*229 Decision will be entered for the respondent.
Lessor, on the cash basis, agreed in lease contract to contribute a specified amount toward the cost of improvements to be made by lessee on leased premises, one-half of such contribution to be credited to lessee from rental due and owing by it under lease. Held, amounts thus withheld by lessee from rents constituted taxable income to lessor during the years involved.
*147 The respondent determined deficiencies in the income tax of petitioners in the amounts of $ 14,093.91 for the year 1948 and $ 8,902 for the year 1949.
Portions of the deficiencies have been assessed and paid by the petitioners, and the parties are in agreement that the remainder, here in controversy, is $ 12,153.67 for the year 1948 and $ 5,668.35 for the year 1949.
The sole issue is whether the amounts of $ 20,528.72 and $ 11,971.28, expended by a lessee in 1948 and 1949, respectively, under the terms of a lease for improvements to the leased premises, constitute taxable income to the lessor on the cash basis, where, pursuant to the*230 terms of the lease, these amounts were credited against cash rent otherwise payable.
FINDINGS OF FACT.
Part of the facts have been stipulated and are found accordingly.
Petitioners, husband and wife, are residents of Chicago, Illinois. They filed joint income tax returns for the years 1948 and 1949 with the collector of internal revenue for the first district of Illinois. Petitioner Gladys J. Brown will hereinafter be referred to as the petitioner.
From October 24, 1945, to September 30, 1950, petitioner was the sole owner of a building located at 2800 Milwaukee Avenue, Chicago, Illinois. In 1946, petitioner, as lessor, entered into a lease with Morris B. Sachs, Inc. (hereinafter sometimes referred to as "Sachs"), as lessee, for a period of 10 years and 4 months, commencing June 1, 1947, and ending September 30, 1957. The lease covered the basement and first and second floors of the building, and provided that the lessee, Sachs, should pay a fixed rental of $ 40,000 per year, commencing July 1, 1947, plus percentage rental at varying percentages on gross sales in excess of $ 1,000,000 per annum.
*148 In the lease Sachs was given permission to remodel the exterior and interior*231 of the demised premises and to air condition the same, and the petitioner agreed to contribute $ 65,000 towards the cost of these improvements, $ 32,500 of which was to be paid by her as the improvements were made (paragraph 22 (a) of the lease), and the remaining $ 32,500 (paragraph 22 (b) of the lease) as follows:
THIRTY TWO THOUSAND FIVE HUNDRED DOLLARS ($ 32,500) to be credited to the Lessee from the rental due and owing by it under this Lease, if and after the Lessor has received a minimum of FIFTY THOUSAND DOLLARS ($ 50,000.00) as rent for the demised premises in any one year of the tenancy herein created, and until such deductions aggregate THIRTY-TWO THOUSAND FIVE HUNDRED DOLLARS ($ 32,500.00). For the purposes of this Lease, one (1) year is defined as commencing with the 1st day of October and ending with the last day of September in the succeeding year.
The lease provided that if the cost of the improvements exceeded $ 65,000, the excess was to be paid by the lessee, and, if less than $ 65,000, the petitioner would be required to pay only the actual cost thereof, and the credits provided in paragraph 22 (b) would abate accordingly.
The fixed rental and percentage rental*232 due and owing to petitioner under the terms of the lease for the years 1948 and 1949 (before application of credits provided for in paragraph 22 (b)) were as follows:
| 1948 | 1949 | |
| Fixed rental | $ 40,000.00 | $ 40,000.00 |
| Percentage based on sales | 30,528.72 | 22,318.13 |
| $ 70,528.72 | $ 62,318.13 |
The amount expended by Sachs for remodeling, altering, and air conditioning the leased premises was $ 79,372.53. Petitioner paid Sachs $ 32,500 in cash, and, in accordance with paragraph 22 (b) of the lease, credited Sachs with $ 32,500 from the rental due and owing by it under the lease. The balance of $ 14,372.53 was assumed by Sachs and charged to leasehold improvements. Of the $ 32,500 credited to Sachs, $ 20,528.72 was credited on the total rental of $ 70,528.72 for 1948, thereby reducing the cash payment of rental by $ 20,528.72, and $ 11,971.28 was credited on the total rental of $ 62,318.13 for 1949, thereby reducing the cash payment of rental by $ 11,971.28.
