Robertson v. Commissioner

E. G. ROBERTSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Robertson v. Commissioner

Docket No. 28867.

United States Board of Tax Appeals

19 B.T.A. 534; 1930 BTA LEXIS 2378;

April 9, 1930, Promulgated

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The real estate transactions of the petitioner based on a so-called lease option contract were sales on the installment plan and income therefrom should be computed on the installment basis.

Harry W. Hart, Esq., for the petitioner.

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

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LANSDON

The respondent asserted deficiencies in income tax against the petitioner for the years 1920, 1921, 1922, 1923, and 1924, in the respective amounts of $1,190.67, $568.35, $1,913.07, $963.22, and $318.06, only a portion of which is in dispute. In support of his appeal the petitioner alleges that the respondent committed error in treating certain payments received by him in each of the taxable years upon real estate transactions as rentals from real estate leases and, therefore, income to him for the year received; that, in fac, the major portion of such payment constituted part payments upon outstanding contracts for the sale of real estate between himself and clients, and formed no part of his taxable income when received.

FINDINGS OF FACT.

The petitioner is a resident of Wichita, Kans., and engaged in real estate operations in that city. A large part of his business consists in the marketing of new, moderate priced residence property acquired and developed by him in his own name. On account of the redemption laws of the State of Kansas, which make it possible for a purchaser in possession of property, either under a deed or contract of purchase, to hold the same for a period of eighteen months after default, without cost or obligations, the petitioner adopted a plan of makreting his properties through the employment of a lease and option contract in part as follows:

THIS LEASE, Made and entered into this 23rd day of May, 1922, by and between G. C. Robertson and E. G. Robertson, parties of the first part, hereinafter called Lessor, and M. E. Loder and Florence I. Loder, his wife, parties of the second part, hereinafter called Lessees.

WITNESSETH, That the said Lessor, in consideration of the rents, covenants and agreements of said Lessees hereinafter set forth, do by these present lease and rent to the said Lessees the following described property situated in Sedgwick County, State of Kansas, to-wit:

Lots number Eighty-two (82) and Eighty-four (84) on Ellis Avenue, McCormicks addition to the City of Wichita.

TO HAVE AND TO HOLD THE SAME unto the said Lessees from the Twenty-fourth day of May, 1922, to the 24th day of May, 1927, and the said Lessees as part of the rent from the leasing of the said premises as above set forth, herewith pays the said Lessor the sum One Hundred ($100.00) Dollars the receipt of which is hereby acknowledged by said Lessor, and said Lessees covenants and agrees to pay said Lessor, its successors or assigns as the remainder of the rent for such leasing of the premises aforesaid the insurance, taxes, and assessments duly levied against said property commencing with the taxes and assessments due and payable November First, 1922, and all the taxes duly levied and assessed against said property during the lifetime of this lease, also the sum of Twenty-one Hundred Fifty ($2150.00) Dollars to be paid as follows:

* * *

Hereby waiving the benefit of the exemption, valuation and appraisement laws of the said State of Kansas to secure the payment thereof.

The said Lessees further covenant with the said Lessor that at the expiration of this lease, by forfeiture or otherwise, they will give peaceful possession of the said premises to the said Lessor in as good condition as they are now, the usual wear, inevitable accidents and losses by fire excepted, and will then leave in place on said premises all fixtures and improvements added by said Lessees or assigns, and will not make or suffer any waste thereof, nor lease nor permit any other person to occupy the same, or make or suffer to be made any alterations therein without the consent of the said Lessor in writing, having been first obtained, and not use or occupy the said premises for any business or thing deemed extra hazardous on account of fire; and upon the non-payment within thirty days after the maturity of any of the payments of rent aforesaid, the said Lessor may at their election either distrain for said rent due, or declare this lease at an end and recover the said premises as if held by forcible detainer, the said Lessees hereby waiving any notice of said election or any demand for the possession of said premises, provided that a penalty charge of 4% of the amount due shall be charged by Lessor if Lessees do not make payments promptly on the dates when said payments are due, but are made within the thirty days aforesaid.

It is further stipulated and agreed between the parties hereto that the reception by the Lessor of any one or more of the said rental payments after the expiration of the said thirty days after maturity thereof shall be considered in no wise as a waiver of the rights of forfeiture as set out above by reason of the non-payment according to this lease of any of the other rental payment aforesaid.

It is further agreed as a part of this Lease that in case said Lessees or Assigns or anyone claiming through or under them or any of them do or cause anything to be done that casts a could upon said title, such could is to be removed by Lessees or Assigns without delay, and in case a deed be made hereunder, said Lessor may make said deed subject to said cloud, if the same be not removed prior thereto as stated above.

It is further understood and agreed between the parties hereto that the covenants herein made shall extend to and be binding upon the heirs, executors and administrators of the respective parties hereto.

