In the event of a lease buyout, taxpayers may wonder if they will be subject to capital gains taxes.

IRC Sec 61 provides that a taxpayer’s gross income includes all income from whatever source derived, except as otherwise provided by law. A taxpayer’s Section 61 gross income is not limited to the actual receipt of gain, but also includes the receipt of any economic benefit unless excluded by law. See Glenshaw Glass Co. v. Commissioner, 348 U.S. 426 (1955).

Stotis v. Commissioner, T.C. Memo. 1996-431, involves the case of a residential leasehold. Mr. Stotis, the petitioner, leased space in an apartment building that he used as a residence. The landlord, desiring to use the real estate for other purposes, entered into a surrender agreement with the petitioner whereby the petitioner exchanged his right in the property for a cash payment. The Tax Court held that the petitioner’s leasehold interest in a residence was a capital asset, and that the petitioner’s sale of the leasehold interest constituted a sale or exchange, taxable as capital gain.

Further, a taxpayer’s interest in a leasehold is either a capital asset under Section 1221 or real property used in a trade or business under Section 1231. Either way the sale of a leasehold interest is treated as a long-term capital gain if held over one year.