Leases Assignment of subleases Assumption of liabilities for assets; basis Automotive equipment; trust agree- ment.

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1 Leases Acquisition costs; merchandise and fixtures. The loss incurred on the sale of merchandise and fixtures purchased from a merchandising company to acquire the lease to the building it occupied is not allowable as a current deduction. However, the loss is held to be the cost of acquiring the lease and amortizable over the remaining life of the lease. A.R.R superseded (Sec. 178, 86 Rev. Rul , C.B Amortization; acquisition costs. The amount paid to acquire the right to lease additional space under a lease which had 17 months remaining on the original 2-year term with the option to renew for an additional 12 months was amortizable over a 29-month period. (Sec. 178, 86 Giumarra Bros. Fruit Co., 55 T.C. 460, Acq., Amortization; improvements; shortterm lease; interlocking directorates. A corporation entered into a 10-year nonrenewable lease for land owned by a related corporation and erected buildings and improvements on that land that were to pass to the lessor upon the termination of the lease. Held, the corporation was not a sham and was entitled to amortize the cost of the buildings and improvements over the life of the lease. (Sec. 23(a), 39 Code; Sec. 162, 86 Fort Wharf Ice Co., 23 T.C. 202, Acq., Amortization; prospective business; locating camp site. Preliminary expenses incurred in search of a site for a boys camp and expenses attributable to the promotion of the business to be established are not deductible as either business expenses or nonbusiness expenses. The expenses incurred in the acquisition of a lease on the selected site are capital in nature and are amortizable over the life of the lease. Rev. Rul superseded , , , 1.263(a)-1. (Secs. 162, 178, 212, 263; 86 Rev. Rul , C.B Assignment. An amount paid by the purchaser for the assignment of a lease is considered in the nature of an advance rental payment reportable by the seller as ordinary income in the year received where the facts indicate the relationship between the parties to be that of lessor-lessee. (Sec. 61, 86 Rev. Rul , C.B Assignment of subleases. Payments received by a lessee-sublessor, attributable to an assignment of subsisting subleases on leased property, in connection with a reassignment of the basic ground lease to the lessor, are includible in the gross income of the lessee-sublessor as ordinary income (a) 1. (Sec. 22(a), 39 Code; Sec Rev. Rul. 129, C.B Assumption of liabilities for assets; basis. A transfer by a lessee of certain assets and cash in consideration of the transferee s assumption of the lessee s liabilities under a lease will not result in taxable income to the transferee. The assets received have a basis to the transferee recipient of cost, based on the obligations assumed by the transferee, and does not include any amount with respect to any obligations which are so contingent and indefinite in nature that they are not susceptible of present valuation (a)-1, (a)(7)-1, (Secs. 22(a), 113(a), 114, 39 Code; Secs. 61, 362, 612, 86 Rev. Rul , C.B Automotive equipment; trust agreement. Taxpayer leased automotive equipment from a bank under a trust agreement providing for rental payments equal to the costs incurred by the bank in acquiring title, interest and incidental expenses. The bank held only bare legal title and the taxpayer was virtual owner of the vehicles and entitled to depreciate the cost, which included the rental payments, over the life of the equipment, rather than over the lease period. The rental payments constituted part payments for capital items and should be capitalized insofar as they represent capital payments (a) 10, 39.23(1)-1, 39.24(a)-2. (Secs. 23(a); 23(1), 24(a), 39 Code; Secs. 162, 167, 263, 86 Rev. Rul , C.B Building constructed by lessee; depreciation. The devisee of a lessor who is devised an interest in property on which a building had been constructed by a lessee without cost to the lessor, under a lease which extends beyond the useful life of the building, is not entitled to a depreciation allowance on the building (1)-1. (Sec. 23(1), 39 Code; Sec. 167, 86 Rev. Rul , C.B Building demolished by lessee. A taxpayer-lessor who leases a building for a period of years with renewal rights for additional periods and the lease provides that the lessee shall have the right to demolish all or any part of the building on the leased premises at his own expense, may not deduct a loss on account of the demolition of the building. However, the adjusted basis of the demolished building shall reconsidered as part of the cost of the lease to be amortized by the lessor over the term thereof (Sec. 165, 86 Rev. Rul , C.B Coal deposits; economic interest; joint venture. A joint venture that mines coal deposits under a 16-year non-terminable lease from the parent of one of its participants and derives its income from the sale of the coal to the parent and others has a depletable economic interest in the coal deposit. Modified by Rev. Rul (Sec. 611, 86 Rev. Rul , C.B Coal deposits; economic interest; terminability of a mining lease. Terminability of a mining lease at will or upon short or nominal notice is not an essential criterion that, by itself, will preclude a taxpayer from acquiring an eco-

