Lab Estates, Inc. v. Commissioner

Lab Estates, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Lab Estates, Inc. v. Commissioner Docket No. 18595 United States Tax Court 13 T.C. 811; 1949 U.S. Tax Ct. LEXIS 30; November 29, 1949, Promulgated *30 Decision will be entered under Rule 50. Petitioner, in order to retain tenants, in the taxable year forgave unpaid rents, accrued both in the taxable year and previous years. Held, the amounts forgiven are deductible from gross income as business expenses or as losses. Sec. 23 (a) (1) (A) and (f), I. R. C. Walter F. Sloan, Esq., and Z. N. Diamond, Esq., for the petitioner. J. Richard Riggles, Jr., Esq., for the respondent. Disney, Judge. DISNEY *811 This proceeding involves a deficiency of $ 32,265.74 in excess profits tax asserted against the petitioner for the year 1944. The question for our determination *31 is whether the total amount of rent arrearage forgiven by the petitioner-landlord is an allowable deduction in computing its taxable net income for that year. In the alternative, petitioner argues that, if the total amount of rent arrearage forgiven in 1944 is not deductible, then the rentals which became payable and were accrued on its books during 1944 and which were forgiven by the petitioner in the same year should not be included in its income for that year. The case was submitted on a stipulation of facts and oral and documentary evidence. The facts as stipulated are so found. Such part thereof as it is considered necessary to set forth is included with other facts found from the evidence adduced in our findings of fact. FINDINGS OF FACT. Lab Estates, Inc., petitioner herein, was incorporated on September 24, 1925, under the laws of the State of New York. Its excess profits tax return for the year 1944 was filed with the collector of internal revenue for the third district of New York. Petitioner kept its books and filed its tax returns on an accrual basis. *812 From July 15, 1936, and continuously thereafter to the present time, petitioner owned the property known*32 as "The Berkshire," consisting of a hotel and stores in a building located at 500 Madison Avenue, New York City. From July 15 to December 4, 1936, petitioner operated "The Berkshire;" on which latter date the 21 East 52nd Street Corporation became the operator of the hotel property. On August 31, 1939, petitioner resumed the operation of the hotel property and continued to operate it up to the present time. On the date petitioner resumed the operation of "The Berkshire" it became the assignee of the leases and all rights thereunder, including the accrued and unpaid rents. On October 8, 1936, petitioner leased to Livingston Gowns, Inc. (hereinafter sometimes referred to as Livingston), an exclusive ladies' wear shop, the store known as Store No. 1, in "The Berkshire" for a term of four years and eleven months, commencing on November 1, 1936. On July 21, 1937, the 21 East 52nd Street Corporation, the then operator of "The Berkshire," leased to Livingston the store known as Store No. 2, in "The Berkshire" for a term of one year, commencing October 1, 1937, with an option to renew for a further term of four years. On September 30, 1942, the leases for Stores Nos. 1 and 2 were merged*33 and extended for a two-year period, the annual rental being set at $ 12,800, payable monthly. For the period of time during which petitioner operated the hotel property the rents payable to petitioner by Livingston were accrued on the books of petitioner and the rents so accrued for the years 1940 to 1944, inclusive, were included in gross income of petitioner for those years. On August 11, 1936, petitioner leased to Tyra Hat Shop, Inc., (hereinafter sometimes referred to as Tyra) an exclusive millinery shop, Store No. 3 in "The Berkshire" for a term of two years and eight months, commencing August 1, 1936. The lease was extended from time to time until March 31, 1943, from which date it was operated on a year to year basis. The annual rental under the lease was as follows: $ 4,400 from August 1, 1936, to March 31, 1937; $ 4,600 for the next year of the term; $ 5,000 for the last year of the term. During the period from May 1, 1939, to March 31, 1942, the annual rental was $ 5,500, at which latter date the amount was reduced to $ 5,000. For the periods of time during which petitioner operated the hotel property, the rents payable to petitioner by Tyra were accrued on the books *34 of petitioner and the rents so accrued for the years 1940 to 1944, inclusive, were included in gross income of petitioner for those years. During the period from June 1938 to September 1944, Livingston made payments on account of the rent due, but did not keep the rent paid in full. On December 31, 1943, rent arrearages due petitioner *813 from Livingston totaled $ 12,050. From January 