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this tax return to treat any property they placed in service in
1996 as section 179 property.
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No more than $18,739 of petitioner’s capital expenditures
for the Improvements constitutes a substitute for rent.
OPINION
I. Deducting the Cost of Improvements
Petitioners contend that, under section 162(a)(3), they may
deduct the cost of the Improvements because they (1) were
required to pay for and make the Improvements, and (2) did not
acquire either title to, or an equity interest in, the
Improvements. Petitioners’ contention closely tracks the
statutory language. Petitioners’ contention also appears to be
based on assumed economic realities; i.e., that the Improvements
that the lessee was required to make would increase the Store
Space’s value, that this expected value increase implicitly
reduced the amount of the rent obligations, and that, to the
extent of the reduction, the cost of the Improvements is
deductible rent expense under section 162(a)(3). Respondent
contends that petitioners must capitalize and depreciate the cost
of the Improvements because they are nondeductible capital
expenditures under section 263. We agree with respondent’s
conclusion and much of respondent’s analysis.
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