*1852 1. Value of a lease for invested capital and exhaustion purposes determined.
2. Subsequently part of the lease was sublet for a part of the remainder of the term in consideration of certain agreed annual rentals and a bonus payment of $19,182.07. Held, the bonus payment to petitioner was not a return of capital, but was income to it in the year when received. James M. Butler,19 B.T.A. 718">19 B.T.A. 718; Douglas Properties, Inc.,21 B.T.A. 347">21 B.T.A. 347, followed.
*566 In this proceeding the petitioner seeks a redetermination of its tax liability for the fiscal years ended June 30, 1922, June 30, 1923, and June 30, 1924, for which years the respondent has proposed deficiencies of $2,473.35, $3,190.08, and $294.27, respectively.
The petition alleges the respondent in his determination erred as follows: (1) In failing to allow in each of the years under consideration an annual deduction based upon exhaustion of a ten-year lease which petitioner alleges cost $50,000; (2) in failing to allow the above mentioned $50,000 as invested*1853 capital for the fiscal year ended June 30, 1922; and (3) in including in income for the fiscal year ended June 30, 1923, the sum of $19,182.07, paid to the petitioner by its sublessee upon the execution of a sublease.
FINDINGS OF FACT.
The petitioner is a corporation organized under the laws of the State of Colorado, with its principal office in Denver in that State.
Georgia A. Barth in 1920 was the owner of the real property in Denver known as the William Penn Hotel, which was improved *567 with a building containing 166 hotel rooms, together with nine store rooms on the street floor. The hotel had been leased to one Weidensol, who was the owner of the furniture used therein. His lease expired in the early part of 1920. In the spring of 1920, Mrs. Barth, desiring to secure a new tenant, listed the property for rent with a real estate agency in Denver. For about thirty days the agents exhibited a notice in their window calling to the attention of the public that they had a 166-room hotel property for rent, without mentioning the rental. No further publicity was given to the fact that the property was for rent until one of the real estate firm's representatives*1854 called the attention of Morris H. Block, who was a hotel operator in Denver, to the fact that the William Penn Hotel was for rent and the amount of rental asked. Block discussed the proposition with three of his associates in the hotel business. These four, Block, Buchalter, Bronstein and Karsh, decided that the proposed terms were very advantageous and entered directly into negotiations with the owner, which culminated in an agreement whereby they were to lease the entire property for a ten-year term at an annual rental of $22,000, payable $1,833.33 per month, provided they would execute an individual bond in the penal sum of $12,000, guaranteeing the payment of the rent and agree to make certain repairs to the building, including the rebuilding of the roof, and that they would purchase the furniture of the then tenant and thus enable her to get possession of the property without delay and legal difficulties. The cost to Block, Buchalter, Bronstein and Karsh of the agreement with Georgia A. Barth to lease the premises was $4,000, $2,000 of which was for commissions paid to the real estate agency negotiating the lease and the balance was for miscellaneous expenses.
In April, *1855 1920, a corporation, the petitioner herein, was organized with an authorized capital of $50,000, consisting of 50,000 shares of common stock having a par value of $1 per share. Four qualifying shares were issued for cash and the remainder of the stock was issued to Buchalter, Bronstein, Block and Karsh, fully paid and nonassessable, in exchange for their rights in and to the proposed lease of the hotel premises, and in and to the purchase of the furniture contained in the hotel. The minutes of a meeting of the petitioner held on April 5, 1920, contain the following entry in regard to the transaction:
Messrs. Buchalter, Block, Bronstein and Karsh, presented an offer to sell, transfer, assign, or turn over to the corporation any and all rights in and to the William Penn Hotel property in the City and County of Denver, a leasehold interest therein, which they had made arrangements to acquire, and to which they were entitled, and had rights in and to purchase the furniture of the William Penn Hotel, whenever same might be accomplished or completed, and to secure such leasehold in the said property, in writing, for and in the name of the corporation, from Georgia A. Barth as lessor*1856 to the William Penn *568 Hotel Company as lessee for a term of ten years, commencing with the 5th day of April, 1920, at and for a rental of $22,000 per year, payable in monthly installments of $1,833.33 per month, said lease to be secured for and in the name of the company, and the rights to purchase and acquire the furniture and fixtures and furnishings of the said hotel and any rights therein or thereto, turned over and assigned to this company for and in consideration of the full capital stock of the company with the exception of one share subscribed for by each director.
This offer was accepted by the corporation, the lease being obtained in its favor, and the liability for the furniture and fixtures being assumed by it.
Thereupon, Buchalter, Block, Bronstein and Karsh assigned their rights to the lease to petitioner.
