Rosenberg Inv. & Realty Trust v. Commissioner

ROSENBERG INVESTMENT & REALTY TRUST, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Rosenberg Inv. & Realty Trust v. Commissioner Docket No. 81963. United States Board of Tax Appeals 38 B.T.A. 1051; 1938 BTA LEXIS 793; October 28, 1938, Promulgated *793 No merger of leasehold estate with the fee results where there is an intervening estate in the leasehold in a third person, and petitioner is entitled to amortize the cost of the leasehold, notwithstanding it is the owner of the fee and owns the lease subject to the outstanding rights of such third person. Alfred Beck, Esq., for the petitioner. B. M. Brodsky, Esq., for the respondent. ARNOLD *1051 This proceeding involves a deficiency of $604.71 income tax for the year 1932. The question presented is whether petitioner is entitled to amortize amounts paid as rentals under a sublease when it is also the owner of a fee interest in the property subject to the sublease. The proceeding was submitted upon stipulated facts, documentary evidence, and briefs. FINDINGS OF FACT. The petitioner is a trust, taxable as an association, with its principal office in Evanston, Illinois. It was created under a declaration of trust executed on October 17, 1929, as of May 1, 1929. The purpose of its creation is hereinafter set forth. *1052 Under date of February 15, 1923, the Chicago Title & Trust Co., as trustee, and others, as lessors, demised*794 and leased certain property, known as the Mann property, to the S. Rosenbaum Co., a corporation, as lessee. By the terms of this indenture the Mann property was demised and leased for a period commencing March 1, 1923, and expiring February 29, 1948. In consideration of the "demise and lease" the lessee covenanted and agreed "to pay to the lessors as rental for said demised premises" the sum of $300,000, payable in equal monthly installments of $1,000 each in advance during the entire term. Furthermore, the lessee covenanted and agreed to pay all taxes, assessments, water rates, and special assessments, except income and inheritance taxes, levied on the demised premises during the term of the lease, to keep the buildings insured, to pay interest on a mortgage in the principal amount of $22,500 then on the fee, to prohibit any use of the premises in violation of law, to do and perform various other things connected with the maintenance of the demised premises, and to peaceably surrender the demised premises to the lessors immediately upon the expiration of the lease. The lessee was given the right to assign the lease and to make subleases, and the lessors agreed to assign and transfer*795 to the lessee the leases then in force. This indenture is hereinafter referred to as the underlying lease. Subsequently, and on February 11, 1929, Viola B. Rosenbaum, pursuant to a decree of the Superior Court of Cook County, bid in all the right, title, and interest of the lessee in the underlying lease. By master's deed dated April 2, 1929, executed by Sidney S. Pollack, master in chancery of the said court, all the right, title, and interest of the lessee in the underlying lease was sold, assigned, and delivered to the said Viola B. Rosenbaum. Rosenberg's, an Illinois corporation, operated a department store in Evanston, Illinois, on premises adjacent to the Mann property. The common stockholders of Rosenberg's were the same individuals as those who subsequently owned the certificates of beneficial interest in the petitioner. Under date of March 26, 1929, a trust agreement was executed, known as Trust No. 160, wherein it is stated that the Evanston Trust & Savings Bank, an Illinois corporation, as trustee, was about to take title to the leasehold estate created by a certain lease, dated March 26, 1929, between Viola B. Rosenbaum, a widow, as lessor, and the trustee of*796 Trust No. 160, as lessee, demising the property which was the subject of the underlying lease. The beneficiary of Trust No. 160 was Rosenberg's. Under date of March 26, 1929, Viola B. Rosenbaum, as lessor, demised and leased to the Evanston Trust & Savings Bank, as trustee of Trust No. 160, the Mann property hereinabove referred to. By the express terms of this lease the Mann property was sublet for *1053 the period commencing March 26, 1929, and ending February 28, 1948, or one day prior to the expiration of the underlying lease. The Evanston Trust & Savings Bank, as trustee, in this Trust No. 160, covenanted and agreed, in its capacity as lessee, to pay as rental the sum of $105,000, payable $52,500 in cash upon the signing and sealing of the lease, and $52,500 in equal monthly installments of $230.26 each, together with interest at 6 percent per annum upon the balance. The lessee further covenanted and agreed to perform in all respects the covenants, agreements, and conditions provided for in the underlying lease. The initial cash payment of $52,500 hereinabove referred to was made with funds of Rosenberg's. During the year 1929 Wieboldt Stores, Inc., hereinafter*797 referred to as Wieboldt's, an Illinois corporation engaged in the department store business, negotiated with Rosenberg's for the purchase of the latter's business. The contract of purchase was finally executed some time prior to October 18, 1929, as of May 1, 1929. At or about the same time the petitioner was formed in order to hold title to the Rosenberg property which was not sold to Wieboldt's and to concentrate certain holdings of the Rosenberg family, the members of which were the stockholders of Rosenberg's, and for certain other purposes. Under