Barker v. Commissioner

EXECUTORS OF THE ESTATE OF GEORGE E. BARKER, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Barker v. Commissioner

Docket No. 8728.

United States Board of Tax Appeals

13 B.T.A. 562; 1928 BTA LEXIS 3225;

September 26, 1928, Promulgated

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1. Amounts received by decedent in the nature of a cash bond as security for the performance of a 99-year lease do not constitute taxable income when recieved.

2. The deficiencies for the years 1919 and 1920 are not invalidated by respondent's failure to comply with section 1309 of the Revenue

Act of 1921.

C. J. Baird, Esq., for the petitioners.

L. A. Luce, Esq., for the respondent.

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LANSDON

Respondent has determined deficiencies in income tax as to George E. Barker for the years 1919, 1920, and 1921 in the respective amounts of $5,221.92, $811.21, and $2,341.83. Only parts of the deficiencies are in controversy. The errors assigned by petitiners are: (1) That the respondent did not make a legal determination of the deficiencies for the years 1919 and 1920, in that the provisions of section 1309 of the Revenue Act of 1921 were not complied with; (2) that the respondent erroneously included as income an amount received as security for the performance of a 99-year lease; and (3) that the respondent erred by disallowing deductions of 20 per cent of the cost of certain alternations made for the benefit of a tenant under a 5-year lease.

At the hearing petitioners expressly abandoned the last assignment of error.

George E. Barker died on November 27, 1927, after the date of the filing of the appeal and prior to the date of hearing.

FINDINGS OF FACT.

George E. Barker, prior to his death on November 27, 1927, resided in Omaha, Nebr. On December 30, 1919, George E. Barker leased to Joseph L. Wolf and Samuel N. Wolf certain property known as the Karbach Block, situated in Omaha, Nebr., for a term of 99 years, beginning January 1, 1920, and ending December 31, 2018. Annual rental in the amount of $22,500 was payable quarterly, and provision was made in the lease for the deposit of $50,000 as security for the performance by the lessees. Payment of said amount was made, $25,000 at the commencement of the lease, and $5,000 per year for each of the succeeding five years. The material provisions of the lease follow:

5. Lessees agree to pay or cause to be paid and fully discharged, before the same become delinquent, all taxes, assessments, charges, duties, payments, rates and liens, of every nature, name or kind whatsoever * * *

7. It is understood that lessor shall pay and discharge all liens now on said demised premises, including the existing mortgage, as the same becomes due and payable.

8. Lessees agree, at all times to keep the buildings now on said demised premises and those which may hereafter be erected insured against loss by fire in an amount not less than $100,000.00 or, if $100,000.00 fire insurance is not obtainable, in an amount not less than the full insurable value of all buildings and against loss by tornado in an amount not less than $25,000.00 and to maintain compensation, elevator and public liability insurance in an amount not less than $10,000.00 and $20,000.00 limits in company or companies acceptable to lessor, and to deliver all policies without delay to lessor. All policies shall be written to cover the interests of lessor as the principal insured, and, when the interest of lessor is mortgaged, shall have a proper mortgage clause. In case lessees fail to provide such insurance lessor may take the steps and advance the money required to do so and lessees agree to pay same to lessor on or before the next rent day.

10. In every case of destruction, complete or partial, without fault of lessees, of buildings now on said premises or hereafter to be erected, lessees shall not be obliged to expend more for reconstruction or rebuilding than the moneys realized from insurance; but, in no case, shall destruction, complete or partial, or damage terminate or suspend this lease or vary any of the obligations of lessees herein assumed.

15. Every assignment or attempted assignment of lessees' interest or any part thereof, by operation of law (meaning by judgment, decree, execution, attachment, bankruptcy, voluntary assignment for the benefit of creditors or other process of law excepting foreclosure of permitted mortgages) and every assignment of part or parts of lessees interest, by gift or contract, shall be null and void and, at the option of lessor, terminate all intersts of lessees, unless said assignment is consented to by lessor in writing.

18. When an assignment is made as herein permitted and only in such case lessees shall be released from further liability hereunder, but lessor shall not be obliged, in any case, to return money or release security or securities of any kind.

20. If said demised premises or any part thereof is hereafter condemned under the law of eminent domain, all the awards, to whomever made, up to $500,000.00, shall be paid to and belong to lessor. In case less than all of said premises is taken under the law of eminent domain, the rental installments which lessees shall pay lessor thereafter for the part not taken shall be such proportion of the rental installments herein fixed as will be determined by at least two members of a board of three arbitrators, of whom one is to be chosen by lessor, one by lessees and the third by said two members. If all of the demised premises are taken under the law of eminent domain, this lease shall be terminated and lessees shall be entitled to a return of such balance, if any, of the security, $50,000.00 hereinafter described, as they shall then be entitled to.