1 to September 30, 1944, petitioner accrued on its books and included in gross income the amount of $ 9,600.03, representing the rents which became payable by Livingston to petitioner for that period. During that same period Livingston made rent payments to petitioner in an amount of $ 5,300.04, resulting in an increase of $ 4,299.99 in the rent arrearages due petitioner from Livingston, thereby making the total rent arrearages due petitioner from Livingston on September 30, 1944, an amount of $ 16,349.99. During the period from May 1939 to September 1944, Tyra made payments on account of the rent due, but did not keep the rent paid in full. On December 31, 1943, rent arrearages due petitioner from Tyra totaled $ 6,491.70. From January 1 to September 30, 1944, petitioner accrued on its books*35 and included in gross income the amount of $ 3,750.03 representing the rents which became payable by Tyra to petitioner for that period. During that same period Tyra made rent payments to petitioner in an amount of $ 3,516.66, resulting in an increase of $ 233.37 in the rent arrearages due petitioner from Tyra, thereby making the total rent arrearages due petitioner from Tyra on September 30, 1944, an amount of $ 6,725.07. Petitioner applied current payments received on account of rents from Livingston and Tyra to the oldest rent arrearages. There was no agreement between petitioner and Livingston or petitioner and Tyra to apply any payments to rent currently due in the month of payment. During the period when Livingston and Tyra were in arrears in payment of rent, petitioner made numerous efforts to secure payment in full. Petitioner's assistant secretary-manager, as well as its accountants, interviewed them frequently and advised them of the extent of the arrearages and requested that payment be made or that arrangements for payment be made. Statements of arrearages and requests for payment in full accompanied the monthly bills. Petitioner did not bring suit or even threaten*36 to bring suit in its effort to collect the amounts in arrearages. During September 1944 both Livingston and Tyra requested that they be relieved of the rent arrearages and that their rental obligations be reduced. Petitioner, thereafter and in the latter part of 1944, entered into a rent settlement with them whereby the above mentioned rent arrearages were canceled, and effective as of October 1, 1944, the rental obligation of Livingston was reduced to a minimum of $ 10,000 per annum. A new lease for one year was entered into between petitioner and Tyra, as of October 1, 1944, at a rental of $ 5,000 per annum. Both Livingston and Tyra enhanced the business reputation of "The Berkshire" by presenting a good appearance and fine window *814 displays and attracting a high type of clientele. At the time Livingston and Tyra requested that the rent arrearages be canceled, petitioner knew that both tenants were negotiating to lease stores at other locations. Petitioner received many offers for the space occupied by Livingston and Tyra, all of which were for less than the amount of rentals called for from Livingston and Tyra, except one, which was for the use of the space for a drug*37 store. On March 19, 1947, petitioner and Livingston entered into a lease for Stores Nos. 1 and 2, commencing as of October 1, 1946, at a rental of $ 15,000 per annum, and at the time of the hearing of this case both Livingston and Tyra were meeting their rental obligations promptly. There is no relationship between petitioner and Livingston or between petitioner and Tyra except that of landlord and tenant. OPINION. The petitioner's position is, primarily, that for business reasons and considerations it agreed to nonpayment of certain rents, which were in arrears, that no gift was involved, and that the amounts are proper deductions as expense of business, or a loss. It is not concluded that the arrearages represented bad debts. The matter must be shown to be within the statute. Spring City Foundry Co. v. Commissioner, 292 U.S. 182; New Colonial Ice Co. v. Helvering, 292 U.S. 435. The respondent argues that the total amount of rent arrearages due to and forgiven by the petitioner is neither an ordinary and necessary business expense nor a loss as provided by section 23 (a) and (f) of the Internal Revenue Code. *38 He argues that "The same factor which principally militates against the deduction of the canceled indebtedness under the bad debt provision applies, however, to prevent the transactions from qualifying as losses," i. e., the petitioner has not pointed to any circumstances to indicate that the debt was worthless, and, further, that disposition in the nature of a purchase of something of unascertainable value is not an "identifiable event" which can make the determination of a loss possible. The respondent, to