2 nomic interest under reg (b). Rev. Ruls and modified; Rev. Ruls , , and revoked (Sec. 611, 86 Rev. Rul , C.B Coal deposits; joint venture; royalties. Royalty income received by a power company for the lease of its coal lands, held more than six months, to a joint venture that included as a member the company s wholly owned subsidiary and that sells the coal to the company is subject to the capital gain treatment under section , (Secs. 631, 1231; 86 Rev. Rul , C.B Coal deposits; royalties; advanced payments; substantially uniform. An accrual method limited partnership entered into a sublease under which it was to pay a royalty based on coal production, an advanced payment recoupable from future coal production royalties, and, in subsequent years, a minimum advanced payment based on the prior 3 years coal production. The advanced payment and the payments in subsequent years are not substantially uniform in amount and do not qualify as advanced royalties paid or accrued according to the minimum royalty provisions under reg (b)(3) (Sec. 612, 86 Rev. Rul , C.B Coal deposits; surface lease. Royalty payments received under a lease granting the lessee the right to enter upon, use and/or destroy surface lands in order to prospect for and mine coal, the extraction of which is or will be covered by other leases, are not proceeds from the disposal of coal within the meaning of section 631(c) (Sec. 631, 86 Rev. Rul , C.B Coin-operated device located on another s premises; information returns. An agreement whereby a corporation places coin-operated amusement or gaming devices on the premises of another is a leasing arrangement in the particular circumstances involved; the corporation must file the required information returns. Amplified by Rev. Rul (Sec. 6041, 86 Rev. Rul. 57-7, C.B Computer software; allowable deduction. Guidelines are provided for use in connection with the examination of income tax returns involving deductions of costs incurred in the developing, purchasing or leasing of computer software, effective with respect to taxable years ending after October 27, 1969; however, the Service will not disturb taxpayers treatment of software costs for prior taxable years except to the extent such treatment is markedly inconsistent with the practices set forth , (Sec. 162, 86 Rev. Proc , C.B Condemnation award. Taxpayer, who leased property to a lessee who intended to demolish and replace the existing building, obtained a restraining order to delay destruction, hoping to obtain a favorable award in a pending city condemnation against part of the property. The lessee purchased the taxpayer s rights to the condemnation award. Held, taxpayer received proceeds from the sale of a capital asset, not income from the modification of a lease. (Sec. 117(a), 39 Code; Sec. 1221, 86 Anton L. Trunk, 32 T.C. 1127, Acq., C.B Corporate facilities to subsidiary; surtax exemption. Where pursuant to a lease agreement a parent corporation transfers its property for use to a newly formed wholly-owned subsidiary (owning no physical assets), the lease of such property is considered a transfer of property. The subsidiary was not entitled to the surtax exemotion or the accumulated earnings credit (Sec. 1551, 86 Rev. Rul , C.B Depreciation; improvements by lessee; subsequent purchase. Where a lessee places depreciable improvements on the leased land, and then purchases the land in fee, subject to a sublease running to the end of his original lease, the purchase price paid by the lessee shall be allocated as his cost basis for the land and improvements acquired therewith in proportion to (1) the purchase date fair market value of the land, (2) the purchase date value of the right to acquire the improvements he placed on the land at the end of the lease term, and (3) the purchase date value of the right to acquire at the end of the sublease the improvements made by the sublessee (a)-1. (Sec. 167, 86 Rev. Rul , C.B Equipment; financing through insurance company. Where the terms of a contract for the lease of certain equipment, together with a separate contract for financing payment to the lessor through an insurance company, clearly indicate an intent to transfer the ownership of the equipment to the lessee, the contract is considered a conditional sales contract. Quarterly payments made by the lessee under the contract are capital expenditures, recoverable