On April 5, 1920, the petitioner as assignee of Buchalter, Block, Bronstein and Karsh, entered into a lease with Mrs. Barth for a ten-year term from July 1, 1920, at an annual rental of $22,000, payable in monthly installments of $1,833.33 1/3 per month. At the time the lease was made the fair rental value of the 166 hotel rooms was $10 per month*1857 per room, and the fair rental value of the nine store rooms in the building was $900 per month. The agreement which Buchalter, Block, Bronstein and Karsh had from Georgia A. Barth to lease them the property for a term of ten years at an annual rental of $22,000 had a fair market value of at least $50,000 at the time it was paid in to the petitioner, William Penn Hotel Company, for the issuance of all its capital stock except four qualifying shares.
The hotel was partially refurnished by the petitioner in 1921. But there is no controversy between petitioner and respondent in respect of the amount which petitioner is entitled to deduct on account of depreciation on the furniture. In 1923 a ten-year extension of the lease was obtained by petitioner upon the payment of $1,000. The material terms of this extension are stated therein as follows:
TO HAVE AND TO HOLD the same with all the appurtenances unto the said lessee for an extended term of ten years commencing upon the expiration of the term mentioned and described in a certain written indenture of lease between the same parties, and bearing date the 5th day of April, A.D. 1920, which said lease was recorded on the 7th day*1858 of April, A.D. 1920, in book 3081, at page 127 of the records in the Office of the Clerk and Recorder of the City and County of Denver, State of Colorado; said extended term, however, being conditioned upon the faithful performance by the lessee of all of the covenants, agreements, terms and conditions of the existing lease above mentioned; said extended term to commence at Twelve o'clock Noon upon the 1st day of July, A.D. Nineteen Hundred and Thirty (1930), and to extend for, during and until Twelve o'clock Noon on the 1st day of July, A.D. Nineteen Hundred and Forty (1940).
The rental for said extended term of Ten Years (10) aforesaid shall to Two Hundred and Twenty Thousand ($220,000.00) Dollars and shall be payable in monthly installments of One Thousand Eight Hundred Thirty-three Dollars and *569 Thirty-Three Cents ($1,833.33) per month, in advance, on the 1st day of each calendar month during said extended term.
The lessor and the lessee mutually agree that each and every the covenants, agreements, terms and conditions, reservations and limitations set forth in said existing lease, bearing date the 5th day of April, A.D. 1920, between the parties hereto and respecting*1859 said property shall apply to and govern the extended term of Ten Years (10) by this instrument agreed upon and granted, the same as if said covenants and agreements, terms and conditions, reservations and limitations were herein written and made a part hereof; nevertheless it is understood and mutually agreed that the surrender, cancellation or forfeiture of the said lease bearing date the 5th day of April, A.D. 1920, shall by the same act constitute a surrender cancellation or forfeiture of the extended term agreed upon and granted in this instrument, and that no extended term as in this instrument expressed shall exist or be implied unless by full performance of the lessee up to and including the 1st day of July, A.D. Nineteen Hundred and Thirty (1930); the term expressed in said agreement of lease bearing date the 5th day of April, A.D. 1920, is then in existence.
The petitioner in 1923 sublet the hotel portion of the premises for a term of ten years to Maurice Levy and Morris H. Block, upon receipt of the payment of a bonus of $19,182.07 and the agreement by the sublessees to pay a monthly rental of $1,833.33 per month to petitioner during the term of the lease, together with*1860 an additional payment of $500 per month to be applied on the furniture contract with Weidensol.
The respondent for the fiscal year 1922 disallowed as a deduction $10,000 claimed as amortization of leasehold and also reduced the depreciation on the furniture, which was carried on the petitioner's books at $46,340.11, from $6,750 to $4,634.01. No complaint is made by petitioner as to this latter adjustment. Also, respondent did not allow anything for invested capital for the fiscal year ending June 30, 1922. For the fiscal year 1923 he disallowed $4,338.54 claimed as amortization on the lease and added to income the sum of $19,182.07, which had been received as a bonus on the subletting of the lease. For the year 1924 he disallowed amortization of the lease in the amount of $2,354.20.
OPINION.
BLACK: The evidence in this proceeding establishes that the agreement which Buchalter, Block, Bronstein and Karsh had with Georgia A. Barth, to lease from her the William Penn Hotel property in the city of Denver for a rental of $22,000 per annum for a period of ten years, had a fair market value at the time it was paid in to petitioner of at least $50,000. When the petitioner issued*1861 and delivered its capital stock of the par value of $49,996 in payment for the assignment of the lease, it acquired something of value for such payment which it is entitled to exhaust over the term of the lease. *570 In , we said: "A lease has an actual cash value or fair market value only when the value of the rights granted thereunder is in excess of the payments and obligations imposed on the lessee."