The remodeling, altering, and air conditioning consisted of making a new entrance at the corner of the building, making a new entrance from the rear of the store into the lobby of the building, installation of new show*233 windows, extensive renovations of the basement, first, and second floors including the demolition of walls so that what were three stores became one, the installation of a dumbwaiter, the lowering of ceilings to modernize the building, the installation of air conditioning, and many other such betterments.
*149 Petitioner employed the cash basis method of accounting in keeping her books and reporting income for the years 1948 and 1949. The following amounts were reported by her as income received under the lease in the joint returns filed by her and her husband:
| 1948 | 1949 |
| $ 50,000 | $ 50,346.85 |
The amounts of $ 20,528.72 for 1948 and $ 11,971.28 for 1949, credited under paragraph 22 (b) of the lease, were not reported in these returns as rental income.
Sachs employed the accrual method of accounting in keeping its books and reporting income for 1948 and 1949, except that it used the installment method for its installment sales. It deducted as rent expense in its returns the gross amounts of $ 70,528.72 in 1948 and $ 62,318.13 in 1949, which amounts included the $ 20,528.72 expended in 1948 and the $ 11,971.28 expended in 1949 in remodeling, altering, and air conditioning*234 the leased building.
Petitioner sold the property at 2800 Milwaukee Avenue on September 30, 1950.
In determining the deficiencies herein the Commissioner charged petitioner with the full rental of $ 70,528.72 and $ 62,318.13 for the years 1948 and 1949, respectively, undiminished by the amounts of $ 20,528.72 and $ 11,971.28, respectively, which had been credited against those rentals by reason of the improvements pursuant to paragraph 22 (b) of the lease; however, the Commissioner at the same time allowed petitioner additional depreciation deductions with respect to such improvements, measured by the amounts credited against the rentals.
OPINION.
The petitioner contends that she was required to include in gross income for 1948 and 1949, as rental income, only the amounts actually received in cash from Sachs. In support of her contention she argues that she has consistently reported her income and kept her books on the cash basis; that on this basis she is required to account for income when and only when it is received; that in the lease she granted her tenant, Sachs, an abatement of, reduction of, or limitation upon the rental otherwise due thereunder; that she had no legal right*235 to receive from Sachs as rent any amount in excess of what she reported; and that the manner in which Sachs, on the accrual basis, handled its accounts is not determinative or persuasive as to her taxability on the cash basis.
In the lease the petitioner assumed an obligation to contribute $ 65,000 towards the cost of certain permanent improvements to be made by Sachs on the demised premises. Of this amount, $ 32,500 was to be paid by petitioner to Sachs as the improvements were made. *150 This payment is not in issue in this proceeding. The method by which petitioner was to satisfy her obligation as to the remaining $ 32,500 is set forth in paragraph 22 (b). Therein the petitioner agreed that there should be credited to Sachs from rental due and owing by it under the lease the portion of the rental due in any year which exceeded $ 50,000 until "such deductions" aggregated $ 32,500. The rental due and owing by Sachs under the lease amounted to $ 70,528.72 for 1948 and $ 62,318.13 for 1949. The petitioner received from Sachs $ 50,000 in 1948 and $ 50,346.85 in 1949. The remainder of the rental due amounting to $ 20,528.72 for 1948 and $ 11,971.28 for 1949 was retained by*236 Sachs, in accordance with paragraph 22 (b) in partial satisfaction of petitioner's obligation to pay $ 65,000 of the cost of permanent improvements made on the leased premises.