date of October 17, 1929, an indenture was entered into, as of May 1, 1929, between the trustee of Trust No. 160 as lessor, and Wieboldt Stores, Inc., as lessee. This instrument provides that for and in consideration of the rents hereinafter reserved, the lessor has demised and leased the premises described in the underlying lease which had been successively leased and sublet to the parties hereinabove named for a period commencing May 1, 1929, and ending February 27, 1948. The indenture expressly states that the lease was subject to (1) leases to parties in possession of portions of said premises, which leases are being assigned*798 to Wieboldt's simultaneously with the execution of this lease; (2) the lease dated February 15, 1923 (the underlying lease); and (3) the lease of March 26, 1929, between Viola B. Rosenbaum and Trust No. 160. Under this indenture Wieboldt's agreed to pay for the demised premises the rental reserved by the underlying lease, the rental reserved by Viola B. Rosenbaum, and other sums based on a percentage of net sales, so that the minimum rental per year would be at least $30,750 and the maximum rental would be not more than $4k,000 per year. Wieboldt's further covenanted and agreed to perform in all respects the covenants, agreements, conditions, and stipulations contained in the underlying lease, with certain stated exceptions not here material. By letter dated May 1, 1929, Rosenberg's assigned and transferred to Harry M. Rosenberg, Ira Rosenberg, and Clarence Mendelsohn, trustees of Rosenberg Investment & Realty Trust, all its rights, *1054 title, and beneficial interest in and under that certain trust agreement known as Trust No. 160, and in and to the subject matter of Trust No. 160. The assignment contained the following paragraph respecting the lease to Wieboldt's: "So*799 long as the lease of even date herewith on the premises covered by Trust No. 160 shall be in force, Trust Number 160 shall not be terminated or abandoned without the consent of Wieboldt Stores, Inc., an Illinois corporation, but except for the fact that such consent shall be prerequisite to the termination or abandonment of said Trust, said corporation shall have no interest therein." The Evanston Trust & Savings Bank, trustee under this Trust No. 160, consented to the foregoing assignment and directions of Rosenberg's, the beneficiary of the trust. Under date of October 17, 1929, as of May 1, 1929, the petitioner, as party of the first part, entered into an agreement with Rosenberg's and Wieboldt's, as parties of the second part, whereby petitioner agreed to indemnify and save harmless the second parties from, among other things, any loss or expense which second parties might sustain if occupancy of the premises described in the aforementioned leases and subleases were terminated by reason of (1) a default by Evanston Trust & Savings Bank, trustee, under Trust No. 160, as lessee under the lease of March 26, 1929, or (2) a reversal or modification of the decree entered by the Superior*800 Court of Cook County on December 28, 1928. On August 22, 1929, Harry M. Rosenberg, now deceased, who was a member of the Rosenberg family, a stockholder in and officer of Rosenberg's, one of the trustees of the petitioner, and a holder of certificates of beneficial interest therein, created Trust No. 170, with the Evanston Trust & Savings Bank as trustee, for the purpose of taking title to an undivided one-third interest in the Mann property. Harry M. Rosenberg was sole beneficiary of said trust. Thereafter, Trust No. 170 acquired the fee simple title to the Mann property by deeds executed on August 22, 1929, January 3, 1930, and February 1, 1930. Each of the deeds conveyed an undivided one-third interest in the Mann property to Trust No. 170, subject to the lease of February 15, 1923, herein referred to as the underlying lease. To secure part payment of moneys due as part of the purchase price on account of the purchase of a portion of the Mann property, Trust No. 170 executed its trust deed in the nature of a purchase money mortgage conveying said premises to the Chicago Title & Trust Co., as trustee, which trust deed was dated February 1, 1930, and was recorded on February 3, 1930. *801 The trust deed secured a principal indebtedness of $205,000, evidenced by two principal promissory notes of Trust No. 170, dated February 1, 1930, each of the notes being in the principal sum of $102,500, payable February 1, *1055 1940, with interest at the rate of 6 percent per annum, payable semiannually. The trust deed conveyed said premises subject to the existing leases. The two principal notes secured by the trust deed were endorsed by Harry M. Rosenberg and Ira Rosenberg. (Ira Rosenberg is a member of the Rosenberg family, was a stockholder in Rosenberg's, and is a trustee and holder of beneficial interest in the petitioner.) The cash payments required to purchase the fee simple title to the Mann property were made with funds provided by Rosenberg's and the petitioner. On February 2, 1930, Harry M. Rosenberg assigned and transferred to the petitioner all his right, title, and beneficial interest in and under Trust No. 170 and in and to the subject matter of said trust. The trustee of Trust No. 170 was directed to hold, deal with, and dispose of the subject matter of the trust in accordance with the direction of the trustees of the petitioner. On July 18, 1930, a*802 further trust agreement was executed in the matter of Trust No. 170 by the petitioner, covering the original one-third interest conveyed to the