24. All losses, costs and expenses of every nature and kind, in court or elsewhere, whether the suits or claims are well founded or not, including attorneys fees, which lessor shall incur in enforcing, maintaining, preserving or defending lessor's rights under this contract or which may arise or grow out of or on account of or in connection with this contract, in any manner, lessees agree to pay to lessor, in each case, with interest at the rate of 7% per annum from date of payment by lessor on the next quarterly rent day after lessor will have incurred the same or sooner, the intention being that lessees shall hold and keep lessor harmless from all damages, losses, costs and expenses whatsoever.

25. All buildings and improvements which will be made or erected on said premises shall remain on and be surrendered to lessor with said premises at the termination of this lease by lapse of time or otherwise, and lessees agree at the termination of this lease by lapse of time or otherwise to surrender said premises and all buildings, appurtenances and improvements thereon in as good condition as the same now are, ordinary wear and tear and changes herein permitted excepted, and the title free and clear of all liens and clouds. Provided, however, during the first half of the last year of said term of 99 years, but only in case this lease will not have been terminated before that time, if a request be made by lessees of lessor in writing and ten days notice thereof be given, three disinterested appraisers shall be chosen, one by lessor, one by lessees and the third by these two appraisers and said three appraisers by a vote of at least two of the three shall determine the then fair market value of all the buildings and improvements then on said premises and also the then fair market value of said premises exclusive of all buildings and improvements and, thereupon, before the termination of said period of 99 years or within thirty days after the findings of said appraisers will have been delivered in writing to lessor, lessor shall have the option either (a) to finally terminate all interests of lessees hereunder by returning whatever balance, if any, of said security $50,000.00 lessees will then be entitled to and paying lessees said appraised value of the buildings and improvements less $200,000.00 or (b) lessor may offer to convey to lessees by special warranty deed, warranting only against incumbrances of lessor, the said premises with buildings and improvements thereon (or what remains of said premises after condemnation) for such appraised value exclusive of buildings and improvements plus $200,000.00 but deducting whatever balance, if any, of said security $50,000.00 lessees will then be entitled to. If lessor fails to so purchase the buildings and improvements, then within ten days after the offer at (b) is made by lessor, or before the end of said term of 99 years, lessees must accept said offer and complete the purchase or, if lessees fail, neglect or refuse to do so, all lessees interests in said premises shall thereby terminate. Nothing herein contained shall be construed as an expansion of said term of 99 years.

27. Each and every failure, neglect or refusal of lessees to comply fully and promptly with the obligations herein assumed by lessees shall give lessor the right, at his option, to terminate all interest of lessees. In case lessor exercises his option to declare a forfeiture, lessor must give lessees notice thereof in writing.

31. In addition to all the payments herein provided for, and as security for the performance by and compliance by lessees of and with each and all of the obligations assumed by lessees herein and to make good to lessor any loss which lessor may sustain by reason of the building now on said premises, in any manner except by ordinary wear and tear, becoming or by reason of the building or buildings hereafter to be erected being or, in any manner except by ordinary wear and tear, becoming of a value less than $200,000.00, lessees agree to pay to lessor Fifty thousand and no/100 dollars ($50,000.00) as follows: Twenty-five thousand and no/100 dollars ($25,000.00) at the time of the execution hereof and twelve-hundred and fifty and no/100 dollars (1,250.00) on January 1, 1920, and twelve hundred fifty and no/100 dollars ($1,250.00) on the first day of each and every April, July, October and January thereafter until the remaining twenty-five thousand and no/100 dollars ($25,000.00) with interest on unpaid balances from January 1, 1920 at the rate of 5% per annum are fully paid. Said security $50,000.00 shall remain in possession of lessor during said entire term of ninety-nine (99) years and lessor shall not be charged with any interest thereon; if at any time the buildings on said demised premises, by additions to the present building or by new buildings, will be made of value greater by $50,000.00 than the amount which it would cost then to erect the present building new, the balance, if any, of said security $50,000.00 to which lessees are then entitled to shall be returned to lessees, but in that case the rental for the remainder of the term shall be increased by $2,500.00 per year.

35. So long and only so long as lessees will have complied faithfully and promptly with each and all of the obligations of lessees hereunder and until December 31, 1929, but no longer, lessees shall have and they are hereby given the option or privilege of purchasing all said demised premises together with the buildings and appurtenances thereunto belonging for five hundred-thousand and no/100 dollars ($500,000.00) payable one half in cash and one half by coupon notes of lessees secured by first mortgage on said premises, said notes to be payable five years after their date and bearing interest from their date at the rate of 5% per annum, interest payable semi-annually, and said mortgage to be on Douglas County, Nebraska, form with clause that mortgagors must pay taxes on debt as well as on the premises and proper insurance clauses.

