The proceeds received from a lease buyout are definitely taxable. The more complicated question is whether or not it is treated as "Other Income" or Capital Gain.
In some cases the tenant can receive favorable capital gain treatment
on the lease buy out. Sec 1241 - states that amounts received by a
lessee for cancellation of the lease shall be considered as amounts
received in exchange for such lease or agreement. Therefore if the lease
is a section 1231 asset, the tenant could recognize the lease
termination income as capital gain. Generally a lease held for use in a
tenant's business is considered section 1231 asset. However in order to
receive this treatment the tenant would need to have had the lease over
a year and give up all ownership rights to the leases - meaning
subleases or other rights of re-entry would not qualify the tenant for
capital gain treatment.