through deductions for depreciation (1) 1, 39.24(a) 1. (Secs. 23(1), 24(a), 39 Code; Secs. 167, 263, 86 Rev. Rul , C.B Equipment; office machines. Where a corporation manufacturing office equipment leases certain items of such equipment to another corporation, the lease being in reality a transfer of equitable ownership of the equipment to the lessee, the sum of the payments properly allocable to the sale price constitutes proceeds from sale of the equipment. Such payments made or to be made by the lessee corporation constitute capital expenditures, recoverable through depreciation deductions (a)-1, 39.23(1)-1. (Secs. 22(a), 23(1), 39 Code; Secs. 61, 167, 86 Rev. Rul , C.B Equipment; used in trade or business. Guides are presented for use in determining the treatment of leases of equipment used in the trade or business of the lessee (a)-1, 39.23(a)-10, 39.23(1)-1. (Secs. 23(a), 23(1), 39 Code; Secs. 162, 167, 86 Rev. Rul , C.B Equipment; used in trade or business. If a taxpayer acquires under contract the use of business equipment for a period substantially less than its useful life, with no provision for renewal, such arrangement constitutes a lease. If the lease payments constitute advance rental, the rental deduction will be apportioned over the term of the lease. However, if the item is acquired for the entire period of its useful life and the payments for such use over a relative short period approximates the equipment s purchase price, such arrangement constitutes a purchase, the cost of which may be recovered through depreciation , 1.167(a)-1. (Secs. 162, 167; 86 Rev. Rul , C.B Farmland; rental income; personal holding company. Payments received by a personal holding company under the Soil Bank Act with respect to farmlands which it leased to another corporation under a crop-sharing arrangement, under which it materially participated in the management of the farm production, are not rents for personal holding company income purposes , (Secs. 542, 543; 86 Rev. Rul , C.B Fire protection sprinkler system. A renewable lease for the installation and use of an automatic sprinkler system was a contract for a conditional sale where the annual payments for the first five-year period of the lease approximated the cost of the system and of its installation. The amounts paid as rent, except to the extent representing interest or currently deductible charges, are capital expenditures recoverable through annual deductions for depreciation over the estimated life of the sprinkler system (a) 1. (Secs. 167, 263; 86 Rev. Rul , C.B Ground; condominium apartment sold. A corporate land owner constructed condominium apartments on its land and sold them to individuals and leased them the land for a period of 75 years. The purchasers are required to pay their own taxes and insurance. There are no restrictions on the sale, assignment, or mortgaging of the interest in the apartment and the common elements other than that they cannot be sold separately. The ground lease rental payment is based solely on the fair market value of the land excluding improvements. Held, the purchasers have an equity interest in the condominium apartment and the amount of money received by the corporate land owner for each apartment is income from the sale of property which is not a capital asset (Sec. 61, 86 Rev. Rul , C.B Improvements; lessee s mortgage assumed by lessor. A lessee defaulted on a mortgage executed by him in connection with the construction of improvements on leased land, and the owner-lessor assumed the mortgage. By so doing, the owner-lessor protected his interest in the land that was subordinated to the mortgage and also acquired title to the improvements. For the purpose of determining basis, the amount of the mortgage assumed must be allocated by the owner-lessor between the land and the improvements , (Secs. 1012, 1016; 86 Rev. Rul , C.B Improvements; obligation of lessee; amortization. An accrual-method taxpayer entered into a renewable lease requiring an expenditure of $250,000 for improvements and, upon the expiration of the lease, an obligation to pay the lessor the difference between the $250,000 and the amount actually spent if such amount was less. Held, taxpayer s obligation to expend 250,000 constituted amortizable consideration for the lease. (Sec. 23(a), 39 Code; Sec. 162, 86 Joseph N. Neel Co., 22 T.C. 1083, Acq., C.B Leaseback. A sale-and-leaseback agreement, entered into by a bank as the only feasible method of financing the construction of a new office building, that obligated the bank to pay rent equal to the mortgage payments made to a third party mortgagee by the legal owner of the building and gave the bank an option to repurchase legal title at specified times for amounts equal to the lessor s unpaid mortgage, its downpayment, and 6 percent interest compounded on the downpayment was not a sham and the lessor was entitled to deductions for mortgage interest and depreciation. (Secs, 163, 167; 86 Frank Lyon Co., 435 U.S. 559, Ct. D. 1991, C.B Leaseback; rental value of occupancy rights. Taxpayer sold a warehouse for cash plus a contractual rent-free-right-of-occupancy of part of the warehouse, reporting as long-term capital gain the cash plus the fair market value of the occupancy agreement, which he amortized as prepaid rent and deducted to the extent it exceeded rental payments from a third party. Held, the transaction was a sale and leaseback with the fair mar-