We have found that the fair rental value of the premises was $2,560 per month. The rent agreed to be paid was $1,833.33 per month. The petitioner contends that the saving spread over the life of the ten-year lease was a large amount and made the agreement for the lease worth at least $50,000 in excess of the rentals reserved at the time it was paid in to the petitioner. We are of the opinion that this contention is correct. Numerous witnesses, whose qualification to testify as to value of hotel leases seemed well established, testified that the lease had a fair market value in 1920, at the time it was paid in to petitioner, of at least $50,000.
*1862 It having been established that petitioner had acquired the lease at a cost of $49,996, paid by the issuance of its common stock, it is entitled to take a deduction in each of the taxable years ending June 30, 1922, and 1923, of one-tenth of that amount on account of the exhaustion of petitioner's equity in the leasehold. ; . As to the amount which petitioner is entitled to deduct for exhaustion of this leasehold for the fiscal year ending June 30, 1924, more will be said later.
The petitioner makes the further contention that the lease had a value of $50,000 for invested capital purposes for the fiscal year ending June 30, 1922. Section 331 of the Revenue Act of 1921 provides as follows:
That in the case of * * * change of ownership of property after March 3, 1917, if an interest or control in such * * * property of 50 per centum or more remains in the same persons, or any of them, then no asset transferred or received from the previous owner shall, for the purpose of determining invested capital, be allowed a greater value than would have been allowed under this title in*1863 computing the invested capital of such previous owner if such asset had not been so transferred or received: Provided, That if such previous owner was not a corporation, then the value of any asset so transferred or received shall be taken at its cost of acquisition (at the date when acquired by such previous owner) with proper allowance for depreciation, impairment, betterment or development * * *.
The only cost to the individuals in obtaining the lease which was exchanged for the petitioner's stock was the $4,000 detailed in our findings of fact. Accordingly, the value of the lease for purposes of invested capital must be limited by virtue of section 331, above quoted, to the $4,000 cost.
In 1923, after the lease had been extended for an additional period of ten years, the petitioner sublet the hotel part of the premises *571 for a period of ten years for an annual rental of $22,000, which was the same amount as the rental agreed to be paid by the petitioner on the entire premises, and $500 per month additional as rent on the furniture, and retained the nine stores on the street floor. This sublease was made in further consideration of a bonus payment of $19,182.07*1864 to petitioner, which the respondent has treated as income, while the petitioner contends that it is a return of capital. The contention of petitioner on this point can not be sustained. This bonus was income to petitioner in the year when it was received. ; . Respondent committed no error in including in petitioner's income the $19,182.07 which it received as a bonus for the sublease to Levy and Block.
As pointed out in our findings of fact, on July 16, 1923, petitioner, by a payment of $1,000, secured a ten-year extension of the term of the original lease, so that the lease would expire in 1940 instead of 1930. This made the original lease and the extension thereof cost petitioner $50,996 and for the fiscal year ending June 30, 1924, petitioner was entitled to take a deduction of one-seventeenth of the unexhausted cost of the lease as extended.
In other words, when petitioner secured an extension of the lease for ten more years in 1923, a new basis for exhaustion of the lease arose and that basis is as outlined above.
Reviewed by the Board.
Decision will be entered*1865 under Rule 50.
MURDOCK, concurring: I agree that the bonus payment was income to the petitioner in the year received. See Henry I. Brown,4 B.T.A. 1129">4 B.T.A. 1129, where we held that the income resulting to a lessor from an improvement placed upon his property by a lessee was to be reported in full in the year the improvement was placed upon the property. I am of the opinion, however, that the present decision is inconsistent with certain other decisions of this Board, with which latter opinions I do not agree. For example, we held in Gilbert Butler et al.,4 B.T.A. 756">4 B.T.A. 756, that the value of improvements to a mine made by a lessee was income to the lessor upon the termination of the lease; in Shelby D. Scott,9 B.T.A. 1219">9 B.T.A. 1219; Joseph L. B. Alexander et al.,13 B.T.A. 1169">13 B.T.A. 1169; and J. L. B. Alexander,14 B.T.A. 124">14 B.T.A. 124, we held that the income to a lessor resulting from the erection of a building on the leased premises by the lessee was income to the lessor ratably over the remaining life of the lease; and in Fall River Electric Light Company,23 B.T.A. 168">23 B.T.A. 168, we held that bond premiums*1866 were income to the issuer ratably over the life of the bonds. *572 I am unable to distinguish the cases last above mentioned from the present case in principle; therefore, it seems to me that these cases are overruled. Also, in the case of Julia Building Corporations,3 B.T.A. 333">3 B.T.A. 333, we held that a lessor could include nothing in the computation of its invested capital representing a building erected on its property by a lessee. It seems to me that this case also is overruled by the present decision.