It is true, as petitioner urges, that she is on the cash basis and did not actually receive in cash as rental the amounts of $ 20,528.72 in 1948 and $ 11,971.28 in 1949. It does not follow, however, that she is not required to include these amounts in her gross income for the taxable years. If she had received all of the rent due from Sachs in those years and paid a portion of it to him in satisfaction of her obligation to pay for the cost of permanent improvements on the leased premises, the amount received as rent in each year would clearly be includible in her taxable income. The substance of the transaction is not changed because she permitted Sachs to retain part of the rent due from it in each year in satisfaction of part of her obligation to pay $ 65,000 towards the cost of permanent improvements. Cf. . "Income is not any the less taxable income of the taxpayer because by his command it is paid directly to another in performance*237 of the taxpayer's obligation to that other." . See also . 1 The discharge of petitioner's obligation to pay for the cost of permanent improvements to the extent of $ 20,528.72 in 1948 and $ 11,971.28 in 1949 was equivalent to the receipt by her of these amounts in those years. Cf. ; . Moreover, the provision in paragraph 22 (b) for the crediting of these *151 amounts "to the Lessee from the rental due and owing by it under this Lease, if and after the Lessor has received a minimum of Fifty Thousand Dollars * * * as rent" indicates that the parties intended these amounts to be applied in partial satisfaction of petitioner's obligation and not as an abatement or reduction of rent. Cf. (C. A. 7).
*238 Much of the difficulty in this case is attributable to petitioner's insistence that the question is not whether the $ 32,500 credited pursuant to paragraph 22 (b) of the lease is income, but when it is income. If that item was income at all, $ 20,528.72 thereof was realized in 1948, and $ 11,971.28 in 1949, when these amounts were effectively applied to extinguish petitioner's liability to the lessee. Certainly, there could be no later year in which these amounts might be treated as income, and petitioner has suggested no other time when they might be taken into account. She realized income to the extent of $ 20,528.72 and $ 11,971.28 in 1948 and 1949, respectively, by reason of the application of rent towards the discharge of her liability under paragraph 22 (b) of the lease.
The situation with respect to paragraph 22 (b) is no different in this respect from 22 (a). Under 22 (a) petitioner was required to pay $ 32,500 (out of the total obligation of $ 65,000) directly, and there is no suggestion whatever that the taxable rent received by her must be reduced by that amount merely because $ 32,500 of that rent may have been paid out in accordance with 22 (a). The remaining*239 $ 32,500 was required to be taken out of rent in the first instance by means of the credit under 22 (b), and there can and should be no essential difference in the treatment of these two items. In the case of each of them, petitioner has received the full benefit of the stipulated rent and has in substance reinvested a portion of it in the making of improvements to her property. In neither case should she be permitted to reduce the amount of rent reportable by her. And in both cases, the increase in her investment in the property operates to give her higher deductions for depreciation. Indeed, in determining the deficiencies herein, the Commissioner has given petitioner the benefit of an increased basis in the property and has allowed her proportionately greater deductions for depreciation. We think that is the correct treatment tax-wise of this situation. Income may be realized in a variety of ways, other than by direct payment to the taxpayer, and, in such situations, the income may be attributed to him when it is in fact realized, without any special inquiry as to whether he is on the cash or accrual basis. 2 E. g., ;*240 ; ;;; ; .
Decision will be entered for the respondent.
Footnotes
1. In the Horst↩ case, the Supreme Court said (at pp. 114, 115): "* * * the rule that income is not taxable until realized has never been taken to mean that the taxpayer, even on the cash receipts basis, who has fully enjoyed the benefit of the economic gain represented by his right to receive income, can escape taxation because he has not himself received payment of it from his obligor. The rule, founded on administrative convenience, is only one of postponement of the tax to the final event of enjoyment of the income, usually the receipt of it by the taxpayer, and not one of exemption from taxation where the enjoyment is consummated by some event other than the taxpayer's personal receipt of money or property. Cf. . This may occur when he has made such use or disposition of his power to receive or control the income as to procure in its place other satisfactions which are of economic worth."
2. Of course, if the taxpayer is on the accrual basis, it is possible that such income might be attributed to him at an even earlier time, namely, when the right to realize it matures.↩