1932 BTA LEXIS 1131">*1131 Held, that attorneys' fees, court costs and other similar expenditures made by a lessor in connection with litigation involving a lease contract, are not deductible as ordinary and necessary business expenses, but the aggregate amount should be spread over the life of the contract and an aliquot portion deducted from gross income of each year. Julia Stow Lovejoy,18 B.T.A. 1179">18 B.T.A. 1179, followed.
27 B.T.A. 57">*57 This proceeding is for the redetermination of a deficiency in income tax for the year 1926 in the amount of $1,241.07. The only matter in controversy is whether the petitioners are entitled to a deduction in 1926 for legal fees and expenses paid in connection with certain litigation arising from the construction of a building by a lessee on certain real estate owned by the petitioners' testator and another. The amount originally claimed and deducted in decedent's tax return was $5,395.89, but the parties have since stipulated that the amount paid by the decedent during the year 1926 was $2,933.65.
FINDING1932 BTA LEXIS 1131">*1132 OF FACTS.
Prior to his death on September 23, 1931, Frederick M. Hilton, hereinafter referred to as the decedent, was a resident of Scarborough, New York. The decedent having instituted this proceeding prior to his death, the Board, on suggestion of death of the decedent and notice of appointment of executors, ordered, on November 23, 1931, that Richard G. Babbage and Seth Sprague Terry, executors of the decedent's estate, be substituted as petitioners in this proceeding.
The decedent and Justice Edward R. Finch were joint owners of land located at Madison Avenue and 70th Street, New York City, known as 860 Madison Avenue.
Under an indenture executed on July 1, 1924, between Finch, as lessor, and the Joray Holding Company, Inc., a New York corporation, as lessee, the owners leased the property for a period of 21 years from July 1, 1924, at an annual rental of $6,000 for the first 5 years, $10,000 for the next 5 years, and $12,000 per year for the remaining 11 years. The indenture contained provisions for renewals for subsequent periods extending not beyond July 1, 1985.
The deed under which Finch and the decedent held the leased premises was subject to certain restrictive1932 BTA LEXIS 1131">*1133 covenants. Among such 27 B.T.A. 57">*58 covenants was one whereby the owners at any time prior to January 1, 1929, were not to erect or permit to be erected upon the premises any building, except a dwelling house for a single family. The lease was made subject to the restrictive covenants.
The indenture also contained the following provisions:
SEVENTEENTH: The Lessee agrees that it will on the last day of the term hereby granted or other sooner termination hereof, quietly and peaceably quit and yield up the said demised premises with the buildings or parts of buildings then thereon and the fixtures and equipment except the retrade, lighting and movable fixtures and trade equipment which are placed thereon by any subtenant in into the possession of the Lessor without fraud or delay.
* * *
TWENTIETH: Within fifteen days after the execution of this lease, the Lessee agrees to cause to be prepared plans and specifications for a building to be erected upon said premises at least two and not exceeding three stories and basement in height adapted for stores and offices, * * * and that the same will be paid for by the Lessee without cost or expense to the Lessor, * * *. And as soon as1932 BTA LEXIS 1131">*1134 said plans and specifications have been approved by the proper authorities having jurisdiction over said premises, and said bond has been delivered, but not before then, the Lessee shall commence and complete the erection of said building in accordance with said plans and specifications, so that the said building will be fully completed on or before July 1st, 1925.
TWENTY-FIRST: The Lessor agrees that upon any action being commenced to enjoin or restrain the said Lessor, the said Lessee or the building contractor from commencing or proceeding with the erection of the said building provided in the preceding clause to be erected, or from occupying the same when completed, upon the ground that the erection and maintenance of such building would be a violation of the covenants and restrictions contained in the Deed or instrument * * * hereinbefore referred to, that the said Lessor shall and will at his own cost and expense and through counsel to be employed by him, undertake the defense of and defend any such action or actions and take such other appropriate legal proceedings as he shall be advised to prevent the making of or to vacate any such injunction or restraining order or judgment. 1932 BTA LEXIS 1131">*1135 And the said Lessor agrees that in the event that the said Lessor, said lessee or the building contractor is enjoined by legal proceedings from commencing or proceeding with the erection of said building provided in the preceding clause to be erected upon the said land, then the rent due or to become due hereunder shall be waived for an additional period equal to the time during which said injunction or restraining order or judgment shall be in force. The Lessor further agrees that if the said Lessor through due legal proceedings shall be unsuccessful in vacating said injunction or restraining order, if made, within three months after the commencement of any such action and notice thereof, then the said Lessor shall pay to the Lessee such sum or sums in cash as will reimburse the said Lessee for the amount that the Lessee has paid or for which it has become liable for actual labor and material actually put into said building, including any sum or sums paid or incurred for fees and services of architects, such fees and services of architects, however, not to exceed the sum of $300.00 and also the cost and expense paid or incurred by the lessee in procuring the bond of the building1932 BTA LEXIS 1131">*1136 contractor, herein provided to be given. And will also repay to the Lessee any sum or sums that may have been paid to the Lessor as rent and any sum or sums 27 B.T.A. 57">*59 that may have been paid by said Lessee for taxes, assessments, water charges, and insurance, less any sum or sums that shall or may have accrued to the benefit of the Lessee as rent from any sub-tenants of said building and said Lessor shall pay no other sum whatever including no sum or sums whatever for damages that may be claimed by said building contractor for delay or for prospective profits arising out of the suspension of prevention of the total or partial erection of said building, and thereupon this lease shall terminate and come to an end, and neither of the parties hereto shall have or make any other or further claims against each other.
It is understood and agreed that said building shall not be increased in height or materially altered until after January 1st, 1929.
