Univ. Washington leased some
land to Metropolitan. Metropolitan turned around and subleased it to
another company (Olympic) to build a hotel.
A few years later, Olympic and
Univ. Washington decided to get rid of the middleman. Univ. Washington
bought out Metropolitan's lease so they could lease directly to Olympic.
Olympic paid Metropolitan $137k to buy out the lease.
When they filed their taxes,
Metropolitan claimed the $137k as a capital gain. The IRS disagreed.
Metropolitan argued that
they had sold a capital asset (the
lease).
The IRS argued that the
$137k was payment in lieu of the rental income they would have received
had they held onto the lease. Therefore it is taxable as ordinary
income.
See Hort v. Commissioner (313 U.S. 28 (1941).
The Tax Court found for the
IRS. Metropolitan appealed.
The Appellate Court reversed
and found that the $137k was taxable as a capital gain.
The Appellate Court found
that Hort was inapplicable. In
that case, a lessee paid to break their lease with Hort (the property
owner), and the US Supreme Court found that the income was the equivalent
of rent. In this case, Metropolitan was selling their entire interest.
Hort didn't give up
anything to get his money, he still owned the building and could lease
it to someone else. But Metropolitan gave up their property interest to
get their money.
The Court found that since
Metropolitan had exchanged a property interest (a capital asset), the $137k was taxable as a capital
gain.