trust and including the remaining two-thirds interest in the fee acquired subsequent to August 22, 1929. The petitioner was the sole beneficiary under this trust agreement. During 1935 and 1936 the petitioner attempted to secure a loan from the Western & Southern Life Insurance Co. of Cincinnati, Ohio, for the purpose of refunding the mortgage of $205,000 hereinbefore mentioned. On February 25, 1936, the insurance company informed the petitioner that it refused to make the loan and contemplated mortgage securing the loan because of the existence of the underlying lease, for the reason that under Ohio law it was not permitted to make anything other than first mortgage loans and, in the opinion of the company's legal department, said indenture would be superior to the contemplated first mortgage. Trusts Nos. 160 and 170 are naked trusts, performing no managerial or other active duties. They receive no income and make no disbursements except as agents of the petitioner. Thus, Trust No. 160 receives monthly from the petitioner sufficient*803 funds with which to pay Viola B. Rosenbaum in accordance with the provisions of the lease of March 26, 1929, and makes the payments. These are the only items of income and disbursement of Trust No. 160. Trust No. 160 does not take any active part in the maintenance of the Mann property, does not cause repairs to be made, does not collect any rent or other income from said property, and in general does not manage the property in any way. All acts of management of the premises are carried on by the petitioner. Trust No. 170 receives no income and makes no disbursements, and in general does not manage the Mann property in any way, all acts of management of the premises being carried on by the petitioner. *1056 The fee of the Mann property is carried as an asset on the petitioner's books; the $205,000 mortgage thereon is carried as a liability on the petitioner's books; the petitioner reports the income received from the Mann property as its income for Federal income tax purposes and pays Federal income taxes thereon; the petitioner deducts on its Federal income tax return the amount which it pays as interest on the $205,000 mortgage; and, finally, the petitioner deducts*804 depreciation on the building located on the Mann property on its Federal income tax returns. In determining the deficiency the respondent disallowed a deduction of $5,526.24 representing amortization of the leasehold from Viola B. Rosenbaum. Having disallowed the amortization, the respondent reduced the cost of the lease by $1j,736.64, which represented amortization claimed and allowed up to January 1, 1932. This resulted in an unamortized cost of the leasehold of $90,263.36. Respondent allocated this unamortized cost between the land and the buildings in the same proportion that the petitioner allocated the cost of the fee to land and buildings on its books and allowed a 5 percent depreciation deduction on that portion of the unamortized cost allocated to the buildings. The parties have stipulated that if the petitioner is entitled to the claimed amortization deduction the additional depreciation allowed by the respondent in computing this deficiency is not allowable to the taxpayer; that the petitioner contends that the additional amount of depreciation allowed by the respondent, namely, $1,128.29, is insufficient if the petitioner is not entitled to amortization, but that*805 the time is too short to permit the parties to examine further into the question of the amount of additional depreciation properly allowable; that the petitioner desires to avoid the binding effect of a decision in this case with respect to the question of the depreciation properly allowable; and, therefore, the parties agree that the respondent's allowance of additional depreciation is to be disregarded in this proceeding, as, though no such allowance had been made in the deficiency notice, with the result that if the respondent's determination is sustained in this case, then the asserted deficiency of $604.71 shall be increased by 13 3/4 percent of $1,128.29, the amount allowed by the respondent as additional depreciation. OPINION. ARNOLD: Despite the complicated nature of the facts herein, this proceeding presents a question which can be stated in simple terms, namely, whether there has been such a merger of estates as to deprive the petitioner of the right to amortize the cost of its leasehold. Briefly stated, the question arises by virtue of a lease of the Mann property to the S. Rosenbaum Co., whose interest was thereafter *1057 acquired by Viola B. Rosenbaum. Viola*806 B. Rosenbaum subleased to Trust No. 160, and the latter subleased to Wieboldt's, thus completing the chain of title as to the leasehold estates. After the foregoing leases had been executed, the fee to the Mann property was acquired by Trust No. 170. It is stipulated that the petitioner became the sole beneficiary of Trust No. 160 and of Trust No. 170, the former holding the leasehold estate and the latter the fee to the Mann property. The petitioner was created by members of the Rosenberg family, and it was to their interest to see that the petitioner became the beneficial owner of the leasehold estate of Trust No. 160, and the fee estate of Trust No. 170. The parties, however, have stipulated that Trust No. 160 and Trust No. 170 were mere naked trusts, with no duties or activities, and each party proceeds on the theory that petitioner was the actual owner as well as the equitable owner of the leasehold and fee estates. Therefore, it would