Jennings & Co. v. Commissioner

*381 Proceeding for the redetermination of a deficiency of $19,794.81 in income and profits taxes for 1921. The issue is whether the amount *382 of $42,292.90 received under a supplemental lease agreement is taxable income in 1921. Under an alternative issue petitioner claims the right to special assessment.

FINDINGS OF FACT.

The petitioner, an Oregon corporation organized in 1907 and having its principal office at Portland, Oreg., in January, 1918, acquired a lease for the 25-year period from March 1, 1908, to and including February 28, 1933, on two improved lots located at the southeast corner of Washington and Broadway Streets, Portland, Oreg.

On February 11, 1920, the*1860 petitioner sublet a portion of the leased premises to the Metropolitan 5 to 50?? Stores, Inc., at a monthly rental of $2,850 during the period from March 1, 1920, to February 28, 1922, and $3,550 during the period beginning March 1, 1922, and ending February 28, 1933. The instrument provided that the sublessee should use and occupy the leased premises as a retail store for the sale of such merchandise as is usually sold in a "5 to 50??" store, that it should not assign the lease or sublet the premises or any part thereof without first receiving the consent of the petitioner, and that it should surrender the premises to petitioner upon the expiration of the term of the sublease.

The sublease was modified on December 9, 1921, by an agreement reading, in part, as follows:

Now, therefore, the premises being as above stated, it is hereby agreed by and between said lessor and said lessee as follows, to-wit:

First. Contemporaneously with the execution hereof said lessee pays to said lessor the sum of $8,000.00, the receipt whereof said lessor hereby acknowledges, and executes and delivers to said lessor its promissory note in and by which it promises to pay said lessor $34,600.00*1861 on or before February 1, 1922. The consideration for said $42,600.00 is the execution by said lessor of this Agreement; and said $42,600.00 is fully earned by said lessor upon its execution of this Agreement and no part thereof is to be applied on or in satisfaction of any of the payments to be hereafter made by said lessee to said lessor under said lease as modified by this Agreement.

Second. Said lease is hereby so modified that the rentals to be paid by said lessee for and during the last eleven years of the term thereof shall be Thirty-two Hundred and Twenty-seven Dollars ($3,227.00) per month instead of the Thirty-five Hundred and Fifty Dollars ($3,550.00) per month provided is said lease.

Third. The provision of said lease which requires said lessee to use and occupy said leased premises as a retail store for the sale of such merchandise as is usually sold in a 5 to 50?? store is hereby abrogated and canceled.

Fourth. Said lessee may, so long as it fully and faithfully performs and complies with all its covenants and agreements contained in said lease, sublet any part of said leased premises for any term subsequent to March 1, 1922, for any lawful business*1862 except as hereinafter provided; but each and every sublease from or subletting by said lessor shall be subject to all the conditions and provisions of said lease from said lessor to said lessee and no *383 sublessee can conduct or shall suffer in any part of said premises any of the following lins of business, to-wit: (1) A cigar stand or a tobacco store; or (2) A billiard parlor or a pool hall; or (3) A restaurant or a cafeteria or a dairy lunch unless the sublease be to a tenant of said lessor in the same line of business of space to be used by such tenant in connection with the premises he is holding directly under said lessor.

Fifth. Except as herein otherwise expressly provided to the contrary said lease from said lessor to said lessee shall remain in full force and effect as written and continue binding upon both parties during the full term thereof.

The consideration for the modification of the sublease was the sum of $42,600, of which amount $8,000 was paid on December 9, 1921, $14,500 on January 13, 1922, $1,900 on January 27, 1922, $10,000 on February 3, 1922, and the balance of $8,200 on February 16, 1922. The petitioner entered the amounts received in*1863 its books as advance rent.

The agreement of December 9, 1921, reduced the amount of rent payable during the last eleven years of the term by $42,636. The purpose of reducing the rent was to compensate the sublessee for the amount it agreed to pay for the modification of the lease.

Petitioner's income in 1921 and for several years prior thereto was derived from the premises referred to above. The amount of gross rent returned by the petitioner for 1921 was $76,046.25, which sum did not include any part of the $42,600 item.

In 1921 petitioner kept its books and filed its return on the accrual basis of accounting.

In determining the deficiency involved herein the respondent included in petitioner's income the sum of $42,292.90, that being the amount paid under the agreement of December 9, 1921, less $307.10 representing cash discount on the note given by the sublessee.

OPINION.

ARUNDELL: Petitioner's claim is that the sum of $42,600 agreed upon in the instrument modifying the lease was prepaid rent, and, as its books were kept on the accrual basis, that amount should be spread over the period for which it was paid.

The agreement between petitioner and its lessee*1864 modifying the lease, under which the $42,600 was paid, we think plainly precludes that sum from the category of rent. Under the original lease the lessee was restricted in its use of the demised premises; it wanted to be rid of the restrictions and was willing to pay for the riddance. This was accomplished by means of the agreement of modification, whereupon the lessee paid the sum stipulated therein. That the amount paid was not a part of the aggregate rent is shown by the wording of the agreement itself, wherein it is provided that the "$42,600 is fully earned by said lessor upon its execution of this *384 agreement." This provision would prevent the lessee from recovering any part of the $42,600 as prepaid rent in the event of breach of the lease by the lessor.

It is true as pointed out by petitioner that the aggregate paid and to be paid under the modification agreement was approximately the same (there being a difference of $36) as the aggregate rent provided for under the original lease. This, however, is the result of that provision in the modification agreement reducing the monthly rental for the balance of the term and does not serve to characterize as rental*1865 the $42,600 which was specifically paid for the execution of the agreement of December 9, 1921, and was agreed by the parties to be fully earned at that time. In our opinion the $42,600 was properly included in income for 1921.

Petitioner's alternative claim to special assessment is made on the ground that if the $42,600 is included in 1921 income it will result in an abnormality in income for that year. The only evidence directed to this point consisted of the testimony of petitioner's secretary to the effect that petitioner's ordinary net income was about $13,000; that the gross rentals reported for 1921 amounted to $76,046.25; and that up until 1921 petitioner was leasing no property other than that here involved. This is obviously insufficient to establish that there was any abnormality in income for 1921.

Decision will be entered for the respondent.