3 ket value, not the rent received, being the amortizable basis of the leasehold interest. (Sec. 162, 86 Steinway and Sons, 46 T.C. 375, Acq., C.B Leaseback-financing arrangement; townhouses; ACRS. Investors are not entitled to deductions under the accelerated cost recovery system for townhouses that are purchased and immediately leased back with the stipulation that they will be resold to the original seller a year and a day following the original sale at a predetermined price. (Sec. 168, 86 Rev. Rul , C.B Leaseback from subsidiary; mineral property. Where a parent corporation, for a price equivalent to book value, transfers mineral properties to a wholly-owned subsidiary and leases back from the subsidiary for specified royalty payments in order to benefit from the allowance of both cost and percentage depletion, the transaction will be disregarded , , , , (Secs. 61, 162, 611, 612, 613; 86 Rev. Rul , C.B Leaseback from trust; deduction of rent. Taxpayer and his wife transferred jointly held building and land to an 11-year Clifford trust for the benefit of their minor children, naming a bank as trustee. Taxpayer continued using the property in his profession and paid rent to the trust. He deeded his future interest in the real property to his wife who was later appointed guardian for the children and had the control and management of the property subject to accountability to the Probate Court. Held, the rental payments were deductible as ordinary and necessary business expenses. (Sec. 162, 86 Alden B. Oakes, 44 T.C. 524, Nonacq., C.B Leveraged; electric generating facility coowner. The income consequences are set forth resulting from the operation of an electric generating facility by two utility corporations, when one of the utilities holds its interest in the facility under a lease that was part of a sale and leaseback transaction between the utility and a subsidiary of a financial institution , (Secs. 61, 761; 86 Rev. Rul , C.B Life insurance policy to leasing company; annual charge. Where a life insurance policy is assigned to a leasing company and subsequently leased back from the company by the assignor under an agreement which establishes no indebtedness on the part of the lessee, no portion of the amount annually charged by the company to cover its expenses under the agreement, including interest expenses, is deductible as interest by the lessee (Sec. 163, 86 Rev. Rul , C.B Machines for Government use; option to purchase; accounting methods. Method of reporting income received by a lessor on machinery under a Government contract giving the Government title after payments have been made over an established period and permitting the Government to purchase the machinery prior to the termination of such period. However, the method set forth for returning income from such contracts is limited in its application to those cases in which it is determined that the taxpayer s income will be more clearly reflected by the use of such method. I.T and I.T superseded , (Secs. 446, 1011; 86 Rev. Rul , C.B Mining property; ad valorem taxes paid by lessee. The Service will follow the Meyer Handelman, United States Steel Corp., and John W McLean decisions holding that the payment of ad valorem taxes on mineral property by the lessee is additional royalty to the lessor to the extent that income from production covers the tax payment. In the absence of production or to the extent the tax paid exceeds current income from production, the payment of the taxes by the lessee is additional rent that is not income subject to depletion by the lessor. Rev. Rul revoked , (Secs. 612, 613; 86 Rev. Rul , C.B. 177; John W. McLean, 54 T.C. 569, Nonacq., C.B Mining property; option to purchase. Taxpayer granted an option to purchase mining claims. Payments were to be made at a fixed rate, plus a percentage of annual returns in excess of a set amount. Held, the transaction constituted the sale, not a lease, of a capital asset. (Sec. l17(a), 39 Code; Sec. 1221, 86 Ima Mines Corp., 32 T.C. 1360, Acq., C.B Mining property; option to purchase. A taxpayer transferred his interest in mining claims to a mining company under a lease and purchase-option agreement whereby fixed annual payments and percentage royalty payments would be first