seem to require no particular comment on our part to justify our considering the issue as though petitioner was the actual owner of the leasehold estate and of the fee simple title to the Mann property, and our discussion of the problem will*807 be premised upon this conclusion. It is petitioner's contention that its leasehold estate was not merged in the fee later acquired, because its leasehold estate was subject to a substantial outstanding estate in a third party, namely, Viola B. Rosenbaum; that the law will not permit a merger of a leasehold estate with a fee simple estate where there is any intervening estate; and that practical considerations of accounting, conveyancing, and financing indicate the injustice which results from the respondent's refusal to allow petitioner to amortize the cost of its leasehold estate. The petitioner relies upon ; , and the legal definitions regarding the merger of estates which are hereinafter discussed. The respondent, while recognizing the force and effect of these legal definitions, denies that this petitioner is entitled to amortize the cost of its leasehold because, as a matter of substance, the petitioner is seeking to act both as landlord and as tenant to the same property. Respondent contends that petitioner's position is based upon a fiction of law and that petitioner*808 justifies its position because of the necessity of exactness in dealing with questions involving interests in real property. Respondent urges that taxation is a practical matter which is not so much concerned with refinements of title as it is with the actual command over the property taxed, and that, if consideration be given to substance rather than to form, petitioner has no right to amortize the cost of a leasehold estate in which it has acquired the fee simple title. The respondent points out that *1058 , is distinguishable from this case because there the taxpayer possessed only a part of the fee, and there were substantial and not merely fictional outstanding interests preventing the merger. He urges that this proceeding is controlled our decision in . The rule with respect to the merger of a lesser estate with a greater estate is stated by Bouvier's Law Dictionary, 3d Ed., vol. 11, p. 2197, as follows: "When a greater estate and less coincide and meet in one and the same person, without any intermedicate estate, the less is immediately merged, that is, sunk or drowned, in the*809 latter; but they must be in one and the same person at one and the same time, in one and the same right [citing cases]." The rule is stated in 21 Corpus Juris, 1035, as follows: "In order that there may be a merger it is essential that there be at least two distinct estates, a greater and a lesser, meeting in the same person, or class of persons, at the same time and without any intervening estate, * * *." The leading case in Illinois regarding leases, their assignment, and the subletting of the premises is ; . In that case the question to be determined was whether the Storage Co. was an assignee of the original lessee or only a sublessee. In its decision the court pointed out that the leases to Cole, the original lessee, and the lease from Cole to the Chicago Storage Co., each used the same identical language, namely, for and during the term of the lease and "until the 1st day of May, 1888." In commenting upon these facts the court stated: * * * No space of time, however minute, therefore, can by any possibility remain after the term of the storage company has ended before the expiration*810 of the term of Cole, in which he could enter upon or accept a surrender of the premises. The general principle as held by all the authorities is that, where the lessee assigns his whole estate, without reserving to himself a reversion therein, a privity of estate is at once created between his assignee and the original lessor, and the latter then has a right of action directly against the assignee on the covenants running with the land, one of which is that to pay rent; but if the lessee sublets the premises, reserving or retaining any reversion, however small, the privity of estate between the sublessee and the original landlord is not established, and the latter ract nor right of action against the former, there being neither privity of contract nor privity of estate between them. The chief difficulty has been in determining what constitutes such reservation of a reversion. [Italics supplied.] In the instant proceeding each of the lessors demised and leased a term for one day less than the term which was acquired under their own lease. For example, Viola Rosenbaum's lease expired February 29, 1948, but the term for which she demised and leased the Mann property expired*811 on February 28, 1948, and the term of Wieboldt's lease expired on February 27, 1948; thus each succeeding lease after *1059 the underlying lease was a demise for a term of one day less than the preceding leasehold estate. Therefore, there can be no question but what each lessor of the Mann property retained a reversionary interest therein, and so long as each leasehold estate remains in existence there will be a reentry of possession by the lessor prior to termination of its or her lease. ; ; . In addition Viola B. Rosenbaum reserved substantial rights in subletting the property, including the right to terminate the lease and repossess the property upon any default in payment of rent or in performance of the conditions and covenants of the agreement, and subject to the rights granted and reserved in the underlying lease. Neither these