Lindley Trust v. Commissioner

CLARKSON LINDLEY TRUST, ANNA GALE LINDLEY, CHARLOTTE LINDLEY WURTELE, AND ALFRED D. LINDLEY, TRUSTEES, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Lindley Trust v. Commissioner Docket No. 97084. United States Board of Tax Appeals 42 B.T.A. 509; 1940 BTA LEXIS 989; August 13, 1940, Promulgated *989 Under a trust instrument the grantor transferred to petitioner certain real estate in fee, subject to a lease for years thereon in favor of the grantor, as lessor. By its express terms the trust instrument purported to also separately transfer to the trust the right of grantor to receive certain United States bonds which the lease contract provided should be received by the lessors estate six months after his death. A clause in the lease contract recited that the bonds were to be received by the lessor's estate as purchase price of the buildings then situated on the leased premises. The lease contract also provided that the buildings should be insured for the benefit of the lessor; that any of the buildings removed should be restored at the expense of the lessee by the erection of a building of at least equal value to the one removed; that before removal of any building the lessee should enter into a bond, unless waived by the lessor, guaranteeing the proper erection of the new building; that at the expiration of the term of the lease, or on default of the lessee, all buildings should remain attached to the land as the property of the lessor. Held, that, considering all the*990 provisions of the lease contract together, the bonds constituted additional rental, or bonus in the nature of rental, for the real estate; held, further, that the purported separate transfer of the right to receive the bonds in the future, and subsequent to the execution of the trust instrument, did not constitute a gift to the trust, as donee, free of tax under section 22(b)(3) of the Revenue Act of 1932; and held, further, that when the bonds were received by petitioner trust, after the death of the grantor, who was also the lessor in the lease, the value of such bonds constituted rental income of the petitioner trust for the taxable years in which they were received, and not part of its corpus. Kenneth Taylor, Esq., for the petitioners. Henderson A. Melville, Esq., for the respondent. TYSON *510 This is a proceeding to redetermine a deficiency of $573.55 in income tax for the calendar year 1935, and of $30,197.46, for the calendar year 1936. The only issues are whether the respondent erred (1) by including in the income of petitioners for 1935 the amount of $9,735.43 as the value of certain United States bonds received by them in*991 that year, and (2) by including in their income for 1936 the amount of $93,655.64 as the value of other United States bonds received by them in that year. The proceeding has been submitted upon a stipulation of facts, which is included herein by reference, but only such of those facts as are deemed material to consideration of the issues presented are set out herein. FINDINGS OF FACT. The Clarkson Lindley trust, with address at 1510 Hennepin Avenue, Minneapolis, Minnesota, is a trust created pursuant to a trust agreement, dated May 20, 1932, between Clarkson Lindley, as grantor, and Charlotte Lindley Wurtele, his daughter, as trustee. Petitioners Anna Gale Lindley and Alfred D. Lindley were, on June 3, 1932, duly appointed as cotrustees by petitioner Charlotte Lindley Wurtele, pursuant to a power of appointment contained in the trust agreement, and they duly accepted such appointment. *511 The trust was to continue for 21 years after the death of the last survivor of the grantor's wife, four children, and his then living grandchildren. The net annual income from the trust was to be paid to Anna Gale Lindley, the wife of grantor, during her lifetime, and after her*992 death to the four children of grantor in equal parts during their lives, and thereafter to the issue of such children during their respective lives. The grantor, by the trust instrument, conveyed in fee to the trust "an undivided one-half (1/2) part of those certain tracts or parcels of land and the buildings and improvements located thereon situated in Minneapolis, Hennepin County, Minnesota, and described as follows, to-wit", the particular description by metes and bounds of such "tracts or parcels of land" being then set out in the trust instrument. Immediately following the description of the real estate, the trust instrument sets forth that the conveyance of the real estate was made "subject, nevertheless, to, * * * that certain lease of the whole of said premises made" by the grantor "to S. S. Kresge Company, lessee, dated May 10th, 1924." The trust instrument also contained the following provision: "There is also hereby assigned, transferred and conveyed to the Trustee * * * in trust all interest of the Grantor in an undivided one-half (1/2) of said lease and the leasehold interest thereby created, including one-half (1/2) of all rentals hereafter accruing under said lease*993 and a one-half interest in and to all securities deposited pursuant to Paragraph V of said lease, and the Trustee * * * is hereby empowered to receive, receipt for, and the perform all acts necessary or desirable in connection with the collection and recovery of said rentals, securities, and other rights accruing to her * * * as owners of an undivided one-half interest in and to said premises and lease." The trust was in force and effect throughout the taxable years. Its books were kept and its income tax returns were filed on the cash basis. On May 10, 1924, prior to his execution of the trust instrument, Clarkson Lindley, who was then the sole owner in fee of the entire interest in the land as described by metes and bounds in that instrument, leased by written agreement that land to the S. S. Kresge Co. for a period of 35 years begining June 1, 1924, at an annual specified rental, with an option to renew the lease for an additional period