Lease as Capital Asset

Yes. The tenant is not selling a home that he owns. He is selling a lease. The landlord owns the home.

But the tenant owns the lease, which is the right to occupy and use the property. He has most of the rights of the "owner" except that his rights are temporary. It is still property, and he still owns it.

Are you aware of any regulations or rulings on this point?

Thanks.

Just the plain language of the code and regs and every case I ever read that discussed ownership and the exclusion. Someone who rents is not the owner of his primary residence. Every rental lease is an asset. Using your logic anyone who sells his lease can take the exclusion.

Not exactly. Leases are generally for a year at a time. So you only own one year at a time. To me that is an impediment to the exclusion under section 121, since the lease may have been "owned" by the tenant, but temporarily.

With the rent control ordinance, as long as the tenant complies with the lease terms (primarily pays rent on time) it's his as long as he wants to stay there, lease or not. So from that standpoint it's similar to regular concepts of "ownership."

The first hudle for me was to determine that a lease (or right to rent property, at any rate) is a capital asset, and if the right to live in/use the property is long enough, its sale can be a long term capital gain.

Based on that, it seems to me to lead to the conclusion that, if that property has been the person's primary residence for two years, it would qualify under section 121.

I concur.

Section 121 refers to "property [that] has been owned and used by the taxpayer as the taxpayer?s principal residence"

The lease may be property, but the lease was not used by the taxpayer as a residence. The REAL property was.

I think the tenant should be happy with his extortion money and not be disappointed with the lack of tax benefits under Section 121 to boot.

That is not entirely true. There are exceptions to that under the ordinance. Much different than owing a piece of real property in fee.

I once owned a condo unit that was located on leasehold land (60 year lease). So I owned the apartment, but NOT the underlying land. Are you arguing that (and assume that all other conditions are met) I would NOT be entitled to claim the IRC 121 exclusion upon the sale of this residence??? Or that I would be required to apportion the sales proceeds between the apartment and the land, and only claim the exclusion with respect to the apartment??? Or???

In my opinion the unit (both structure and leasehold interest) would be eligible for the 121 exclusion under these circumstances.

MTW

It's not entirely true with fee ownership, either. A fee owner can lose his property if he doesn't pay property tax or his mortgage. He can be displaced if the government wants his property for some other purpose.

The IRS has said that a property can qualify as a principal residence if "occupancy was by the taxpayer pursuant to a lease arrangement pending settlement under a binding contract to purchase or pursuant to a lease arrangement where a written option to purchase the then existing residence was contained in the original lease agreement." Treas. Reg 1.44-5(a).

If that kind of lease arrangement can qualify as a principal residence, why not a lease under rent control?

The tax court has recognized,

"'A common idiom describes property as a "bundle of sticks" ? a collection of individual rights which, in certain combinations, constitute property.' [Citation]. "Likewise, ownership of property is not a single indivisible concept but rather an aggregate or bundle of rights pertaining to the property involved.' [Citation]." Patel v. Commissioner (2012) 138 T.C. 395, 404.

The fee holder has a deed, but he doesn't use that has his residence. The fee holder has certain rights to use the property. That is all. He has transferred most of those rights to a tenant. It has nothing to do with the piece of paper transferring those rights.

The landlord requested the tenant to move out and offered to pay to terminate the tenant's rights. You call that extortion?

I agree with you. But in your case the situation is more clear because the regulations, while not specifically addressing your situation, do say that an owned mobile home (presumably on rented land) qualifies under section 121. So yours should, too.

I don't see how this helps you.

it has everything to do with the pieces of paper.

given that the tenant's rights were conjured up out of thin air by the city, and the tenant has paid nothing for them, yes I do.

are not long term leases capital assets and short term leases not?

The owner is in control of those events. The tenant is not in control of the exceptions stated in the SF ordinance.

He can be displaced if the government wants his property

inapplicable.

now you are saying SF's rent control ordinance gives the tenant an option to purchase?

not that it matters as to the interpretation of the law, but what sort of dollars are we talking here?

I don't know how to make this any clearer. The person renting the apartment does not own his principal residence. I don't care if it is or is not rent controlled. If he sells his lease for a profit, he has a capital gain on the sale of his lease, not the sale of his home. He has no title to the real property to transfer. The landlord is the owner.

State law determines the nature of property rights. Federal law determines the tax treatment of those property rights. The few states that I am familiar with, such as CA and NM, have a presumption that the person holding legal title is the owner of the full beneficial title. As this is a presumption, it can be rebutted by clear and convincing evidence to the contrary. Based on case law, here are the factors used to determine beneficial ownership, otherwise known as the benefits and burdens of ownership: (1) whether the taxpayer had the right to possess the property and to enjoy the use, rents, and profits thereof; (2) whether the taxpayer had the duty to maintain the property; (3) whether the taxpayer was responsible for insuring the property; (4) whether the taxpayer bore the risk of loss of the property; (5) whether the taxpayer was obligated to pay taxes, assessments, and charges against the property; (6) whether the taxpayer had the right to improve the property; and (7) whether the taxpayer had the right to obtain legal title at any time by paying the balance of the purchase price.

Feel free to draw your own conclusions but I am convinced that your tenant has not assumed the benefits and burdens of ownership to obtain a tax benefit.