applied against the option price. All fixed payments were made, no production payments were made, and the purchase-option had not been exercised. Held, the agreement constituted a sale, not a lease. (Sec. 1221, 86 Joseph J. Strutzel, Jr., 60 T.C. 969, Acq., C.B Mining sand and gravel; removal royalties. Percentage depletion is allowable to owners of land leased to a corporation and subleased to an unrelated mining company under an agreement providing for sand and gravel removal and requiring royalties to be shared by the owners and the corporation (Sec. 611, 86 Rev. Rul , C.B Modification; additional rental payments; amortization. Additional rental payments made over a part of the lease term, in accordance with a lease modification agreement, are capital expenditures amortizable over the full term of the lease , 1.263(a)-1. (Secs. 162, 263; 86 Rev. Rul , C.B Money paid to acquire leases to Federal lands. A taxpayer must capitalize as leasehold acquisition costs both money paid to a filing service company to file applications to lease Federal lands under the noncompetitive simultaneous offer procedure and an additional amount paid for an option to sell an interest in any leases acquired with a concurrent guarantee by the company that if no leases are so acquired it will assign a lease and buy it back. If a lease is assigned and repurchased by the filing service company, the taxpayer s loss, subject to treatment under section 1231(a), is the difference between the total amount paid to the company and the amount received on the repurchase. Modified and clarified by Rev. Rul (a)-1. (Sec. 263, 86 Rev. Rul , C.B Oil and gas; acquisition fees. Fees paid for services rendered in connection with the acquisition of noncompetitive government oil and gas leases must be capitalized as part of the cost of acquisition of the leases acquired and may be recoverable through depletion. Distinguished by Rev. Rul (Sec. 611, 86 Rev. Rul , C.B Oil and gas; acquisition fees; 5-year program. A fee paid by an investor to participate in a five-year program to acquire federal oil and gas leases is a capital expenditure includable in the basis of any leases acquired. Furthermore, since an Leases investor who does not acquire any leases during the five-year term of the program receives a refund of the fee paid, the investor has not sustained any uncompensated loss within the meaning of section 165(a) (Sec. 165, 86 Rev. Rul , C.B Oil and gas; acquisition fees; option fees. An explanation is provided of the tax treatment of (1) fees paid to a corporation that provides geological advice and files applications to acquire noncompetive federal oil and gas leases, (2) fees paid for an option to sell an interest in any leases acquired, and (3) fees allocable to the corporation s practice of offering to purchase a specified fractional interest in acquired leases. Rev. Rul modified and clarified; Rev. Rul distinguished , 1.263(a)-1, (Secs. 165, 263, 7805; 86 Rev. Rul , C.B Oil and gas; attempted acquisition. Fees paid by an individual for expert geological advice and filing service rendered in connection with an unsuccessful attempt to acquire specific noncompetitive government oil and gas leases are deductible under section 165(c)(2). Rev. Rul distinguished (Sec. 165, 86 Rev Rul , C.B. 77; Rev. Rul , C.B Oil and gas; drawing to select lessee. An amount equal to the difference, if any, between the fair market value and the cost of a lease obtained by a taxpayer by means of a drawing conducted by the Bureau of Land Management of the Department of the Interior is not a prize nor includible in the taxpayer s gross income when he obtains the lease , (Secs. 61, 74; 86 Rev. Rul , C.B Oil and gas; first year payments. Examples illustrate certain first year payments made by a leasee upon obtaining an oil and gas lease that are delay rentals that maybe capitalized or expensed a the election of the lessee or are lease bonuses that must be capitalized. Rev. Ruls and superseded , (Secs. 162, 612; 86 Rev. Rul , C.B Oil and gas; first year rental; rights assigned. A first year rental payment on a noncompetitive governmental oil and gas lease application must be capitalized as depletable costs of the overriding royalty retained; amounts received from a third party for the assignment of the rights under the lease application and upon granting of the lease are bonus payments and are gross income from the property in the taxable year received. Rev. Rul amplified (Sec. 612, 86 Rev. Rul , C.B Oil and gas; rental income; personal holding company. Sums received by a personal holding company under a lease agreement that are designated as rent, fixed in amount and payable in advance semiannually for the use of, or the right to use, oil and gas property constitute rents under section 543(a)(2). I.T superseded (Sec. 543, 86 Rev. Rul , C.B Oil and gas; royalties; personal holding company. Amounts received by a personal holding company under a lease agreement with a drilling company providing for the delivery to the lessor of a one-eighth part of the oil and gas produced and for the sale of such oil and gas to the lessee for a stipulated price are royalties for purposes of computing personal holding company income (Sec. 543, 86 Rev. Rul , C.B Oil and gas; royalty interest received for service. A corporate promoter, an attorney,

