[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: 26CFR1.162-11]

[Page 783-784]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.162-11  Rentals.

    (a) Acquisition of a leasehold. If a leasehold is acquired for 
business purposes for a specified sum, the purchaser may take as a 
deduction in his return an aliquot part of such sum each year, based on 
the number of years the lease has to run. Taxes paid by a tenant to or 
for a landlord for business property are additional rent and constitute 
a deductible item to the tenant and taxable income to the landlord, the 
amount of the tax being deductible by the latter. For disallowance of 
deduction for income taxes paid by a lessee corporation pursuant to a 
lease arrangement with the lessor corporation, see section 110 and the 
regulations thereunder. See section 178 and the regulations thereunder 
for rules governing the effect to be given renewal options in amortizing 
the costs incurred after July 28, 1958 of acquiring a lease. See Sec. 
1.197-2 for rules governing the amortization of costs to acquire limited 
interests in section 197 intangibles.
    (b) Improvements by lessee on lessor's property. (1) The cost to a 
lessee of erecting buildings or making permanent improvements on 
property of which he is the lessee is a capital investment, and is not 
deductible as a business expense. If the estimated useful life in the 
hands of the taxpayer of the building erected or of the improvements 
made, determined without regard to the terms of the lease, is longer 
than the remaining period of the lease, an annual deduction may be made 
from gross income of an amount equal to the total cost of such 
improvements divided by the number of years remaining in the term of the 
lease, and such deduction shall be in lieu of a deduction for 
depreciation. If, on the other hand, the useful life of such buildings 
or improvements in the hands of the taxpayer is equal to or shorter than 
the remaining period of the lease, this deduction shall be computed 
under the provisions of section 167 (relating to depreciation).
    (2) If the lessee began improvements on leased property before July 
28, 1958, or if the lessee was on such date and at all times thereafter 
under a binding legal obligation to make such improvements, the matter 
of spreading the cost of erecting buildings or making permanent 
improvements over the term of the original lease, together with the 
renewal period or periods depends upon the facts in the particular case, 
including the presence or absence of an obligation of renewal and the 
relationship between the parties. As a general rule, unless the lease 
has been renewed or the facts show with reasonable certainty that the 
lease will be renewed, the cost or other basis of the lease, or the cost 
of improvements shall be

[[Page 784]]

spread only over the number of years the lease has to run without taking 
into account any right of renewal. The provisions of this subparagraph 
may be illustrated by the following examples:

    Example (1). A subsidiary corporation leases land from its parent at 
a fair rental for a 25-year period. The subsidiary erects on the land 
valuable factory buildings having an estimated useful life of 50 years. 
These facts show with reasonable certainty that the lease will be 
renewed, even though the lease contains no option of renewal. Therefore, 
the cost of the buildings shall be depreciated over the estimated useful 
life of the buildings in accordance with section 167 and the regulations 
thereunder.
    Example (2). A retail merchandising corporation leases land at a 
fair rental from an unrelated lessor for the longest period that the 
lessor is willing to lease the land (30 years). The lessee erects on the 
land a department store having an estimated useful life of 40 years. 
These facts do not show with reasonable certainty that the lease will be 
renewed. Therefore, the cost of the building shall be spread over the 
remaining term of the lease. An annual deduction may be made of an 
amount equal to the cost of the building divided by the number of years 
remaining in the term of the lease, and such deduction shall be in lieu 
of a deduction for depreciation.

    (3) See section 178 and the regulations thereunder for rules 
governing the effect to be given renewal options where a lessee begins 
improvements on leased property after July 28, 1958, other than 
improvements which on such date and at all times thereafter, the lessee 
was under a binding legal obligation to make.

[T.D. 6520, 25 FR 13692, Dec. 24, 1960; as amended by T.D. 8867, 65 FR 
3825, Jan. 25, 2000]