New Capital Hotel, Inc. v. Commissioner

New Capital Hotel, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent New Capital Hotel, Inc. v. Commissioner Docket No. 57299 United States Tax Court 28 T.C. 706; 1957 U.S. Tax Ct. LEXIS 151; June 25, 1957, Filed *151 Decision will be entered for the respondent. Petitioner lessor, an accrual basis taxpayer, entered into a lease contract in 1949 for a 10-year period, 1950 to 1959, inclusive, with a rental of $ 30,000 per year. Petitioner received an advance payment of $ 30,000 in 1949, which was to cover the rent for the last year of the lease, 1959. The sole question involved is whether the advance payment of $ 30,000 received by the petitioner in 1949 was includible in petitioner's gross income for that year, as determined by the respondent. Held, respondent's determination upheld. Advance payment was primarily rent and is includible in gross income in the year of receipt rather than in a subsequent year regardless of the fact that the petitioner is on an accrual basis. J. Bernard Brown, Esq., for the petitioner. David M. Robinson, Esq., for the respondent. Black, Judge. BLACK *706 The respondent determined a deficiency in petitioner's income tax for the year 1949 in the amount of $ 11,724.50. The sole issue is whether a $ 30,000 advance payment received in 1949 by the petitioner lessor, an accrual basis taxpayer, pursuant to lease contract is includible in gross income in 1949, as determined by the respondent, or in 1959, the year in which the advance payment is to be applied as rent. FINDINGS OF FACT. Some of the facts were stipulated and are incorporated herein by this reference. The petitioner, New Capital Hotel, Inc., hereinafter sometimes referred to as lessor, is a corporation organized and existing under the laws of the Commonwealth of Kentucky. It is engaged in the real estate rental business and has its principal office and place of business at Frankfort, Kentucky. The petitioner, for the year 1949, reported its income on an accrual method of accounting, *153 the method of accounting regularly employed in keeping its books. It filed its corporation income tax return for the year 1949 with the then collector of internal revenue for the district of Kentucky. The petitioner owns property located in the city of Frankfort, Kentucky, known as Capital Hotel Company Property, on which a hotel business is operated by a lessee. A lease with American Hotel Corporation expired on December 31, 1949. The petitioner entered into a lease contract dated August 12, 1949, with Capital City Hotel Corporation, hereinafter sometimes referred to as lessee, for a 10-year period from January 1, 1950, to December 31, 1959. The lease, inter alia, provided: *707 1. Lessee covenants with the Lessor that he will: 1. Pay to the Hotel Company, the Lessor, rents as follows: Thirty Thousand Dollars ($ 30,000.00) for each year of this lease, payable monthly, at the rate of Twenty-Five Hundred Dollars ($ 2500.00), at the end of each month, on the first day of each and every month throughout the first nine years of this lease. And, for the last year of this lease, Lessee agrees to pay in advance the sum of Thirty Thousand Dollars ( $ 30,000.00), the receipt*154 of which is hereby acknowledged. Said sum, however, shall apply only on the rental for the last year of this lease. * * * * It is further agreed between the parties hereto: * * * * (b) In the event said building shall be totally or substantially destroyed by fire or other elements at any time during the first nine years of this lease, the first party shall refund to second party the $ 30,000.00 hereinbefore referred to, or in the event such property should be totally or partially destroyed by fire or other elements during the tenth year of such lease, such part of said sum of $ 30,000.00 as may not cover the rental of the property up to the time of such destruction, if any. Provided, however, no rental is then in arrears. The petitioner received an advance payment of $ 30,000 in 1949 in accordance with the terms of the lease contract. The lessee preferred the term of the contract requiring the advance rental payment rather than execute a performance bond which the lessor was demanding. The petitioner paid no interest to the lessee on the $ 30,000. The petitioner had unfettered control and unrestricted use of the $ 30,000. The advance payment was primarily rent. Petitioner did*155 not reflect on its books the receipt of the $ 30,000 as income in 1949; it reflected the $ 30,000 in question on the December 31, 1949, balance sheet in a liability account entitled "Deposit on lease contract." OPINION. The sole question involved here is whether the $ 30,000 advance payment received in 1949 by the petitioner is includible in its gross income for that year. The petitioner lessor leased certain hotel property, which it owned, for a period of 10 years from January 1, 1950, to December 31, 1959. The lease contract provided that the lessee would pay rents as follows: $ 30,000 during each year of the lease and "for the last year of this lease, Lessee agrees to pay in advance the sum of Thirty thousand Dollars ($ 30,000.00), the receipt of which is hereby acknowledged. Said sum, however, shall apply only on the rental for the last year of this lease." The lease also provided that if the building should be substantially destroyed during the period of the lease the lessor shall refund to the lessee all or part of the $ 30,000 as may not cover the rental of the property up to the time of such destruction, provided, however, that no rental is then in arrears. *708 The*156 petitioner's president testified that the lessee preferred paying the last year's rent in advance rather than executing a performance bond, which the lessor was demanding. The lessee, during 1949, paid the above-mentioned $ 30,000 to the petitioner. There were no restrictions on the use of the $ 30,000; the petitioner had unfettered control over it. The petitioner, an accural basis taxpayer, reflected the advance rental payment in a liability account entitled "Deposit on lease contract" and contends that it should be reported as income in 1959, the year in which petitioner contends it would be considered as earned. The respondent determined that the $ 30,000 constituted gross income in 1949, the year of receipt, under section 22 (a), Internal Revenue Code of 1939. 