of 64 years at an annual rental of $120,000. Paragraph V of the lease agreement, referred to in the last above quoted provision of the trust instrument, reads as follows: The second party as further consideration for the making of this*994 agreement covenants and agrees that it will concurrently with the execution hereof deposit with Minneapolis Trust Company hereinafter referred to as the "depositary", Fifty Thousand Dollars ($50,000.00) par value of United States Government Liberty Loan Bonds or United States Treasury Certificates *512 of the market value of not less than par and of a like par value, and that if will, on or before the first of June in each of the years 1925, 1926, and 1927 deposit a like amount of such bonds or certificates, all payable to bearer, so that when said final deposit of Fifty Thousand Dollars (50,000.00) to be made June 1, 1927, shall have been deposited there shall have been deposited the total amount of Two Hundred Thousand Dollars ($200,000.00) par and market value of such bonds or certificates with said depositary. Such bonds or certificates shall be held by said depositary until a date six (6) months after the death of the first party, and shall then be transferred and delivered to his executors or administrators, duly qualified, and shall constitute payment in full to his estate for the buildings now located on said premises, the ownership of which said buildings shall thereupon*995 be transferred by the personal representatives of the lessor to the second party. All interest accruing upon said bonds or certificates up to the date when the same are required to be transferred to the personal representatives of the lessor shall be paid over to the second party when and as collected, and said bonds or certificates and all interest accruing thereon after the date when the same are so required to be transferred shall thereupon become the absolute property of the estate of said lessor. If the lessor shall die previous to the first day of June, 1927, within six months after his death the tenant shall deposit with said depositary the undeposited amount of said Two Hundred Thousand Dollars ($200,000.00) worth par and market value of said bonds or certificates and the same shall be paid over and delivered to the executors or administrators of the lessor with the same effect and for the same purpose as and upon the same conditions and agreements as if the same had been deposited at the several specific dates above specified. If default shall be made by the tenant in any of its obligations under this lease resulting in the termination or cancellation thereof, then*996 the whole amount of Two Hundred Thousand Dollars ($200,000.00) in bonds or certificates, whether all of said bonds or certificates have been deposited or not, shall become forthwith due and shall be forthwith delivered to the lessor, and all bonds or certificates theretofore deposited with said depositary shall be forthwith paid over by it to the lessor, and the tenant shall be liable to the lessor for any undeposited portion of said total amount of Two Hundred Thousand Dollars ($200,000.00) in bonds or certificates, whether the time first above specified for their deposit has arrived or not. All bonds or certificates to be deposited hereunder or to be delivered hereunder shall at the time of such deposit or delivery respectively have attached thereto and deposited or delivered therewith all interest coupons evidencing the interest thereon which have not matured prior to such deposit or delivery respectively. The lease agreement contained the following further provisions that: "in the event that any of the buildings now on, or hereafter erected on any part of said demised premises, are * * * or destroyed or removed", the lessee should restore such building or buildings within twelve*997 months thereafter and in case such building or buildings should be removed, the building or buildings erected in the place thereof should be of such a value as would make the total value of all buildins thereafter on the leased premises not less than the total value of the buildings on those premises at the date of the lease, to wit, $250,000; that the buildings should be insured by the lessee, with loss payable to the lessor, so much of the proceeds *513 of the insurance as might be necessary to be applied to the restoration of any destroyed or damaged buildings; that "the tenant shall have the right at its own cost and expense to make alterations, changes in, improvements and additions to the buildings or improvements now on said demised premises or that may hereafter be erected thereon which shall not substantially diminish the value thereof"; that "when the tenant shall be prepared to remove either of the present buildings on said premises for the purpose of erecting instead thereof a new building of the character hereinbefore provided for and shall give the bond provided for in Paragraph XI of this lease, if such a bond shall be required to be given prior to the removal*998 of said buildings or any of them, and the erection of new buildigns on said premises, the tenant may * * * wreck the building or buildings so to be replaced and appropriate the material therefrom to its own use * * *." Paragraph XI of the lease instrument provided that "before the tenant shall commence the construction of any new building or buildings, * * * and before the tenant shall, at any time, * * * wreck or remove any building or buildings * * * costing more than Ten Thousand Dollars ($10,000.00), the tenant shall" unless same is waived, "esecute and deliver to said lessor a bond in a sum equal to the estimated cost of the removal of such building or buildings to be removed, and the estimated cost of the new building to be built * * *." The lease instrument further provided that at the termination of the lease, either by the expiration of its period or by default of the lessee, all the buildings and improvements thereon should remain attached to the freehold as the