Deductibility of Pre-Demolition Payments to Tenants

Pre-Deficit Reduction Act of 1984 (DRA ’84) Sec. 280B allowed for the immediate expensing of a structure’s demolition costs (except for certain historic structures). After the DRA ’84, any amount expended for demolition of a structure is nondeductible, under Sec. 280B(1)(a). Moreover, the costs incurred are capitalized to the land, under Sec. 280B(2); thus, the taxpayer receives a tax benefit for the demolition costs only if the land is sold. (There is no depreciation of such costs, for example, over the new building’s life, even though, presumably, it will be built on the site of the old structure.)

Frequently, in demolishing a structure, there can be costs other than those of demolition itself; how are they treated? Neither Sec. 280B nor its regulations provide an answer.

Lease Termination Costs

When tenants occupy a building to be demolished, they may be paid a fee to vacate (lease termination fee). Rev. Rul. 71-283 addressed a situation in which a building owner had leased the property to a tenant. Three years into the five-year lease, the owner decided to use the building for his own purposes and, thus, paid the tenant a lease cancellation fee. The Service ruled that the fee was amortizable over the lease’s unexpired term, under general Sec. 263 rules.

Although Rev. Rul. 71-283 does not deal with a demolition, its logic seems to apply. Thus, in a demolition situation, a lease termination payment is amortizable over the lease’s remaining life, not capitalized to the land.

When a landlord/owner is making lease cancellation payments so that it can use the building, as opposed to renting it to new tenants, the Tax Court has ruled similarly. In Peerless Weighing and Vending Machine Corp., 52 TC 850 (1969), the taxpayer made a lease cancellation payment to a tenant, so that it could use the building for its own purposes (not to rent it out to new tenants). The court denied the taxpayer a deduction for the lease termination fee; rather, it was amortizable over the cancelled lease’s remaining life.

In a demolition, if the owner will build the new structure for its own use, Peerless would dictate that the lease termination fee is deductible over the cancelled lease’s remaining life, and not added to the new building’s basis. Thus, lease termination fees are not within the purview of Sec. 280B and its limits on deductible expenditures.

From Bernard Leibtag, CPA, MBA, Gorfine, Schiller & Gardyn, P.A., Owings Mills, MD