4 and an employee of a closely held corporation, receive overriding royalty interests for services provided in connection with the acquisition/development of oil and gas leases. Each has received a property interest the fairmarket value of which is includible in gross income under section (Sec. 83, 86 Rev. Rul , C.B Oil and gas; sale of leasehold interest. The sale by a lessee of his entire leasehold interest (or an undivided portion thereof) in oil and gas in place is a sale of real property used in the trade or business within the meaning of section 1221 and, therefore, his interest is not a capital asset as defined therein. Where such lease has been held for more than six months and is then sold or exchanged, it qualifies as a real property used in the trade or business as defined in section 1231 and is subject to the treatment provided by that section. Income from such sale may be reported on the installment basis under section 453. I.T superseded , , (Secs. 453, 1221, 1231; 86 Rev. Rul , C.B Oil and gas; undivided interest; royalties based on production. No part of the royalty payments received by the lessor of an undivided interest in oil and gas producing properties, under a lease agreement providing that, from month to month, the royalty percentages could decrease or increase based on average daily gross production for the previous three consecutive month periods, is a production payment (Sec. 636, 86 Rev. Rul , C.B Oil and gas; unproductive acreage relinquished. Where a portion of a leased oil and gas property is unitized and the lessee of the property relinquished the remaining leased acreage falling outside the productive unit boundaries, the lessor is not required to restore to gross income any of the depletion allowance taken on the lease bonus income received (Sec. 612, 86 Rev. Rul , C.B Oyster shell deposits. Where more than one taxpayer is a lessee under a lease entered into on behalf of a state granting them the exclusive rights to dredge oyster shells from a deposit area and to use or sell the extracted shells, subject to the payment of a royalty to the State, each lessee has acquired an economic interest (Sec. 611, 86 Rev. Rul , C.B Payment; use of property or services. For purposes of section 1274(d), relating to certain transactions in which a debt instrument is issued for property, tables set forth the applicable federal short-term, mid-term, and long-term rates for each six-month period ending as indicated. (Secs. 280G, 467, 468, 483, 1274, 7872; 86 Rev. Rul , C.B. 179, (6/84) Rev. Rul , C.B. 179, (12/84) Rev. Rul , C.B. 179, (6/85) Rev. Rul , C.B. 287, (12/85) Rev. Rul , C.B. 186, (6/86) Payment for cancellation. Taxpayer paid for cancellation of a 20-year lease with an unexpired term of 814 years and then, at a substantial rental increase, entered into a new 20-year lease with a new tenant. Held, the payment was made to regain possession and obtain more favorable benefits for the unexpired term of the old lease and thereby amortizable and deductible for 3 1/4 years, not 20 years. (Sec. 263, 86 Trustee Corp., 42 T.C. 482, Acq. in result, C.B Payment for cancellation. A lump sum payment by a lessee as damages for cancellation of a business lease that is equal to a certain amount for each month of the unexpired term is deductible as a business expense. O.D. 974 superseded , (Sec. 162, 86 Rev. Rul , C.B Payment for cancellation; amortization. An amount paid by the lessor to cancel a warehouse lease to secure the warehouse for his own use is a capital expenditure amortizable over the lease s unexpired term. The lessor s subsequent lease of the warehouse to another lessee does not affect the period over which the cancellation payment is amortized. O.D. 397 superseded (a)-1. (Sec. 263, 86 Rev. Rul , C.B Payment for termination. A settlement agreement, terminating a prior agreement providing for monthly payments from the taxpayer-operator to the owner of a cardroom that was found to bean assignment of the owner s license to operate and caused the suspension of the license, called for the taxpayer to receive a lump sum payment plus a percentage of gross receipts for a term of years. Held, the prior agreement constituted a lease, not an employment contract, and its termination was a sale or exchange of property the proceeds from which were taxable as capital gains. (Secs. 61, 1245; 86 Howard G. Kingsbury, 