property of the lessor. Pursuant to paragraph V of the lease agreement, $50,000 in face amount of United States bonds and Treasury certificates, in bearer form, were deposited by the S. S. Kresge Co. with the Minneapolis*999 Trust Co., as depositary, on or about the first day of June in each of the years 1924 to 1927, inclusive. Clarkson Lindley died July 26, 1935. At all times his books were kept and his income tax returns were made on a cash basis. He did not report any income on account of the bonds pursuant to paragraph V of the lease contract during the years 1924, 1925, 1926, and 1927, during which years the bonds were deposited, and no income tax was assessed against him as the result of the deposit of said bonds during those years. On October 2, 1935, less than three months after the death of Clarkson Lindley and pursuant to an agreement between petitioners and the S. S. Kresge Co., $10,000 in face amount of the deposited United States bonds were released by the depositary to petitioners and were sold by them for the sum of $9,915.63. Interest on these released bonds from October 2, 1935, to January 26, 1936, was paid to the S. S. *514 Kresge Co. to obtain the release prior to the expiration of six months after Clarkson Lindley's death. The finduciary return of income filed by the petitioners for the year 1935 showed a net income of $40,356.01, all of which was distributable*1000 to the beneficiaries, so no tax was paid by petitioners. The trust treated the $9,915.63 as corpus. The notice of deficiency added the $9,735.43 proceeds from the sale of the bonds, to the net income of the trust reported in the fiduciary return and asserted a deficiency of $573.55 in tax on the income. In making such addition the respondent treated the amount received from the sale of bonds, less the discount and interest from January 26, 1936, as income in the nature of rent received in the year 1935. On January 26, 1936, six months after the death of Clarkson Lindley, $90,000 in face amount of the deposited bonds, then having a market value of $93,655.64, were released by the depositary and petitioners received same. In their fiduciary return of income for 1936, the petitioners showed a net income of $43,148.58, of which $1,332.50 represented capital gain on the disposition of the bonds referred to above, all of which was treated as being distributable income. The trust treated the market value of the bonds of $93,655.64 as corpus. The notice of deficiency added to the income reported on the fiduciary return the amount of $93,655.64, representing the market value on January 26, 1936, of*1001 the bonds released to the petitioners. The respondent's assertion of a deficiency of $30,197.46 against the petitioners was based upon the ground that the market value of the bonds released on January 26, 1936, constituted ordinary income in the nature of rent received in the year 1936. OPINION. TYSON: Petitioners contend that the interest of Clarkson Lindley in the bonds in question was, under the terms of his lease agreement with the S. S. Kresge Co., a property right which was fixed and certain prior to the time of his transfer, on May 20, 1932, of such interest to the petitioner trust and that such property right, upon that transfer being made, became part of the capital or corpus of the trust and constituted a gift from Clarkson Lindley to the trust specifically exempt, as to the donee trust, from taxation under section 22(b)(3) of the Revenue Acts of 1934 and 1936, 1 except only as to any capital *515 gains derived from the sale of the bonds after the trust had acquired them. *1002 Respondent contends, on the other hand, that the bonds were additional rent, or bonus in the nature of rent, for the leased premises and that when received by the trust in the taxable years the value thereof became rental income to it and includable in its tax returns, as such, for those years. We are presented with the preliminary questions of whether the bonds constituted the purchase price of the buildings on the leased premises or additional rent, or bonus in the nature of rent, for those premises, since if they were the purchase price of the buildings the petitioners' contention should be sustained without further consideration of other features of the case. Paragraph V of the lease contract, as above set out, provided that the bonds, when delivered to the executors of Clarkson Lindley's estate, should constitute full payment for the buildings. Other provisions of the lease contract provided, inter alia: That the buildings thereon should be insured by the lessee, with loss payable to the lessor; that any building removed should be replaced by another building at least equal in value to the one removed, all at the expense of the lessee; that the lessee, before demolishing*1003 or removing a building for the purpose of replacing it, should execute a bond guaranteeing the proper completion of the new building or buildings, unless same was waived by the lessor, for any or all buildings costing in excess of $10,000; that at the termination of the lease, either by the expiration of its period or by default of the lessee, the buildings would remain attached to the leased premises as the property of the lessor. Under all the provisions of the lease instrument taken together for the purpose of construing its meaning, we are of the opinion that the bonds in question constituted additional rental, or bonus in the nature of rental, of the leased premises and not the purchase price of the buildings thereon, notwithstanding the provisions of paragraph V of the lease instrument. ; ; affd., ; certiorari denied, ; ; affirmed on this point, *1004 ; and . The contention of petitioners, however, presents the further question of whether, even if the bonds were additional rentals, or bonus in the nature of rentals, the right to receive the bonds had, nevertheless, accrued to Clarkson Lindley as a property right either when the lease contract was executed in 1924 or when the bonds