substantiate his claim that the cancellation of the arrearages did not constitute a loss, relies on Lee Mercantile Co. v. Commissioner, 79 Fed. (2d) 391. His argument appears to be that the case is authority for the principle that a loss can not be claimed when a taxpayer makes a voluntary adjustment of an account owed by a customer. The taxpayer in the Mercantile Co. case was seeking a loss for the year 1927, but the court held that the record did not disclose any identifiable event by which to associate the loss with the 1927 tax year. That fact alone was sufficient for the court to hold as it did. The cloth involved had been delivered*39 in 1920. *815 The taxpayer there did not contend, as here, that the amount involved was a deductible business expense. The customer was affirmatively shown to be a large and responsible concern, able to respond in damages. No business reason was shown for not recouping the loss. We consider the case not helpful here. In contrast the instant case does have an identifiable event during the taxable year to connect it with the loss claimed. Such an event transpired when, during September 1944, both Livingston and Tyra requested that they be relieved of the rent arrearages and that their rental obligations be reduced. In consideration of that request, along with the fact that petitioner knew that both tenants were negotiating to lease stores at other locations, and their promise to continue the lease, petitioner forgave the arrearages here in question. There can be no question in the instant case but that the accrual of the rent arrearages at the particular intervals was a proper transaction; in fact, neither party suggests otherwise. That being true, i. e., the accrual of the rental income being proper, petitioner would not now have the privilege of eliminating this income*40 on its previous tax returns. See B. F. Avery & Sons, Inc., 26 B. T. A. 1393. Neither can there be any question as to petitioner's reasons for forgiving the arrearages. It is certain that its acts could not be interpreted as bestowing gifts on its tenants. Petitioner's assistant secretary-manager testified that its forgiveness of the arrearages was based on the fact that both Livingston and Tyra were very desirable tenants in that they enhanced the business reputation of "The Berkshire" by presenting a good appearance and attracting a high type of clientele. Filing of a suit would have been bad business, for it might have caused the tenants to press their negotiations to lease stores at other locations. See Cruger Co., 11 B. T. A. 306. In Helvetia Milk Condensing Co., 5 B. T. A. 271, the question was considered as to when certain credits of payments made to jobbers constituted a reduction of the company's gross sales. There we held that the deduction was to be taken in the year of payment, because the liability did not accrue until payment was made. The facts in that case are different*41 from the facts in the instant case, but the legal principle applied there has a close resemblance to the one to be applied in the instant case. The same principle was applied in Chicago Pneumatic Tool Co., 21 B. T. A. 569, cited and relied on by the petitioner. Petitioner had taxable income and paid a tax thereon, i. e., as to the amounts accrued on its books before January 1, 1944. Livingston and Tyra requested the rent arrearages be adjusted. We are not called upon to judge the wisdom of the petitioner's decision in granting the request. The fact is that it forgave the tenants of all the *816 rent arrearages due September 30, 1944. The case is a close corollary to the Chicago Pneumatic Tool Co. case. There the company found it necessary to adjust and reduce the prices of inventory on hand and we held that the credits representing such payments constituted a deductible loss, although the forgiving corporation owned the stock of those forgiven. Here there was no relationship between petitioner and Livingston and Tyra, except that of landlord and tenant. Nothing indicates donative intent, and business reasons appear for throwing off the*42 amounts involved. The matter appears to us to come logically and clearly within business expense incurred, under section 23 (a) (1) (A) of the Internal Revenue Code, or loss, under section 23 (f). We so hold. We see no real difference in principle between the rent arrearages accruing before January 1, 1944, and those accruing between January 1 and September 30, 1944. In any event, our holding on the first issue that the total amount of rent arrearage forgiven by the petitioner-landlord is an allowable deduction in computing its taxable net income makes a decision of petitioner's alternative contention unnecessary. Because of other adjustments in the deficiency notice, not specified as error in the petition, Decision will be entered under Rule 50.