A POWER CONTRACT buyout payment had to be reported by the generator as ordinary income rather than capital gain, the IRS said. 

A partnership owned a power plant that sold electricity to a utility under a 30-year contract. The project was a “qualifying facility” for regulatory purposes.The utility owned a 50% interest in the partnership. The other partner was unrelated.

The IRS said the payment the utility made to terminate the contract had to be reported as ordinary income by the partnership because there was no “sale or exchange”of the contract — a condition to being able to report the payment as capital gain. The contract was extinguished when the utility paid to buy out the contract.The IRS said this meant there was no transfer of property since the property disappeared.

The IRS made its position known in a “technical advice memorandum,” or a ruling by the national office to settle a dispute between a taxpayer and a field agent on audit.The ruling is TAM 200427025. The IRS was bothered by the fact that the utility deducted its buyout payment against ordinary income, but then reported its half share of the income allocated to it by the partnership as capital gain.