31.5 Cancellation of a Lease

Payments received by the tenant on the cancellation of a business lease held long term are treated as proceeds received in a Section 1231 transaction (44.8). Payments received by the tenant on cancellation of a lease on a personal residence or apartment are treated as proceeds of a capital asset transaction. Gain is long-term capital gain if the lease was held long term; losses are not deductible.

Payments received by a landlord from a tenant for cancelling a lease or modifying lease terms are reported as rental income when received (9.1).

Cancellation of a distributor’s agreement is treated as a sale if you made a substantial capital investment in the distributorship. For example, you own facilities for storage, transporting, processing, or dealing with the physical product covered by the franchise. If you have an office mainly for clerical work, or where you handle just a small part of the goods covered by the franchise, the cancellation is not treated as a sale. Your gain or loss is ordinary income or loss. If the cancellation is treated as a sale, the sale is subject to Section 1231 treatment (44.8).