OPTION TO PURCHASE

It is further stipulated and agreed between the parties hereto that if the said Lessees shall have promptly kept all of the covenants and agreements set out in this lease, then at the expiration of the term of this lease the said Lessees shall have the option of purchasing the said property, applying the rental payments so paid as stipulated above on the purchase price and paying in addition thereto the cash sum of Three Hundred Seventy-Six and 91/100 Dollars, and assuming the First Mortgage now thereon of One Thousand ($1000.00) Dollars, with interest thereon at seven per cent per annum from date of deed with privilege of paying principal at any interest maturity, and the second Mortgage of Fifty Dollars ($50.00) which is one per cent on the First Mortgage paid as commission, but it is expressly stipulated and agreed that in order that the said Lessees may be able to have and exercise the said option they must give to the said Lessor thirty days written notice immediately previous to the time when the said option can be exercised as aforesaid, and said Lessees having so exercised said option and paid the additional money as stipulated above shall be entitled to a Warranty Deed to said property from said Lessor, subject to and assuming said mortgages (and it is further agreed that in case said option so obtained is exercised to purchase said property, then the said Lessees shall accept the title of said Lessor, provided the same is as good as it now is, the same having been examined and approved at the date of the execution of this lease.

PRIVILEGE TO PAY OFF

It is further agreed and stipulated that, if at any time after the date of this lease, the said Lessees having previously complied with all the terms of this lease promptly desires to buy said property and pay all cash therefor, he shall, by giving thirty days written notice to the Lessor as aforesaid have the option of so purchasing, upon the payment of a sum equal to the amount that he has paid and would otherwise pay under the terms of this lease, as set out above, adding thereto the amount to be paid upon the delivery of the deed as set out above, but crediting upon the said sum all rents previously paid, and estmating and crediting the present value computed at 8 per cent per annum of all the rental payments remaining unpaid and of the said sum of $376.91. Said Lessee in addition thereto assuming said mortgages with interest from date of deed as above, according to the terms thereof.

It is, however, expressly understood and agreed by and between the parties hereto that time is of the essence of this lease, that if each rental payment stipulated for herein is not promptoly and punctually paid then any and all option or options or rights given to said Lessee by this lease in and to said property shall be forever cut off and barred, and said Lessor shall have immediate right to re-enter upon said property, and retain all previous payments made to him as Lessor, as rent, as well as said payments of taxes as stipulated above, and all improvements made upon said property by said Lessees.

IN WITNESS WHEREOF, The said parties have hereunto set their hands this 23rd day of May, 1922.

(Signed) G. C. ROBERTSON

BY E. G. ROBERTSON

E. G. ROBERTSON M. E. LODER

FLORENCE I. LODER

Under similar contracts prospective purchasers were given possession of the property they desired to acquire, and, upon the making of all payments and fulfillments of other requirements of their respective contracts, received deeds thereto. In each instance, preceding the execution of a lease-option contract, there was a verbal agreement had between the parties for a sale of the property effected. This agreement predetermined all details of the transaction which were thereafter to be carried out in effecting the sale. It fixed the total sale price for the property; the amount that should be paid before execution of the deed and the terms of such payment; the interest to be paid upon deferred payments, and the amount that should be carried over and secured, after conveyance, by note and mortgage back on the property. The prices at which the petitioner marketed his various properties, under the system adopted, ranged from $2,500 up to $6,000, and the terms of payments were determined in accordance with the requirements of each individual case without regard to the rental value of the property sold. In all contracts, after first deducting the initial payment which varied according to the circumstances of each case from $25 to $2,000, the balance of the part to be paid before execution of the deed was spread over a period of five years through provisions in the rental clause of the lease. The balance of the purchase price, to be paid after conveyance, was provided for in the "option" feature of the contract and fixed as the amount to be paid upon the exercising of the option. During the years involved, the petitioner collected from ninety or more of these contracts, as first payments, rents and otherwise, amounts in the aggregate as shown in the following column:

	Rent	Rent bonus	Total
1920	$13,410.00	$6,925.00	$20,335.00
1921	19,682.85	3,896.75	23,579.60
1922	21,762.10	4,013.75	25,775.85
1923	24,314.84	1,125.00	25,439.84
1924	22,440.12	1,175.00	23,615.12

The respondent determined that the petitioner derived taxable income in the amount collected, as shown above, parts of which the petitioner now concedes. These amounts, as claimed by the respondent and conceded by the petitioner, are shown for the years as follows:

Year	Respondent's determination	Conceded by petitioner	Amount disputed
1920	$15,831.54	$2,565.13	$13,266.41
1921	10,589.19	10,373.70	205.49
1922	21,876.65	10,523.93	11,352.72
1923	18,373.34	17,284.80	1,088.50
1924	13,495.60	15,626.44

It is stipulated that the difference, as shown above, between the amounts determined by the respondent and those conceded by the petitioner, is the amount of taxable income in dispute, and that the differences arise by reason of the Commissioner including and charging as rents received the sums received by the petitioner in connection with the sale of real estate under contracts as hereinabove set forth.

OPINION.

LANSDON: The respondent contends that the instruments used by the petitioner in his real estate transactions were plan leases, coupled with options to purchase the property described therein; and that, for this reason, the payments in controversy which were made under them must be regarded as income from leased property and for the year received. The petitioner contends that these instruments, in view of the purposes for which they were employed and the prior understandings which formed the inducement for their execution, must be regarded as contracts of sale for the property described therein, and that collections thereunder, otherwise called rent, except in cases of their forfeiture through default or abandonment and to the extent of which they are interest, must be regarded as payments upon the purchase price.

