## Facts

- Alstores Realty Corp., a subsidiary engaged in owning and leasing real estate, purchased a warehouse in Queens, New York, from Steinway & Sons.
- The property had been offered for sale for about $1,000,000, but Alstores paid $750,000 cash.
- As part of the same transaction, Alstores granted Steinway the right to occupy specified portions of the warehouse for 2½ years rent-free under a leaseback-type agreement.
- Alstores received fee simple title and bore typical ownership burdens (e.g., taxes and insurance); Steinway retained no legal title but had a contractual right to rent-free occupancy.
- The parties understood the $250,000 difference between the $1,000,000 value and the $750,000 cash price reflected the economic value of Steinway’s rent-free occupancy rights.
- The Commissioner determined Alstores had $253,090.75 of rental income (the fair market value of the rent-free occupancy) and asserted an income tax deficiency of $120,429.60 for Alstores’ fiscal year ended January 31, 1958.
- In related litigation involving Steinway, Steinway was treated as having realized $1,000,000 on the sale and as entitled to a deduction for prepaid rent corresponding to the rent-free occupancy.

## Issues

1. Whether Alstores realized taxable rental income equal to the fair market value of the 2½-year rent-free occupancy rights granted to Steinway as part of the purchase transaction.
2. If Alstores realized such rental income, whether it could increase the property’s cost (depreciable) basis by that amount and correspondingly increase depreciation deductions.

## Decision

- The Tax Court held that Alstores realized rental income equal to the fair market value of Steinway’s 2½-year rent-free occupancy rights (as determined by the Commissioner).
- The court characterized the arrangement as a purchase of the entire fee interest coupled with a leaseback, not a purchase of a remainder interest with a reserved estate for years.
- The Tax Court further held that Alstores’ depreciable basis in the property included the fair market value of the rent-free occupancy rights, permitting increased depreciation deductions.

## Legal Principles

- In a sale coupled with the seller’s continued rent-free use, the transaction may be treated as a fee purchase plus leaseback when the documents and economic arrangement show landlord-tenant use rights rather than a reserved possessory estate.
- Rental income can be realized in kind; providing use rights (e.g., rent-free occupancy) as part of consideration can generate rental income measured by the fair market value of the use rights.
- When noncash consideration is part of what the buyer gives to acquire property, the fair market value of that consideration may be included in the buyer’s cost basis, including depreciable basis, with depreciation computed on the increased basis.
- Tax consequences turn on economic benefit and the practical allocation of consideration, not solely on labels applied by the parties.

## Conclusion

The Tax Court treated the discounted purchase price and rent-free occupancy as a fee purchase with an in-kind leaseback: Alstores had to include the fair market value of the rent-free use as rental income, but it could add the same amount to its depreciable basis and take higher depreciation deductions.


Alstores Realty Corp. v. Commissioner, 46 T.C. 363 (1966)