65 T.C. 1068, Payment in addition to rent; machinery and equipment. Monthly payments received by a lessor under a supplemental lease agreement, in addition to specified rent, until they total onehalf of the sum expended for the purchase and installation of machinery and equipment, constitute rental income. I.T superseded (Sec. 61, 86 Rev. Rul , C.B Prime lease sold to sublessee. Taxpayer transferred the prime lease of a business property to the purchaser of a business by granting a sublease at an increased rental amount then cancelling the sublease for consideration and assigning all interest in the prime lease to the former sublessee. Held, the sublease constituted a capital asset and gain therefrom is subject to capital gains treatment. (Sec. 1241, 86 Code,) Samuel D. Miller, 48 T.C. 649, Acq., Related corporations; sale and leaseback. The corporate taxpayer sold its real estate to a corporation controlled by its stockholders. This real estate was then leased back to the taxpayer for a rental based on a percentage of gross receipts. Held, on the facts, there was no bargain purchase and the stockholders realized no dividends as a result of either the sale and lease back or the rentals received. (Sec. 115(a), 39 Code; Secs. 301, 316, 86 Southern Ford Tractor Corp., 29 T.C. 833, Acq., C.B Rental payment withheld. The portion of rental payments withheld during the first three years of a lease to be paid ratably in monthly installments in later years is deductible by an accrual method lessee in the year in which withheld. O.D. 794 superseded , (Secs. 162, 461; 86 Rev. Rul , C.B Reversionary interest in building. Where a lessee, the owner of a valuable building on leased land, acquires the fee to the land to be relieved of what it considers to be the burdensome terms of a lease, the lessee may not deduct the excess of the payment over the determined value of the land at the date of purchase as an ordinary expense of doing business, Further, the taxpayerlessee may not amortize the cost allocable to the acquisition of the wasting asset over the term of the extinguished lease (a) 1, 39.23(f)-1. (Secs. 23(a), 23(f), 39 Code; Secs. 162, 165, 86 Millinery Center Building Corp., 350 U.S. 456, Ct. D. 1793, C.B Rulings; leveraged leases; ACRS property. Rev. Procs , 75 28, 76 30, and are not applicable to advance ruling requests on leveraged lease transactions in which the taxpayers have elected and complied with the requirements of section 168(f)(8). Rev. Procs , 75 28, 76 30, and modified , , , 1.167(a) 1, 5c.168(f)-1. (Sec , S.P.R.; Secs. 38, 61; 162, 167, 168, 86 Rev. Proc , C.B Rulings; leveraged leases; improvements to property. Guidelines set forth, for advance ruling purposes on leveraged lease transactions, the circumstances in which a member of a Lessee Group may furnish severable and nonseverable improvements to leased property and the information a group member must furnish relating to leased property. Rev. Procs and modified. Modified by Rev. Proc , , , 1.167(a)-1. (Sec , S.P.R.; Secs. 38, 61, 162, 167, 86 Rev. Proc , C.B Rulings; leveraged leases. Guidelines set forth the information and representations to be furnished by a taxpayer requesting an advance ruling with respect to a transaction purporting to be a leveraged lease. Rev. Proc modified. Modified by Rev. Procs and , , , 1.167(a)-1. (Sec , S.P.R.; Secs. 38, 61, 162, 167, 86 Rev. Proc , C.B Rulings; leveraged leases; limited use property. The Service will not issue advance rulings as to whether certain transactions purported to be leveraged leases of limited use property are considered leases for Federal income tax purposes. Rev. Proc modified. Modified by Rev. Proc , , , 1.167(a)-1. (Sec , S.P.R.; Secs. 38, 61, 162, 167, 86 Rev. Proc , C.B Sale of leasehold interest in real property; person other than dealer. The treatment of lessee s gain or loss upon the saleof a leasehold of land, including improvements, used in the trade or business of the lessee, who is not a dealer in leases, is outlined. Rev. Rul clarified and Rev. Rul superseded (a)-3, , , , (Secs. 167, 1221; 1231, 1245, 1250; 86 Rev. Rul , C.B Section 38 property; lease agreement treated as sale. Treatment by a lessor and lessee, for purposes of determining who is entitled to the investment credit and certain other deductions, where a transaction is cast in the form of, and treated as a lease of section 38 property but is subsequently determined to be a sale if property , , , , , 1.167(a) 1, , , , (Secs. 38, 50, 162, 163, 164, 167, 453, 483, 1223, 1231, 1245; 86 Rev. Rul ; C.B Security deposit; repayment obligation released. The entire amount realized by a lessor from the release of his obligation to repay a security deposit as consideration for cancellation of the lease is includible in his gross income in the year of the release. The Revenue Service will not