If the issues here could be determined by a narrow construction of the bare contract in evidence, the decision would be simple, since we consider the law too well settled to admit of an extension of its provisions beyond their plain written terms. Such instruments are lease-option contracts and not contracts for sale of real estate, ; ; ; . The question, however, as to what constitutes taxable income is one of fact and can not be determined alone by a mere regard to the form of instrument under which it was collected. It is the character of the transaction which produced the funds collected, as governed by the intent of the parties in carrying it out, that must determine the character of such funds in the hands of the taxpayer.

In the cases involved here, if the parties to the lease-option contracts, by their acts, intended in each instance to effect nothing more than a lease of the properties described to the lessee named for the period designated, with no thought of committing themselves to a sale, except as provided for in the option feature of the contract, then their relationship throughout was one of landlord and tenant and the payments were rent under the lease. If, however, as claimed by the petitioner, a verbal agreement of sale of the property involved preceded the execution of each of these contracts, and the parties in so executing and carrying them out at all times intended to accomplish a sale of the property described in the lease from the lessor to the lessee, and the lessor and lessees intended that the payments made by the latter to the former under the rental provisions of the leases should be credited upon the purchase price of such property, then such payments must be regarded as purchase-price payments and only so much thereof as represents profit to the lessor, when ascertained, may be attributed to taxable income.

The record here shows that the petitioner, who for many years has been engaged in real estate operations, acquired each of the properties involved in these considerations for the purpose of development and sale on a deferred payment plan to persons of moderate circumstances. That because of the small advance payments required of his buyers upon their taking possession of the property, and owing to the liberal provisions of the Kansas redemption laws in favor of such buyers once in possession, the petitioner considered that the plan most commonly employed in selling homes on the installment plan failed to afford him adequate protection against defaulting purchasers, and for this reason he brought into use the lease-option contract system as shown. None of these leases were executed by the petitioner except in favor of parties who had first agreed to purchase the property involved and in accordance with terms of payments on the purchase price in amounts and at dates as set forth in the lease under the rental and option provisions. In other words, a bona fide agreement of sale was in fact first made between the parties, complete in every respect except for the writing. Under such circumstances, the sale was effective without the writing upon delivery of possession of the property, but under the Kansas redemption laws such possession could be held by the purchaser for a period of eighteen months, without further payments, and it was to prevent such an adverse holding that the system here shown was called into play.

We think the record here supports the hypothesis last suggested. The only evidence as to the intent of the parties in entering into the contracts under consideration is the testimony of the petitioner, who states that in each and every case a sale of the property affected was intended, and that deeds were invariably issued conveying the same to the lessee named upon a full compliance with the terms. He also stated that, although he carried on a regular rental business of other properties, none of the properties involved in the transactions under consideration were either acquired, developed, or held by him except for purposes of sale, and that in effecting these sales, with the consent of the purchasers, the lease-option form was employed because it would enable him more easily to recover possession of the property in case of default. This testimony is consistent with other attending circumstances and, being in no way contradicted, must be accepted as proof of the intent of the parties in carrying out the transactions which gave rise to the revenues in dispute. The intent of the parties to these transactions being to accomplish sales, we think the law must give such effect to them regardless of the forms employed. In thus interpreting these several transactions, we make no attempt to ignore or vary the terms of the written instruments or to declare them to be something different from what they purport to be, but since such instruments evidence only a part of the agreements between the parties, we take notice of the objects sought to be accomplished and the agreements which induced their execution, ; ; . In the transactions between the petitioner and his clients they were selling and purchasing real property and we must so hold, , and although in the interim between the signing of the contract and the final payment under the option, their relationship was that of landlord and tenants, yet, by virtue of the options, these purchasing tenants acquired valuable rights over and above a leasehold estate in the properties. These interests included the exclusive right to acquire complete ownership of the property and to take credit upon the agreed purchase price for all of the payments made by them under the rental clauses in said contracts. ; ; ; ; ; ; ; . Correspondingly, by these contracts the petitioner parted with the interests acquired by his tenants and, in each case, was bound to hold all payments in excess of interest charges made by them for credit upon the agreed purchase price of the property. It is true that in case of default or abandonment of any of these contracts by the purchasing tenants, all payments made by them became income to the petitioner, but these are matters entirely within the control of the tenant and not the petitioner, and since the record here shows that no such contingencies have affected the status of any part of the funds in dispute, we must treat them as intended by the parties.

Our decision that the transactions here involved were, in fact, sales of real estate leaves open the question as to the correct rule for determining and taxing the income resulting therefrom. There are two well established methods for computing the taxes on income included in payments received from real estate sales, viz., the completed sales and installment bases. The method proposed by the petitioner conforms to neither, but it is contended that it is the only way in which the true income and tax liability resulting from the transaction here involved can be computed. We are not convinced that this is true. In our opinion the deals in question were sales of real estate on the installment plan, and the income realized therefrom should be reported on the installment basis.

Reviewed by the Board.

Decision will be entered under Rule 50.