Alan said:
Just the plain language of the code and regs and every case I ever read
that discussed ownership and the exclusion. Someone who rents is not the
owner of his primary residence. Every rental lease is an asset. Using your
logic anyone who sells his lease can take the exclusion.
I concur.

Section 121 refers to "property [that] has been owned and used by the
taxpayer as the taxpayer’s principal residence"

The lease may be property, but the lease was not used by the taxpayer as a
residence. The REAL property was.

I think the tenant should be happy with his extortion money and not be
disappointed with the lack of tax benefits under Section 121 to boot.
 
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P

Pico Rico

Stuart A. Bronstein said:
Not exactly. Leases are generally for a year at a time. So you
only own one year at a time. To me that is an impediment to the
exclusion under section 121, since the lease may have been "owned"
by the tenant, but temporarily.

With the rent control ordinance, as long as the tenant complies
with the lease terms (primarily pays rent on time) it's his as long
as he wants to stay there, lease or not.
That is not entirely true. There are exceptions to that under the
ordinance. Much different than owing a piece of real property in fee.
 
M

MTW

The tenant is not selling a home that he owns. He is selling a
lease. The landlord owns the home.
I once owned a condo unit that was located on leasehold land (60 year lease). So I owned the apartment, but NOT the underlying land. Are you arguing that (and assume that all other conditions are met) I would NOT be entitled to claim the IRC 121 exclusion upon the sale of this residence??? Or that I would be required to apportion the sales proceeds between the apartment and the land, and only claim the exclusion with respect to the apartment??? Or???

In my opinion the unit (both structure and leasehold interest) would be eligible for the 121 exclusion under these circumstances.

MTW
 
S

Stuart A. Bronstein

Pico Rico said:
That is not entirely true. There are exceptions to that under
the ordinance. Much different than owing a piece of real
property in fee.
It's not entirely true with fee ownership, either. A fee owner
can lose his property if he doesn't pay property tax or his
mortgage. He can be displaced if the government wants his property
for some other purpose.

The IRS has said that a property can qualify as a principal
residence if "occupancy was by the taxpayer pursuant to a lease
arrangement pending settlement under a binding contract to purchase
or pursuant to a lease arrangement where a written option to
purchase the then existing residence was contained in the original
lease agreement." Treas. Reg 1.44-5(a).

If that kind of lease arrangement can qualify as a principal
residence, why not a lease under rent control?
 
S

Stuart A. Bronstein

Pico Rico said:
Just the plain language of the code and regs and every case I
ever read that discussed ownership and the exclusion. Someone
who rents is not the owner of his primary residence. Every
rental lease is an asset. Using your logic anyone who sells his
lease can take the exclusion. --
Alan
I concur.

Section 121 refers to "property [that] has been owned and used
by the taxpayer as the taxpayer's principal residence"
The tax court has recognized,

"'A common idiom describes property as a "bundle of sticks" — a
collection of individual rights which, in certain combinations,
constitute property.' [Citation]. "Likewise, ownership of property
is not a single indivisible concept but rather an aggregate or
bundle of rights pertaining to the property involved.'
[Citation]." Patel v. Commissioner (2012) 138 T.C. 395, 404.
The lease may be property, but the lease was not used by the
taxpayer as a residence. The REAL property was.
The fee holder has a deed, but he doesn't use that has his
residence. The fee holder has certain rights to use the property.
That is all. He has transferred most of those rights to a tenant.
It has nothing to do with the piece of paper transferring those
rights.
I think the tenant should be happy with his extortion money and
not be disappointed with the lack of tax benefits under Section
121 to boot.
The landlord requested the tenant to move out and offered to pay to
terminate the tenant's rights. You call that extortion?
 
S

Stuart A. Bronstein

MTW said:
I once owned a condo unit that was located on leasehold land (60
year lease). So I owned the apartment, but NOT the underlying
land. Are you arguing that (and assume that all other conditions
are met) I would NOT be entitled to claim the IRC 121 exclusion
upon the sale of this residence??? Or that I would be required
to apportion the sales proceeds between the apartment and the
land, and only claim the exclusion with respect to the
apartment??? Or???

In my opinion the unit (both structure and leasehold interest)
would be eligible for the 121 exclusion under these
circumstances.
I agree with you. But in your case the situation is more clear
because the regulations, while not specifically addressing your
situation, do say that an owned mobile home (presumably on rented
land) qualifies under section 121. So yours should, too.
 
