## Facts

- The University of Washington owned downtown Seattle land leased long-term to Metropolitan Building Company, with the lease set to expire in 1954.
- Metropolitan subleased a portion of the property (hotel block) under a sublease ending one day before the main lease; the sublessee was to pay annual rent and a proportionate share of certain taxes.
- Olympic, Inc. later acquired the sublease and operated the Olympic Hotel on the premises.
- As expiration approached, the University sought to replace the existing structure with a new long-term lease directly to Olympic, eliminating Metropolitan’s intervening leasehold interest in the hotel block.
- To induce Metropolitan to surrender its remaining leasehold interest early, Olympic agreed to pay Metropolitan $137,000.
- In 1952 Metropolitan executed an agreement relinquishing all right, title, and interest in the hotel block under the main lease and releasing the University from obligations as to that block.
- The Commissioner treated the $137,000 as ordinary income to Metropolitan for the fiscal year ending June 30, 1953, characterizing it as the equivalent of rent; the Tax Court agreed.
- Metropolitan sought review, arguing the payment was proceeds from the sale or exchange of its leasehold interest, producing capital gain.

## Issues

1. Whether the $137,000 payment to Metropolitan for relinquishing its leasehold interest in the hotel block was ordinary income as a substitute for future rents or capital gain from the sale or exchange of a capital asset.

## Decision

- The Ninth Circuit reversed the Tax Court.
- The court held the $137,000 was consideration for Metropolitan’s sale or transfer of its remaining leasehold interest in the hotel block.
- The payment was taxable as capital gain, not ordinary income.

## Legal Principles

- A lessee’s leasehold interest may constitute a capital asset, and a complete surrender or transfer of that interest for consideration can be treated as a sale or exchange producing capital gain.
- The “substitute for ordinary income” doctrine does not control where the taxpayer does not merely commute expected income but instead disposes of the underlying property interest that generates the income.
- A price calculated by reference to anticipated future rentals and related charges may evidence valuation, but it does not, by itself, determine that the payment is rent or ordinary income.
- The identity of the payor (sublessee rather than lessor) does not determine tax characterization; the analysis turns on the nature of the rights relinquished and the substance of the transaction.

## Conclusion

Because Metropolitan fully relinquished its leasehold estate in the hotel block as part of a transaction eliminating its intervening interest, the lump-sum payment was treated as proceeds from the sale or exchange of a capital asset and taxed as capital gain rather than as ordinary income.


Metropolitan Bldg. Co. v. Commissioner, 282 F.2d 592 (9th Cir. 1960)