Bruun was a landlord. He
leased some property to a tenant. When the lease expired, the tenant left
and Bruun took the property back.
While the tenant was in
possession of the property, they knocked down an old building and built a
new building on the property. When they left, Bruun got to keep the new
The new building was
assessed to be worth $51k more than the old one.
The IRS stepped in and said
that Bruun's gain of a new building was a capital gain.
Bruun argued that no income
had been realized yet because his
interest was represented by a deed, and when the tenant left, he had the
exact same deed he had when the tenant arrived. So he hadn't gained
anything. Bruun suggested that the IRS would have to wait until the
property was sold (aka the value was realized).
Basically, the construction
of the new building increased the value of the land, but there were
other ways the value could change. But until the land was sold, Bruun
hadn't received anything.
See Eisner v. Macomber (252 U.S. 189 (1920)), which says that in
general, you don't have to report a gain until you sell the property
(aka "severance is a prerequisite to realization").
The IRS argued that until
the day the tenant left, Bruun didn't own a new building, as soon as the
lease ended, Bruun did own a new building. He had received a gain and
needed to pay taxes on it immediately.
The US Supreme Court found for
The US Supreme Court found
that upon when a lease ended, the landlord repossessed the real estate
and improvements and increase in value attributable to the improvements
The real estate industry felt
that this was very unfair to landlords. If the new building was
expensive, the landlord might be forced to sell the land just to be able
to afford the tax. They lobbied Congress, who passed 26 U.S. C. §109 was to provide relief for exactly landlord's
in Bruun's situation.
Now, under §109, gross income generally does not include improvements made by a tenant.
However, it does not include
"improvements other than rent." That clause was added so the
landlord and tenant couldn't conspire to improve the property instead
of paying rent.
So you can't say to a
tenant, "instead of paying me rent, just build a fancy new building
that I can keep after you leave."