1 It is clear from the record that the advance payment, although securing the lessee's performance of the covenants, *157 was intended to be rent, was described in the lease contract as rent, and was primarily rent. Gilken Corporation, 10 T. C. 445, 451-456 (1948), affd. (C. A. 6, 1949) 176 F. 2d 141, 144-145. Since the rent was received in 1949, it would be includible in gross income in that year even though the rent is to be applied for the use of the property in 1959. Hirsch Improvement Co. v. Commissioner, (C. A. 2, 1944) 143 F. 2d 912, affirming a Memorandum Opinion of this Court. This is so regardless of whether the taxpayer keeps his books and computes his income on a cash basis, see Edwin B. De Golia, 40 B. T. A. 845 (1939), or on an accrual basis, see Palm Beach Aero Corporation, 17 T. C. 1169, 1170, 1177-1178 (1952); Hyde Park Realty, Inc. v. Commissioner, (C. A. 2, 1954) 211 F. 2d 462, affirming 20 T. C. 43 (1953). The petitioner argues that its method of accounting clearly reflects its income and that the inclusion of the rent in gross income for the year 1949, rather than*158 1959, will distort its income for the 2 years because in 1959 it will incur approximately $ 23,000 in expenses incident to the earning of the $ 30,000 rent. 2 We have recognized that the inclusion of prepaid income in gross income in the year of receipt of the item representing it, rather than in a subsequent year when it is considered earned, is not in accord with principles of commercial accounting. See Curtis R. Andrews, 23 T. C. 1026, 1033-1034 (1955); E. W. Schuessler, 24 T. C. 247, 249 (1955), reversed (C. A. 5, 1956) 230 F. 2d 722.*159 We have, however, *709 consistently held that the Commissioner has acted within the discretion granted him under section 41 of the 1939 Code in holding that prepaid income must be returned in the year received in order to clearly reflect income. Cf. Automobile Club of Michigan v. Commissioner, 353 U.S. 180, 188-190 (1957). In the instant case the petitioner seeks to defer a nonrecurring advance rental payment 3 for a period of 10 years. 4 Under the circumstances detailed in our Findings of Fact we cannot say that the Commissioner abused the discretion granted him in section 41, Internal Revenue Code of 1939, in determining that the $ 30,000 was includible in the petitioner's gross income in 1949. *160 Among the decisions which petitioner relies on in its brief in support of its contention that the $ 30,000 is not taxable in 1949, is John Mantell, 17 T. C. 1143 (1952). We think the facts of the instant case are clearly distinguishable from those present in the Mantell case. In the Mantell case our Findings of Fact made clear that the $ 33,320, which was involved there, was not meant to be paid as advance rental. It was paid primarily to be held as security to guarantee the performance by the lessees of the obligations and covenants contained in the lease. The next to the last paragraph of our Findings of Fact in the Mantell case enumerates the several things for which the $ 33,320 was to act as security to guarantee that the lessees would perform. Our Findings of Fact then conclude with the following final paragraph (p. 1147): The sum of $ 33,320 received by the petitioner upon the execution of the lease in 1946 was intended to be and was in fact a security deposit. It was not paid as prepaid rent and was not taxable income when received. Manifestly, we could make no such finding in the instant case because the lease agreement itself*161 provides: And, for the last year of this lease, Lessee agrees to pay in advance the sum of Thirty Thousand Dollars ($ 30,000.00), the receipt of which is hereby acknowledged. Said sum, however, shall apply only on the rental for the last year of this lease. That the $ 30,000 in question was paid by the lessee as advance rental for the year 1959 seems too clear for argument and, under the authorities cited, we must hold that it was taxable income to petitioner in the year 1949, when it was received. Decision will be entered for the respondent. Footnotes 1. SEC. 22. GROSS INCOME. (a) General Definition. -- "Gross income" includes gains, profits, and income derived from * * * rent, * * *↩ 2. The petitioner, in its reply brief, apparently also contends that if the $ 30,000 is includible in its 1949 gross income it should be allowed a deduction of $ 23,000 for expenses to be incurred in 1959 in connection with the earning of the rent. This issue has not been properly pleaded and is not properly before us. Regardless, it has no merit. See Bressner Radio, Inc., 28 T. C. 378↩ (1957). 3. There is no contention that the Commissioner's action in this case will upset a consistent accounting system of long standing. Cf. Pacific Grape Products Co., 17 T. C. 1097 (1952), revd. (C. A. 9, 1955) 219 F. 2d 862↩. 4. Even under the liberalized provisions for reporting prepaid income under the short-lived section 452 (b), Internal Revenue Code of 1954↩, a prepayment 10 years in advance, such as the one involved herein, would be includible in gross income ratably in the year of receipt and the next succeeding 5 years unless the Secretary or his delegate prescribed otherwise. See S. Rept. No. 1622, 83d Cong., 2d Sess. (1954), pp. 301, 302.