5 follow the decisions in Warren Service Corp. and Bradford Hotel Operating Co (Sec. 61, 86 Rev. Rul , C.B Security deposits; retained by grantor on transfer of shopping center to trust. As part of an overall estate plan, taxpayer transferred a shopping center to a new corporation in 1963 in exchange for its stock which was then transferred to a trust for the benefit of family members. Taxpayer continued to manage the property under a contract whereby payment of rents was guaranteed. In 1967 the shopping center was sold and a disagreement arose between the new owner and taxpayer. As part of a settlement agreement taxpayer turned over to the new owner security deposits received from lessees prior to 1963 and retained by taxpayer when he exchanged the shopping center in Held, the new corporation created in 1963 did not assume an obligation to account for the lease deposits, and taxpayer did not realize income from such deposits in that year. (Sec. 61, 86 Simon M. Lazarus, 58 T.C. 854, Acq., Special rules under ERTA. Corrections are made to amendments to the regulations relating to special rules for leases under the Economic Recovery Tax Act of 1981, tables for valuing annuities, tax shelter registration, substantiation with respect to certain means of transportation, and the effect of windfall profit tax overpayments on estimated income tax payments and penalties. 5c.168(f)(8)-5, (c)-2, T. (Secs. 168, 414, 6111; 86 Notice 85 9, C.B Surrender of leasehold interests in real property. Amounts received by a lessee for the surrender of certain leasehold interests in real properties are taxable as proceeds from the sale of capital assets, but amounts received for the relinquishment of simple contract rights constitute ordinary income. Clarified by Rev. Rul (a)-1, (a)-1. (Secs. 22(a), 117(a), 39 Code; Secs. 61, 1221, 86 Rev. Rul , C.B. 983; Isadore Golonsky, 16 T.C. 1450, McCue Bros. & Drummond, Inc., 19 T.C. 667, Louis W. Ray, 18 T.C. 438, Acqs., C.B. 6, 7, Timber; long-term. A lump sum payment received under a contract for the lease of land and the grant of the right to cut timber therefrom constitutes proceeds of the sale of timber to the extent of the fair market value of the timber then existing; the resulting gain or loss is subject to the treatment described in sections 1221 and 1231 provided the conditions thereof are met. Any excess of such payments over the fair market value of the existing timber is ordinary income. Amplified by Rev. Rul , , (Secs. 631, 1221, 1231; 86 Rev. Rul , C.B Transfer; stockpiled iron ore mining leases. Taxpayer received cash plus per ton payments for ore shipped in consideration for stockpiled iron ore mining leases he owned for more than six months before assigning them to a corporation owned by himself and his father. The corporation was under no obligation to ship ore. Held, the transaction was a sale of the leases and the profits realized therefrom were taxable as capital gain. (Sec. 117(a), 39 Code; Sec. 1221, 86 Charles H. Remer, 28 T.C. 85, Nonacq., Transfer to controlled corporation; partnership property exchanged for stock. In an incorporation of a partnership, all assets were transferred in exchange for stock of the corporation except the fee title to certain real estate. The real estate was leased to the corporation, for a period extending longer than its useful life, and was used in the corporation s business. Held, the lease was obtained by the corporation for its stock, not for a separate continuing obligation to pay rent, and the transaction qualifies as a solely for stock exchange. (Sec. 112(b), 39 Code; Sec. 355, 86 R. & J. Furniture Co., 20 T.C. 857, Acq., Vending machine location; depreciation. The cost of vending machine location leases which provide a minimum term of three years with automatic renewals by which the leases may be renewed indefinitely is not depreciable (a)-3. (Sec. 167, 86 Rev. Rul , C.B Water rights. Taxpayers received lump sum payments under agreements conveying the rights to all water underlying their lands for 25 years, renewable for an additional 20 years. Although the taxpayers retained the right to receive up to 100 barrels a day and the right to any water remaining at the end of the lease period, the purchaser could extract, and intended to extract, all the water. Held, the taxpayers did not retain an economic interest, the agreements resulted in sales rather than leases, and the lump sum payments are taxable as capital gains rather than ordinary income. (Sec. 1221, 86 Don C. Day, 54 T.C. 1417, Acq., C.B. xix Water rights. Payments received for water rights under an agreement whereby the landowner retains certain interests in the rights and the grantee is not obligated to pay a fixed amount for the production, use, or sale of the water from the land, are ordinary income from the lease , (Secs. 61, 1231; 86 Rev. Rul , C.B. 173.