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P

Pico Rico

Stuart A. Bronstein said:
Pico Rico said:
Just the plain language of the code and regs and every case I
ever read that discussed ownership and the exclusion. Someone
who rents is not the owner of his primary residence. Every
rental lease is an asset. Using your logic anyone who sells his
lease can take the exclusion. --
Alan
I concur.

Section 121 refers to "property [that] has been owned and used
by the taxpayer as the taxpayer's principal residence"
The tax court has recognized,

"'A common idiom describes property as a "bundle of sticks" - a
collection of individual rights which, in certain combinations,
constitute property.' [Citation]. "Likewise, ownership of property
is not a single indivisible concept but rather an aggregate or
bundle of rights pertaining to the property involved.'
[Citation]." Patel v. Commissioner (2012) 138 T.C. 395, 404.
I don't see how this helps you.
The fee holder has a deed, but he doesn't use that has his
residence. The fee holder has certain rights to use the property.
That is all. He has transferred most of those rights to a tenant.
It has nothing to do with the piece of paper transferring those
rights.
it has everything to do with the pieces of paper.
The landlord requested the tenant to move out and offered to pay to
terminate the tenant's rights. You call that extortion?
given that the tenant's rights were conjured up out of thin air by the city,
and the tenant has paid nothing for them, yes I do.
 
P

Pico Rico

MTW said:
I once owned a condo unit that was located on leasehold land (60 year
lease). So I owned the apartment, but NOT the underlying land. Are you
arguing that (and assume that all other conditions are met) I would NOT be
entitled to claim the IRC 121 exclusion upon the sale of this residence???
Or that I would be required to apportion the sales proceeds between the
apartment and the land, and only claim the exclusion with respect to the
apartment??? Or???

In my opinion the unit (both structure and leasehold interest) would be
eligible for the 121 exclusion under these circumstances.

MTW
are not long term leases capital assets and short term leases not?
 
P

Pico Rico

Stuart A. Bronstein said:
A question just came up that I haven't faced before. The small
amount of research I have done so far hasn't come up with anything,
and I'm wondering what you all think.

The situation is that the client has a rent controlled apartment in
San Francisco, and has lived there more than two years. The
landlord wants to sell the building to a developer, and the sale
will be more likely to happen (or he will make more money) if it is
sold vacant. So the landlord wants to buy out the tenant.

Leases are capital assets - I've found cases that specify that.
But my question is whether this lease as a capital asset can
qualify for the homeowner's exclusion under section 121. It says
that property (and a lease is property) qualifies if,

"during the 5-year period ending on the date of the sale or
exchange, such property has been owned and used by the taxpayer as
the taxpayer's principal residence for periods aggregating 2 years
or more."

Sure sounds like it qualifies to me. Am I off base?

--
not that it matters as to the interpretation of the law, but what sort of
dollars are we talking here?
 
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A

Alan

The first hudle for me was to determine that a lease (or right to
rent property, at any rate) is a capital asset, and if the right to
live in/use the property is long enough, its sale can be a long
term capital gain.

Based on that, it seems to me to lead to the conclusion that, if
that property has been the person's primary residence for two
years, it would qualify under section 121.
I don't know how to make this any clearer. The person renting the
apartment does not own his principal residence. I don't care if it is or
is not rent controlled. If he sells his lease for a profit, he has a
capital gain on the sale of his lease, not the sale of his home. He has
no title to the real property to transfer. The landlord is the owner.

State law determines the nature of property rights. Federal law
determines the tax treatment of those property rights. The few states
that I am familiar with, such as CA and NM, have a presumption that the
person holding legal title is the owner of the full beneficial title. As
this is a presumption, it can be rebutted by clear and convincing
evidence to the contrary. Based on case law, here are the factors used
to determine beneficial ownership, otherwise known as the benefits and
burdens of ownership:
(1) whether the taxpayer had the right to possess the property and to
enjoy the use, rents, and profits thereof; (2) whether the taxpayer had
the duty to maintain the property; (3) whether the taxpayer was
responsible for insuring the property; (4) whether the taxpayer bore the
risk of loss of the property; (5) whether the taxpayer was obligated to
pay taxes, assessments, and charges against the property; (6) whether
the taxpayer had the right to improve the property; and (7) whether the
taxpayer had the right to obtain legal title at any time by paying the
balance of the purchase price.

Feel free to draw your own conclusions but I am convinced that your
tenant has not assumed the benefits and burdens of ownership to obtain a
tax benefit.
 

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