Is settlement agreement for "forcing" out of lease taxable to tenant?

[ptax255]

Hi,

Client is being forced out of lease and getting paid to cover new broker fee, move out expenses and apt rent price increase. Would this be taxable as a lease buyout or non-taxable as reimbursed expenses?

[BobKamman]

That's an interesting question.  Give us some numbers.  Hypothetically, let's say the tenant has already paid $10,000 in rent and the landlord is giving him $5,000 for an early buyout.  (Doesn't really matter what that amount is supposed to cover.)  Then it's just a refund of (presumably) non-deductible expenses.  But what if the tenant has not even moved in yet, and is getting back his deposit plus more?  Then he has taxable income.  

Edited:  I don't know why I'm presuming this is residential, not business property.  Although you do say it involves an "apt".

[ptax255]

So he/she is being asked to leave the apt by a certain date which is prior to the end of the lease agreement. In exchange client will receive let's say $10K which is an estimated cost to cover broker fee of finding new apt, moving expenses and rent price increases compared to current lease. Client will pay rent until actual move out date and security deposit will be fully refunded.

[BobKamman]

If they have paid more than $10K rent under the canceled lease before now, then it's just an adjustment to the contract price and nontaxable.  

[TaxGuyBill]

I don't see any way it could be not taxable.  It is similar to the "cash for keys" program, which is taxable.

[IRonMaN]

If he was submitting actual expenses to the landlord and getting reimbursed for those costs, I could bite on nontaxable.  But it sounds like he is getting a termination payment which would be taxable.

[BobKamman]

You charge your client $500 for preparing a return.  There's a mistake, so you pay the $100 interest.  He has to pay tax on that, because it's just like "cash for keys?"  Well, OK then, he's your client.  

[pkellycpa]

Sounds like the listed amounts are only estimates used to calculate potential expenses.

When someone gives you money to do something it's income.

[BobKamman]

I reserve a room at the Marriott for a weekly rate of $1,400 nonrefundable payment at time of reservation.  After five days there is a fire that knocks out hot water and power to my room, so they move me across the street to the Hilton which charges $300 daily rate.  Marriott refunds me $600 of what I paid them.  I have to pay tax on it?  I have to give them my SSN for a 1099?  Absurd.  

A lease is property.   A tenant has basis in it.  If the landlord is not able to perform and refunds part of the cost, that's not income.  What's so difficult about that?  

[IRonMaN]

But that example is like comparing apples to turnips.  Refunding money already paid is different than writing a check to you because we inconvenienced you.

[BobKamman]

Refunding rent already paid is no different from refunding rent already paid.  

[ptax255]

Not sure this is considered a capital lease though. It's a typical residential one year lease. And it does sound like a cash for keys.

[IRonMaN]

But Bob, I’m not seeing where the rent has already been paid.  The landlord appears to be booting the renter out before the end of the lease term and giving them some cash to go away on reasonably good terms.

[BobKamman]

The tenant has been paying rent since, for all we know, five years ago.  That's why I wrote that this is considered a refund or rebate, only to the extent of the amount paid under the terms of the lease that is being terminated by the landlord.  The lease is property.   The tenant's basis in it is the amount already paid.  

Tenant:  "I will pay you $12,000 for the right to use your property for a year."

Landlord, ten months later:  "You have already paid me $10,000 but now I must ask you to leave, so I am returning $3,000 to you if you surrender your right to stay another two months.  And you won't have to pay the remaining $2,000 of the purchase price."

And comparing this to "cash for keys" is like comparing apples to turnips.  "Cash for keys" payments were made to people who no longer had an interest in the property, because it had been foreclosed.  They no longer owned a capital asset, so they could not have any basis to recover.  

[IRonMaN]

That’s a good story but it isn’t the one ptax gave

[pkellycpa]

When I retire, I am going to tell my landlord that I have been paying too much in rent and claim a capital loss.

Same logic.

[BobKamman]

By the way, all the knee-jerk "protect the revenue" IRS auditor wannabes should be aware of the only Tax Court decision on "cash for keys," where the taxpayers won and did not have to pay tax on the $20,500 they received from the bank in return for a deed in lieu of foreclosure.  

Their return was prepared by a smart CPA.  

https://casetext.com/case/bobo-v-commr-2 

[pkellycpa]

All that payment did was reduce a non deductible loss.

Completely different scenario.

[BobKamman]

"This is just like cash for keys!"

"Here's a Tax Court case where the judge told IRS to stuff it.:"

"This is nothing like cash for keys!"

[ptax255]

Thanks all! To recap and close the thread... this would be taxable as other income? You can just cheer if you agree.