[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.109-1]

[Page 478-479]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.109-1  Exclusion from gross income of lessor of real property 
of value of improvements erected by lessee.

    (a) Income derived by a lessor of real property upon the 
termination, through forfeiture or otherwise, of the lease of such 
property and attributable to buildings erected or other improvements 
made by the lessee upon the leased property is excluded from gross

[[Page 479]]

income. However, where the facts disclose that such buildings or 
improvements represent in whole or in part a liquidation in kind of 
lease rentals, the exclusion from gross income shall not apply to the 
extent that such buildings or improvements represent such liquidation. 
The exclusion applies only with respect to the income realized by the 
lessor upon the termination of the lease and has no application to 
income, if any, in the form of rent, which may be derived by a lessor 
during the period of the lease and attributable to buildings erected or 
other improvements made by the lessee. It has no application to income 
which may be realized by the lessor upon the termination of the lease 
but not attributable to the value of such buildings or improvements. 
Neither does it apply to income derived by the lessor subsequent to the 
termination of the lease incident to the ownership of such buildings or 
improvements.
    (b) The provisions of this section may be illustrated by the 
following example:

    Example. The A Corporation leased in 1945 for a period of 50 years 
unimproved real property to the B Corporation under a lease providing 
that the B Corporation erect on the leased premises an office building 
costing $500,000, in addition to paying the A Corporation a lease rental 
of $10,000 per annum beginning on the date of completion of the 
improvements, the sum of $100,000 being placed in escrow for the payment 
of the rental. The building was completed on January 1, 1950. The lease 
provided that all improvements made by the lessee on the leased property 
would become the absolute property of the A Corporation on the 
termination of the lease by forfeiture or otherwise and that the lessor 
would become entitled on such termination to the remainder of the sum, 
if any, remaining in the escrow fund. The B Corporation forfeited its 
lease on January 1, 1955, when the improvements had a value of $100,000. 
Under the provisions of section 109, the $100,000 is excluded from gross 
income. The amount of $50,000 representing the remainder in the escrow 
fund is forfeited to the A Corporation and is included in the gross 
income of that taxpayer. As to the basis of the property in the hands of 
the A Corporation, see Sec. 1.1019-1.