Millinery Center Building Corp. v. Commissioner

Background

In 1924 a company (the tenant) leased New York City land for 21 years with options to renew and built a 22‑story loft at a $3,000,000 cost. Title to the building was in the tenant, but at lease end the owner could take the building without payment or require its removal. The tenant fully depreciated the building during the first lease term. In 1945 the tenant renewed the lease but then purchased the fee simple interest from the owner for $2,100,000, obtaining release from lease obligations. The Tax Court found the land’s unimproved value was $660,000, making $1,440,000 the excess paid above land value. The Commissioner disallowed a deduction for that excess.

Reasoning

The Court addressed whether the $1,440,000 excess could be deducted as an ordinary business expense or amortized as prepaid rent over the cancelled lease. The Court said the purchase was the acquisition of the complete fee—both land and building—and therefore a capital outlay, not a current business expense. It rejected amortization over the lease term because the rights acquired are assets with useful lives independent of the lease’s remaining years; if treated as a wasting asset the cost should be depreciated over the asset’s useful life. The Court affirmed the Second Circuit and left to the Tax Court the task of allocating the purchase price between land and building for depreciation purposes.

Real world impact

This ruling means businesses cannot deduct large buyout payments to end leases as ordinary expenses; such payments are capital costs. A buyer must allocate purchase price between land and improvements and take any deduction through depreciation over the asset’s useful life, not by spreading it over the old lease term. The Government did not challenge allowing depreciation for the building portion.