Your business has a big customer. The customer wants more product than your business can make. So the customer offers to pay for a building expansion on your property to allow you to make their product. Your business does not take a dime of that building money. The cash goes straight to the contractor from your client. A new wing goes up on the building.
It feels like a wash. Your business got a bigger building, but the customer paid for it. Where is the income in that? Your business never had the money in its hands.
But the tax law does not care whose hands the money passed through. It cares who ended up owning the thing that got built. And when the answer is you, the value of that thing can be income to you, even if a customer wrote every check.
So when a third party pays to improve property you control, do you have income? The recent case of Thermal Circuits, Inc. v. Commissioner, T.C. Memo. 2026-29, gives us a chance to look at this question.
Facts & Procedure
The taxpayer is a small manufacturer. It makes foil heating elements. It has done so since the 1960s. It leases its factory and the land under it from a related trust.
A large customer came calling. The customer wanted to break into a new tobacco product and needed the taxpayer’s heating elements. It needed a lot of them. The taxpayer’s factory could not keep up without running expensive overtime.
The fix was more space. A larger factory would let the taxpayer make more units without raising the cost of each one. This is the kind of real estate decision that comes with hidden tax consequences.
The addition would cost around $4 million. The taxpayer was a small company and did not want to gamble that kind of money on one customer who might walk away.
So the customer agreed to fund the expansion itself. Over 2017 and 2018 it paid about $4.3 million. The money went to the builder. A 33,000-square-foot addition went up on the leased factory. The taxpayer did not report any of that $4.3 million as income. It also did not claim depreciation on the new addition.
You can start to see the issue here. Somebody now owns a $4.3 million building addition. The IRS said that somebody was the taxpayer, and that the value was income. The IRS issued a notice of deficiency for both years, plus accuracy-related penalties. The disputed ended up in the U.S. Tax Court.
What Counts as Income?
The starting point is broad. The tax code says gross income means all income from whatever source. We have covered this concept in a lot of different contexts on this website. As noted in those posts, the Supreme Court has read that to reach any accession to wealth that you clearly realize and control. If your net worth goes up and you have command over the increase, that is usually income.
This is not a new rule. It is the backbone of the income tax. And because the definition is so broad, the exceptions to it are read narrowly. A taxpayer who wants something left out of income has to fit squarely inside an exclusion.
Here, the court had to answer a threshold question first. Who owned the addition? If the customer owned it, the taxpayer arguably had nothing. If the taxpayer owned it, the taxpayer had a $4.3 million asset.
The taxpayer argued the customer held the real ownership and the taxpayer just held bare legal title as an accommodation. The problem was the paper. Nothing clearly said the customer owned the addition. Meanwhile, the taxpayer paid the insurance and the property taxes on the whole building. It bore the risk of loss. The certificate of occupancy was in its name. Those are the classic markers of ownership.
The court found the taxpayer owned the addition for federal tax purposes. And owning a $4.3 million improvement you did not pay for is exactly the kind of accession to wealth the income tax reaches. If you ever face this kind of finding, know how an auditor can adjust your income and where the limits are.
Does the Contribution to Capital Exclusion Help?
The taxpayer had a fallback. It is a corporation. The tax code says a corporation does not include a contribution to its capital in income. So the taxpayer argued the customer’s payment was a contribution to its capital and should be left out.
This sounds promising at first. Money came in from outside and got built into the business. But the exclusion is narrower than it looks. Courts use a multi-part test that traces back to a Supreme Court case. Two parts mattered here.
First, the money has to become a permanent part of the company’s capital structure. That part the taxpayer met. The funds were locked into a building addition that the company used to make its product. So far so good.
The second part is where it fell apart. A contribution to capital cannot be payment for goods or services. If the money is really compensation dressed up as an investment, it is not a capital contribution. And the record showed the customer was not making an investment out of generosity. It ran the numbers. It figured out how many units it would have to buy to recoup the cost of the addition. It funded the expansion to get more product at a steady price. That is payment for goods, not a gift to the company’s balance sheet. Because the money was tied to the product the customer wanted, it did not qualify as a contribution to capital. The exclusion did not apply.
So the taxpayer owned a $4.3 million addition, and the payment that built it did not fit any exclusion. The taxpayer had to include the full $4.3 million in income. This is a harsh result for a company that never touched the cash. But it follows from how broadly the income tax is written.
The Takeaway
Income does not require cash in your pocket. If a third party pays to build something and you end up owning it, the value can be income to you. Business owners who let a customer or partner fund improvements on their property should plan for that before the deal closes, not after the notice of deficiency arrives. The contribution to capital exclusion rarely saves a company when the money is really tied to the products or services the payer wants.
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Stephan is the sports journalist for the Maple Grove Report.