TWENTY-SECOND: If the Lessee shall commence the construction of said building as hereinbefore provided, the Lessor agrees to advance to the Lessee the sum of $15,000 as follows:
$5000 when the excavation for the basement is completed1932 BTA LEXIS 1131">*1137 and the foundation laid.
$5000 when the first floor is enclosed.
$5000 when the building is completed.
* * * The Lessee or any subsequent assignee of this lease shall repay the said sum of $15,000 with interest at six percent (6%) per annum * * * and a repayment of $1,500 of principal annually beginning on the first day of December, 1925 and on the first day of December thereafter in each year, until the whole of said principal sum shall have been repaid * * *.
Pursuant to the obligation assumed in the lease, that it would erect a business building on the leased premises without cost or expense to the lessor, the Joray Holding Company, Inc., erected a two-story business building on the premises during the summer of 1924.
After the building was erected, Julius Forstmann and Adolfine Forstmann, owning the adjacent plot and dwelling thereon, commenced an action in the Supreme Court of the State of New York against the Joray Holding Company, Inc., and Finch for a mandatory injunction requiring the defendants to remove the building erected on the premises by the Joray Holding Company, Inc.
The matter was carried to the Court of Appeals of the State of New York and was1932 BTA LEXIS 1131">*1138 finally disposed of by the decision of that court (; ). In its decision the court said:
The plaintiffs seek to compel the removal of the building under a restrictive covenant contained in a prior deed conveying the premises, subject to which the defendant Finch took title. The restriction expires on January 1, 1929. * * *
* * *
We hold that on the law and the facts, and in the exercise of a sound discretion, it would be inequitable to grant the injunctive relief given below in this case, for the reason that it would "bear heavily on the defendants without benefiting the plaintiffs."
In connection with the above mentioned litigation the decedent paid during the year 1926 legal fees in the amount of $2,500 and for 27 B.T.A. 57">*60 court costs, printing and photographs, $433.65. These amounts, totaling $2,933.65, represented one-half of the total expenditures paid during 1926 in connection with the litigation for the purposes indicated.
The amount of $5,395.89 was deducted by the decedent from rentals collected for the calendar year 1926. In determining the deficiency here involved the respondent1932 BTA LEXIS 1131">*1139 disallowed the deduction on the ground that it represented "a capital expenditure and as such may not be claimed as a current expense."
The decedent kept his books and reported his income on the basis of cash receipts and disbursements.
OPINION.
TRAMMELL: The sole issue in this proceeding is whether or not the petitioners are entitled to a deduction from gross income for the taxable year on account of legal fees and expenditures made in connection with certain litigation arising from the construction of a building by a lessee on real estate in which the decedent owned a one-half interest. The decedent kept his books and reported his income for tax purposes on the basis of cash receipts and disbursements.
The decedent originally claimed a deduction for legal fees in the amount of $4,962.24, and for court costs, printing briefs and other similar items in the amount of $433.65, making a total of $5,395.89. The parties have since stipulated that the amount paid by the decedent during the taxable year 1926 for legal fees was $2,500, so that the total deduction now claimed by the petitioners is $2,933.65.
The petitioners contend that the deduction of said amount from income1932 BTA LEXIS 1131">*1140 for 1926 should be allowed as an ordinary and necessary business expense. The respondent disallowed the deduction as originally claimed on the ground that it represented a capital expenditure, and now contends in effect that the stipulated amount paid by the decedent during the taxable year was in the nature of a capital expenditure which should be allowed as deductions spread ratably over the life of the lease.
A lease contract represents a valuable property right, the right to receive the stipulated rental. The expenditures here in question pertain not alone to the earning of income in the taxable year, during which year they were paid, but are incidental to the earning of income throughout the life of the lease contract. Such expenditures should therefore be exhausted or spread proportionately over the life of the contract, and this is true whether the taxpayer is on a cash or accrual basis.
27 B.T.A. 57">*61 In , we held that commissions, fees and printing costs paid by a taxpayer in securing a loan for a period of years covered by a mortgage on property to be leased were not deductible in full in the year of payment, even though1932 BTA LEXIS 1131">*1141 the taxpayer was on a cash basis. In that connection we said at page 1182:
In its essence such a disbursement is not unlike bond discount, prepaid rent, cost of acquiring or disposing of a leasehold or term contract and many other transactions. They should be spread over the definite period of the loan, lease or contract [citing authorities]. This is on the theory that they result in property of a sort and its cost is being exhausted proportionately over a period of years * * *." [Italics supplied.]
In ; affd., , we applied the principles of the Lovejoy decision in holding that commissions paid by a lessor to an agent for services in procuring a lease contract on the lessor's property for a period of 50 years represented cost of the lease contract, and that such cost should be spread and allowed as deductions over the years of the lease on the time basis.
In the instant case it is apparent that the lease contract in question was entered into by the lessors in full contemplation of the restrictive clause in the deed by which they took title to the property, and that they anticipated1932 BTA LEXIS 1131">*1142 litigation would probably be instituted to prevent the carrying out of the terms of the contract. Such litigation did in fact ensue, which, however, terminated favorably to the lessors. They were thereafter in position to receive the money rentals and to enjoy all other benefits which accrued to them by virtue of the lease contract. The attorneys' fees and court costs paid in connection with said litigation, therefore, represent the cost to the lessors of the unimpaired contract. The value of that contract was and is being exhausted in proportion to the passage of time, and an aliquot portion of the cost should be allowed as a deduction from gross income for each year of the life of the contract. The life of the contract was 21 years from July 1, 1924, and the decedent's portion of the cost paid in 1926 was $2,933.65. For the said taxable year the allowable deduction is $139.69. The deficiency will be redetermined accordingly.
Judgment will be entered under Rule 50.