reserved rights nor the reversionary interest possessed by Viola B. Rosenbaum were ever acquired by the petitioner. It is our opinion, therefore, *812 that in view of the rights reserved by Viola B. Rosenbaum in the lease executed by her and in the underlying lease, and in view of the authorities hereinabove mentioned, there could be no merger of the petitioner's leasehold estate with its fee simple estate so long as those rights were outstanding in Viola B. Rosenbaum. The respondent urges, however, that, even though technically speaking and as a matter of law there may not be a merger under these facts, since taxation is a practical matter and since there is but a one-day interval with regard to Viola B. Rosenbaum's reversionary interest, for tax purposes we should look through technical refinements and recognize the substance of these transactions, which is, that petitioner is attempting to amortize a leasehold estate as to the same property in which it holds the fee simple estate. In the Henry Boos case, supra, relied upon by the respondent, the taxpayer had acquired a 99-year lease, with an option to purchase. This option was subsequently exercised and the fee simple title was acquired by the taxpayer. We refused to allow the taxpayer to amortize the cost of his leasehold estate upon the theory that there had*813 been a merger and that the cost of the property to him became the sum of the unamortized cost of the leasehold plus the amount expended to acquire the lessor's remainder interest. The facts in that case, however, are quite different from the present facts, because there was no intervening estate between the leasehold estate and the fee simple estate. When Boos purchased the fee simple title there was a meeting in the same person at the same time, without any intervening estate, of two distinct estates in property, and under the rule the lesser estate was absorbed or merged in the greater estate. It is impossible here for a merger to result, as the leasehold estate *1060 of Viola B. Rosenbaum bars any merger of the two estates that petitioner owns in the same property. The Wisconsin National Bank case, supra, upon which the petitioner relies, is likewise distinguishable from the instant proceeding upon its facts. In that case there was a lease of property followed by an acquisition of a one-third interest in the fee prior to the taxable year and a one-third interest in the fee during the taxable year Subsequent to the taxable year the tenant acquired the remaining*814 one-third interest in the fee and the question arose whether during the taxable year the petitioner was entitled to amortize the cost of its leasehold estate. We held that no merger f the lesser with the greater estate took place until the entire fee was acquired by the petitioner at a date subsequent to the taxable year there involved, and the petitioner was permitted to deduct an aliquot part of the fair market value at March 1, 1913, for exhaustion of the leasehold. The distinction between that case and the instant proceeding is that there was no intervening estate between the tenant and the original lessor, so that the purchase of the fee simple title by the tenant would result in a merger of the leasehold estate with the fee simple estate. Actually, therefore, there is no inconsistency between the Henry Boos case and Wisconsin National Bank case, but only a difference with respect to the degree of consummation in the purchase of the fee simple title by the tenant. In this proceeding, however, there has been a consummation of the purchase of the fee simple title, so that the petitioner holds not only a fee simple title to the property, but also a leasehold estate*815 therein. The difference between this case and the last two cases above mentioned is that we have an intervening estate in Viola B. Rosenbaum, which prevents a merger of the lesser estate with the greater estate. The petitioner acquired its property rights in the leasehold estate by virtue of the indenture of March 26, 1929, at a cost of $105,000. Later and by virtue of three separate deeds it acquired undivided one-third interests in the fee for a sum undisclosed by the record. The acquisition of the leasehold estate and of the fee simple estate represented the acquisition of separate property rights, each of which was a valuable asset to the petitioner. While each property right related to the same particular land and buildings, each estate was a separate and distinct property right. It is well recognized that a leasehold estate is a wasting asset and that the capital cost thereof is an exhaustible investment which is returnable by annual deductions spread over the term of the lease. , and cases cited therein. Since this is true and since the petitioner will have expended $105,000 in the acquisition of this exhaustible asset, it is entitled*816 to amortize the cost thereof over the remaining term of the lease. *1061 As the parties have proceeded upon the theory that petitioner was the owner of the leasehold estate and the fee estate, we deem it unnecessary to consider the technical question of whether a merger results when separate trusts having the same beneficiary and the same trustee hold title to the two estates. In view of the stipulation which the parties read into the record at the hearing, the additional depreciation of $1,128.29 allowed by respondent in computing the deficiency will be disallowed and the tax liability computed accordingly. Reviewed by the Board. Decision will be entered under Rule 50. DISNEY concurs only in the result.