The Tax Court Misses the Boat in Requiring Capitalization of Lease Termination Payments

Abstract

The authors examine the Tax Court's decision Union Carbide Foreign Sales Corp. in which the Tax Court required a lessee to capitalize the entire purchase price paid to acquire a ship that they had been leasing. The authors conclude that the court relied on a misguided interpretation of statutory law in finding that the taxpayer could not deduct as a current expense that portion of the ship's purchase price that exceeded its fair market value. The court found that Code Sec. 167(c)(2), which states that the acquisition cost of property acquired subject to a lease must be capitalized and depreciated over the life of the underlying property, applied to the lessee of an asset who purchases the asset in order to terminate a burdensome lease. The authors reason, however, that because a lessee would be entitled to a deduction for rent paid, it should also be entitled to deduct the economically equivalent amount paid to terminate the lease.