had all been deposited with the depositary in 1927, as provided in the lease agreement, and that consequently the transfer of that right to the trust constituted a gift to it of corpus or capital which would preclude the *516 bonds from being included in the income of the donee trust, under section 22(b)(3), supra. By the trust instrument, Clarkson Lindley, the grantor therein, conveyed to the trustees an undivided one-half interest in certain definitely described real estate, the entire real estate being owned in fee by Lindley at the time of the conveyance and under lease from him for a term to run approximately 28 years thereafter. The terms of this lease provided for an annual rental in definite amounts, varying as to certain years, and also provided*1005 for additional rent, or bonus in the nature of rent, evidenced by United States bonds of the face value of $200,000, which bonds were to be delivered to the estate of Lindley six months after his death. The conveyance of the one-half interest in the real estate to the trust was absolute and in fee except as stated in the conveyance "it was subject to * * * an undivided one-half (1/2) interest in that certain lease of the whole of said premises", i.e., the real estate conveyed. The recital that the conveyance of the interest in the real estate was subject to the lease did not "work" severance of the rent from the reversion, . The real estate conveyed to the trust undoubtedly constituted a gift by Clarkson Lindley to the trust, the value of which was exempt from taxation to the trust, as donee, under section 22(b)(3), supra. But was the right of his estate to receive the United States bonds six months after his death, as additional rental, or bonus in the nature of rental, which we have found such bonds to be, also a gift and likewise exempt under section 22(b)(3), supra? *1006 Although the trust instrument in terms purported to convey, in addition to the real estate, "all interest of the grantor in an undivided one-half (1/2) of said lease and the leasehold interest thereby created, including one-half (1/2) of all rentals hereafter accruing under said lease and a one-half interest" in all the bonds deposited, which bonds were to be turned over to Lindley's estate six months after his death, we are of the opinion that the purported transfer, in express terms, of such rights in the United States bonds did not constitute a gift, the value of which is exempt from taxation under section 22(b) (3), supra, for the reason that the conveyance of the right to receive the bonds, which was not to accrue until after the execution of the trust instrument and six months after the death of the grantor, was necessarily an incident, and only an incident, to the accompanying transfer, by way of gift, of the real estate from which such bonds, as rentals, were to be derived - the grantor of the trust not having expressly reserved such rentals. The controlling principle of law is that the transfer of the reversion carries with it the right to rent subsequently accruing unless*1007 the rent is expressly reserved. ; ; ; *517 and ; . This rule obtain generally, as well as in Minnesota where the real estate involved is situated. 36 C.J. 364, § 1206; 66 C.J. 1040, § 792; and Tiffany on Real Property, vol. 3, § 881. Rents subsequently accruing are those rents becoming due on a date subsequent to the transfer of the reversion, Tiffany on Real Property, vol. 3, § 888; ; ; ; ; ; and ; . After the conveyance by the trust instrument of the one-half interest in the real estate from which the rentals (including the bonds in question) arose, the further specific purported conveyance in that instrument of the leasehold and the rents to be derived therefrom was superfluous*1008 and did not constitute a gift separate from that of the real estate, since the gift of the real estate, of itself, carried with it, as a necessary incident thereto, the rents to be derived and thereafter after accrued therefrom. Although the one-half interest in the real estate transferred by Clarkson Lindley to the trust constituted a gift to the trust, we are of the opinion, and so hold, that the transfer by Lindley of the right of his estate to receive the bonds six months after his death, which transfer was necessarily incident to his unrestricted transfer of the real estate, did not constitute a gift from Lindley to the trust exempt from taxation under section 22(b)(3), supra. We are further of the opinion, and so hold, that, both Lindley and the petitioner trust being on the cash receipts and disbursements basis as to the keeping of their books and as to the making of their income tax returns, the value of the bonds received by the trust, without restriction, in the respective taxable years involved, is to be included in its income as rentals, or bonus in the nature of rentals, for those years. Cf. *1009 , and authorities cited therein. We hold that the respondent did not err in including in the income of petitioners for 1935 the amount of $9,735.43 as the value of the bonds received by them in that year, and, further, that respondent did not err in likewise including in petitioners' income for 1936 the amount of $93,655.64 as the value of the bonds received by them in that year. No question is raised and the petitioners do not claim that the value of the bonds is distributable currently by the trust to the beneficiaries and that such value is therefore deductible in computing the net income of the trust under section 162(b) of the Revenue Act of 1934. The amount of gain, capital or otherwise, on the sales of the bonds in 1935 and 1936, is not presented as an issue in this proceeding. Decision will be entered under Rule 50. Footnotes 1. SEC. 22. GROSS INCOME. * * * (b) EXCLUSIONS FROM GROSS INCOME. - The following items shall not be included in gross income and shall be exempt from taxation under this title: * * * (3) GIFTS, BEQUESTS, AND DEVISES. - The value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income). ↩