Amounts received on account of a transfer sale or disposition which are

Amounts received on account of a transfer sale or

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right, or continuing interest with respect to the property. Amounts received on account of a transfer, sale, or disposition which are contingent on the productivity, use, or disposition of the property are also not treated as a sale or disposition of a capital asset. Code Sec. 1253(a)-(c).The term “significant power, right, or continuing interest” includes but is not limited to the following rights with respect to the transferred interest:1. To disapprove any assignment of such an interest2. To terminate the franchise at will3. To prescribe the standards of quality of products4. To require that the transferee sell or advertise only products or services of the transferor5. To require the transferee to purchase substantially all supplies or equipment from the transferor6. To require payments contingent on the productivity, use, or sale of the property (Code Sec. 1253(b)(2))Since most franchises involve the transferor retaining at least some of these rights, the transferor is going to have ordinary income upon the transfer of a franchise.Amounts paid by the transferee which are contingent on the productivity, use, or disposition of the property transferred are allowed as business deductions. Other payments are generally amortized over 15 years. Code Sec. 197(g).EXAMPLE 12.5 Farmers Corporation grants Grace Gobbler a franchise to sell fried chicken for a period of 20 years with renewals. Farmers Corporation retains the powers and rights described above. Grace is required to pay $100,000 initially and then three percent of sales. The $100,000 payment and the percentage payments are ordinary income to Farmers. Grace may deduct the percentage payments as ordinary business expenses. The initial payment of $100,000 is amortized over 15 years beginning in the year the payment is made.EXAMPLE 12.6 Denny Doone, a transferee of a franchise, sells the franchise to a third party, transferring all significant powers and rights. Payments to Denny are not contingent. Any reportable gain will be capital gain to him.¶12,155 LEASE CANCELLATION PAYMENTSAmounts received by a lessee (tenant) for the cancellation of a lease are considered as amounts received for the exchange of such lease or agreement. Code Sec. 1241. The type of gain or loss will depend on the character of the lease. A nondepreciable leasehold (for example, for a personal-use asset as a residence) is a capital asset. A depreciable lease used in a trade or business is either an ordinary asset or a Section 1231 asset. Amounts received by the landlord for canceling a lease are ordinary income. W.M. Hort, 41-1 USTC¶9534, 313 U.S. 28, 61 S.Ct. 757 (1941).EXAMPLE 12.7 Terry Thomson pays Lydia Lancer, the owner of his apartment, $500 in order to cancel his lease. Lydia treats the $500 as ordinary income.EXAMPLE 12.8 Lydia pays Tony Terrace, a tenant of one of her apartments, $900 to cancel the lease. Tony would report $900 capital gain since the lease was a nondepreciable leasehold and thus a capital asset.
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