36. In case lessees so purchase under said option, lessees shall be credited with whatever balance, if any, of said security ($50,000.00) lessees may be entitled to and lessor shall make conveyance by deed warranting against only these incumbrances which lessor agrees herein to pay and those incumbrances which may have been placed thereon by, through or under lessor.

Prior to the examination which gave rise to the deficiencies herein involved an examination was conducted of decedent's income-tax return for the years 1917, 1918, 1919, and 1920. No notice in writing was given to him that a second examination was to be made. A department letter dated September 17, 1924, directed to George E. Barker, states:

Years examined: Re-examination 1919-20

Original 1921

OPINION.

LANSDON: Petitioners allege that the deficiencies determined for 1919 and 1920 are invalid inasmuch as they were asserted by the respondent in violation of the provisions of section 1309 of the Revenue Act of 1921, which provides:

That no taxpayer shall be subjected to unnecessary examinations or investigations, and only one inspection of a taxpayer's books of account shall be made for each taxable year unless the taxpayer requests otherwise or unless the Commissioner, after investigation, notifies the taxpayer in writing that an additional inspection is necessary.

That section of the statute merely provides for relief from unnecessary examination of a taxpayer's books and does not mean that any deficiency resulting from a reexamination in violation of section 1309 shall be void. There is no evidence that deceased objected to the reexamination of his books. He might have refused to permit the investigation without notice in writing, but not having done so the protection afforded by the statute will be deemed to have been waived. .

The important issue presented for determination is whether certain cash payments received by deceased from the lessees under a 99-year lease constituted taxable income when received. The respondent contends that the amounts were paid as a bonus for the lease. Petitioners contend that the payments were in the nature of a cash bond as security for performance of the lease.

We must look to the provisions of the lease in determining the nature of the payments. Paragraph 31 provides that in addition to all other payments there should be paid "as security for performance by the lessees" the sum of $50,000, payable $25,000 upon execution of the lease and $1,250 on the first day of each January, April, July, and October thereafter until the remaining $25,000 had been paid. The $50,000 security was to remain in possession of the lessor during the entire term of 99 years without any charge for interest.

At the end of the 99-year term it is provided in paragraph 25 that three appraisers shall be appointed to determine the fair market value of all the buildings and improvements and the fair market value of the land, and that lessor shall have the option either (1) to terminate the lessees' interest by returning whatever balance of the $50,000 security lessees will then be entitled to receive and paying lessees the appraised value of the buildings in excess of $200,000, or (2) to convey to lessees the premises at the appraised value of the land plus $200,000, but deducting whatever balance of the $50,000 security lessees will then be entitled to have returned.

The $50,000 was paid as security for the performance of all lessees' obligations under the lease. The lease provides that upon failure of lessees to pay rent, taxes, insurance premiums, or to discharge any liens against the property lessor shall make the payment and deduct the amount from the $50,000. If lessees make an assignment of the lease the lessor shall not be obliged to return or release money or security of any kind. If at any time the buildings depreciate to a value below $200,000 the lessor can reimburse himself from the $50,000 security fund.

Upon the happening of certain events the $50,000 security will be returned to lessees. Lessees are given the option to purchase until December 31, 1929, at a price of $500,000. If they so elect to purchase under the option, they shall be credited with the balance due them of the $50,000 security. If the premises should be condemned under the law of eminent domain the lessees shall receive back the balance of the $50,000 security. If at any time the buildings, by additions or new structures, will be made of a value greater by $50,000 than the amount which it would cost to erect the present building new, the balance of the $50,000 security shall be returned to the lessees. But in that case the rental for the remainder of the term shall be increased by $2,500 per year. In exchange for the cash security which is thus returned lessor has buildings or additions of equal or greater value, which will result immediately in income to him. ; .

The amounts paid as security were not held in escrow, or as a trust fund. When received by deceased they were a part of his general assets and could be used by him without restriction. He was bound, however, to account to the lessees for the $50,000 and to return the amount under the conditions stated above. The payments were not income to deceased when received any more than borrowed money is income when received.

If lessees failed to pay rent, the portion of the security taken to make the payment would at that time be income. If the lessees make an assignment of the lease, the $50,000 is income when forfeited. If the buildings depreciated below a value of $200,000 for any reason the $50,000 would go to replace the capital. If the lessees elect to purchase before 1929, this $50,000 shall be applied on the purchase price and will then be included in computing income.

We are of the opinion that this money was paid to deceased as security in the nature of a cash bond, and that the respondent erred in including it as income in the years received.

Reviewed by the Board.

Decision will be entered under Rule 50.