Helvering v. Bruun

United States Court of Appeals for the Eighth Circuit · Corporations

CorporationsIncome taxRealized incomeLease improvementsgross incomerealizationlease cancellationtenant improvements

Facts

Bruun owned a lot in Kansas City that he leased in 1915 for 99 years to New Market Investment Company. The lessee removed the existing building in 1929 and constructed a new building, and under the lease the lessee could remove that building under certain conditions until the last four and one-half years of the term, but upon forfeiture or termination the premises were to be surrendered with all buildings and improvements. On July 1, 1933, the lessee defaulted on rent, the lease was cancelled, and the lot with the new building was surrendered to Bruun. The parties stipulated that the building's fair market value on that date, net of the unamortized cost of the old building, was $51,434.25, which the Commissioner treated as taxable gain for 1933.

Issue

Did the lessor realize taxable income in 1933 when the lease was cancelled and he received possession and title to a building erected by the lessee on the leased premises? More specifically, was the stipulated net value of the building includable in gross income under section 22(a) of the Revenue Act of 1932?

Rule

For income tax purposes, an increase in the value of real estate resulting from improvements is not realized income to the lessor, but only an addition to capital. That principle applies even where title to the improvement does not vest in the lessor until the lease is terminated; receipt of the improvement upon forfeiture does not by itself create realized income.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

Lena Ortiz owns a parcel in St. Louis and leases it for 60 years to Riverbend Textile Lofts, Inc. The lease allows the tenant to erect a warehouse, and after the tenant stops paying rent in 2025 the lease is terminated; Lena receives possession of the land with the warehouse still attached, and the warehouse has greatly increased the property's value.

Under the majority rule, how should the warehouse's value be treated for Lena's federal income tax purposes in the year the lease is terminated?

Explanation. The governing rule is that an increase in value of leased real estate caused by tenant-made improvements is not realized income to the lessor merely because the lessor receives the property with the improvement upon lease termination. The majority treated that value as an enhancement of the real estate and therefore an addition to capital, not income within the statute. The termination of the lease does not itself create realization. (Derived from Helvering v. Bruun (n.d.).)