De Golia v. Commissioner

EDWIN B. DE GOLIA AND EVA R. DE GOLIA, HUSBAND AND WIFE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. De Golia v. Commissioner Docket No. 91130. United States Board of Tax Appeals 40 B.T.A. 845; 1939 BTA LEXIS 794; October 31, 1939, Promulgated *794 A sum of money paid to lessors, on the cash basis, upon execution of a lease, which is applicable to rent for the last months of the term of the lease, in the event the lessees comply with all covenants, constituted income, taxable to the lessors in the year in which received, where no provision appears in the lease for the return of any part of the payment to the lessee upon the happening of any contingency in the future. R. A. Bronson, Esq., and Walter Hood, C.P.A., for the petitioners. Alva C. Baird, Esq., and Arthur L. Murray, Esq., for the respondent. HARRON *845 The Commissioner determined a deficiency in income tax for the year 1935 in the amount of $1,864.32. The only question is whether the sum of $20,000 received by petitioners, as lessors, in 1935 under the terms of a lease agreement, which sum is applicable to rent for the last months of the lease, constitutes taxable income in the year received. FINDINGS OF FACT. Edwin B. De Golia and Eva R. De Golia, residents of San Francisco, California, filed a joint income tax return, as husband and wife, for the calendar year 1935. The petitioners own certain real property*795 situated in San Francisco, and buildings located thereon and furnishings and fixtures. The main building on the realty is a sixteen-story hotel, known as the Maurice Hotel. Petitioners leased the premises, the buildings situated on the premises, and all furnishings and equipment contained in the buildings, to the Maurice Hotel Co., a Nevada corporation, under a written indenture of lease executed April 1, 1935, for a period of ten years *846 ending March 31, 1945. The agreed minimum rental to be paid by the lessee is $2,000, payable on the first of each month, beginning April 1, 1935. The lessee agreed to pay as additional rental, on or before the twentieth day of each month, a sum equal to the excess of 30 percent of gross room revenue received for the prior month above $2,000. The lessee agreed to operate a first class hotel on the premises; to maintain the premises in compliance with health and police regulations; to maintain, at its own expense, the interior of the premises and the furnishings and equipment in first class condition, at an expenditure of not more than $5,000 a year; to carry certain insurance to protect both the lessors and the lessee. The lessors*796 agreed to carry certain insurance and to maintain the exterior of the premises. The lease can be terminated, upon due notice, by the lessors upon injury to the building from fire, earthquake, or other causes, if the cost of repairs for injury amounts to $100,000 or more. The lease, among other things, provides in article II as follows: Rental. Section 3. Concurrently with the execution of this lease, the Lessee has paid to the Lessors the sum of Twenty-two Thousand Dollars ($22,000), receipt whereof is hereby acknowledged by the Lessors, Two Thousand Dollars ($2,000) of which said amount is in payment of the minimum payment agreed to be made in Section 2 of this Article II, and the remaining Twenty Thousand Dollars ($20,000) of which is a deposit to secure the faithful and prompt performance by the Lessee of all of the terms, covenants and conditions herein contained, which said sum of Twenty Thousand Dollars ($20,000) shall apply, in the event said faithful performance is had, upon the minimum monthly payments due the Lessors in accordance with Section 2 hereof, for the last ten (10) months of the term of this Lease. The Lessors shall not be required to pay to the*797 Lessee interest upon said sum of Twenty Thousand Dollars ($20,000) or any part thereof. The lease, by article IX, gives the lessee an option to renew the lease for an additional period of five years, to March 31, 1950, by giving written notice of its intention to exercise the option to renew. In the event the term of the lease is extended the rentals for the additional period shall be at the same rate, and, concurrently with the giving of the notice, the lessee shall pay the lessors the sum of $20,000: * * * as and for a deposit to secure the faithful and prompt performance by the Lessee, during such extended term, of all of the terms * * *, which said sum of Twenty Thousand Dollars ($20,000) shall apply, in the event said faithful performance is had, upon the minimum monthly payments due the Lessors * * *, for the last ten months of the extended term of this lease. * * * The petitioners kept their books and made their income tax return for the year 1935 on a cash receipts and disbursements basis. *847 OPINION. HARRON: Petitioners did not include the sum of $20,000 in gross income for the year 1935. The Commissioner added that amount to taxable income as prepaid*798 rent, taxable in the year of receipt. Whether or not the determination of the Commissioner is correct depends upon the construction to be placed upon the terms of the lease and upon the special considerations which must be given to the receipt of income, under the pertinent revenue act, by taxpayers reporting income on a cash basis. The considerations here necessarily differ from considerations which would be pertinent in another type of proceeding where, for example, under local law, a lessee seeks to recover a sum paid in advance under a lease upon termination of or breach of a lease. Petitioners' argument that the question is to be considered with regard for what is contended to be the law of the State of California relating to deposits under leases, suffers from failure to give more consideration to the rule that, for purposes of taxation, earnings of property are gross income in the year received by a taxpayer on a cash basis, where there is no present restriction on the use of the money received, and where the possibility of having to return any of such income in future years is only a remote contingency. Petitioners contend that they did not receive title to the $20,000*799 paid to them by the lessee under the particular lease and that, consequently, they are not taxable thereon. The contention is that the payment was a mere deposit as security for performance by the lessee and that title to the money remained in the lessee. Numerous decisions of courts of the State of California are cited to support the contention. However, our examination of the cases cited shows that there is no clear-cut rule and in each case the question may be whether an advance lump-sum payment, under a lease, is an absolute payment in consideration for the execution of a lease, or an advance payment of rent, or a deposit given to secure performance by the lessee. The terms of each particular lease are controlling and it is not the form of the particular terms, but the substance thereof, which is determinative. Sullivan v. Johnson, 116 Cal.Supp. 591; . The question here must be considered by reference to the terms of the lease, as determinative of the nature of the payment in question for purposes of taxation. Careful reading of the terms of the lease shows that no provision is made anywhere for the return of any part of the advance payment*800 of $20,000 to the lessee. The payment was required under the rent provisions of the lease. The payment was both a down payment and a payment of rent in advance. It apparently constituted part of the consideration for the execution of the lease. When the sum was received, *848 the right of the lessors to the money in question was absolute. That the term "deposit" is used in the lease to describe the payment, is not determinative. Even though the advance payment served to bind the lessee to strict compliance with the terms of the lease, it is a presumption that contracts will be observed and not broken, ; , and such effect of the advance payment does not prevent it from being held to be income in the year received. . Since the lease does not provide, in any way, for return of the payment to the lessee, it can not be concluded that there was even a contingent liability at the time of the payment to return any part, in the future, to the lessee. *801 The lease leaves unstated any provisions for the use of the $20,000 payment in the event of any breach of covenant by the lessee, and it clearly provides that the payment is to be applied to rent. Nothing in the lease indicates that the advance payment was a loan to the lessors. In our opinion, under the terms of the lease the payment, in substance, was an advance payment of rent. Petitioners received the payment without any obligation to return it to the lessee and, being on the cash basis, they are taxable upon the $20,000 in the taxable year. It is so held, upon authority of the following cases: ; ; ; ; . Decision will be entered for the respondent.