*1071 Held, that petitioner-lessor realized no income in the taxable year by reason of the erection of a building on lessor's land by a lessee under a lease for twenty-one years with privilege of three renewals. Blatt Co. v. United States,305 U.S. 267">305 U.S. 267.
*117 This proceeding was brought to redetermine a deficiency in income tax of the petitioner for the fiscal year ending February 29, 1932, in the sum of $4,912.12.
The sole issue is whether or not permanent improvements made by a lessee on lessor's land resulted in realized income to petitioner lessor.
FINDINGS OF FACT.
The facts were stipulated substantially as follows:
The petitioner is a corporation duly organized and existing under the laws of the State of New York, with its principal office at 420 Lexington Avenue, New York City.
The petitioner was the owner of the premises known and described as 82-84 Broad Street, New York City, which it leased to the Marex Realty Corporation (hereinafter called Marex), under date of October 24, 1929.
The land adjacent*1072 to and on both sides of that of the petitioner was owned by the Maritime Association of the Port of New York (hereinafter called Maritime). Maritime leased its two parcels of real estate known as 78-80 Broad Street and 86 Broad Street, respectively, to Marex under date of February 17, 1930.
The lease between Maritime, as landlord, and Marex, as tenant, for the land adjacent to and on both sides of the premises owned by petitioner similarly provided for a lease term of twenty-one years commencing on the first day of February 1930, with the privilege to the lessee of three renewal terms of twenty-one years each.
The lease dated October 24, 1929, granted the lessor the option of renewal for three additional terms of twenty-one years each. It also gave the lessee the right to purchase the fee from the petitioner prior to January 31, 1951, for $1,000,000. The lessee agreed to erect an office building at a cost of at least $750,000 and to pay all taxes, insurance, and other charges on the property. In the event of default by the lessee the lessor might repossess the property under a specified proceeding, with no right of redemption in the lessee.
On February 17, 1930, a supplementary*1073 agreement was entered into by the petitioner, Maritime, and Marex, reciting that Marex desired *118 to erect a single building on the premises owned by both the petitioner and Maritime and setting forth the covenants, rights, and liabilities of the three parties. Marex agreed to erect a single structure on the entire area known as 78-86 Broad Street, subject to diminution through prohibitions of law, in compliance with the terms, conditions, covenants, and provisions of its leases with the petitioner and Maritime. The agreement also provided that, if petitioner and Maritime should become entitled to the possession of their respective properties, "for the purpose of more convenient handling of the property, they should be deemed tenants in common of the whole plot of land covered by said single building and have as against each other and over said plot, the same rights and privileges that they would have had they been tenants in common, each owning an undivided one-half part thereof", and should share equally the net proceeds of such management and operation.
The agreement further provided that upon the final expiration of the terms of the leases the building should be demolished*1074 and removed from the premises as soon as practicable after such termination and that the petitioner and Maritime each should pay one-half of the cost thereof.
The lease of October 24, 1929, and the agreement of February 17, 1930, contained many other provisions not pertinent to the issue in this proceeding. All the provisions of the written leases were in full force and effect during the entire fiscal year ended February 29, 1932.
Marex caused to be erected on the property leased from the petitioner and Maritime a single building known and described as the premises 78 to 86 Broad Street. The single building was completed on or about May 1, 1931, at a cost of $2,800,000, which amount was also the fair market value of the building at the date of its completion.
The new building in question was of steel and stone construction and had a depreciable life of forty years.
The building known as 78-86 Broad Street rests upon a parcel of land, the total ground area of which is 12,911.16 square feet. The parcel owned by the petitioner contains 4,478.41 square feet, or 34.7 percent of the total ground area. The total floor space in the entire building is 352,258 square feet. The*1075 total floor space resting on the land owned by the petitioner is 113,585 square feet, or 32.2 percent of the entire floor space. From the total floor space, that space occupied by stairs, shafts, closets, elevator lobbies, toilets, elevators, and public halls, has been deducted and the net floor space remaining has been termed rentable floor space. The total rentable floor space in the entire building is 277,028 square feet, of which 95,164 square feet rests upon the land of the petitioner, or 34.3 percent of the total rentable floor space.
*119 By May 1, 1931, title to the new building mentioned above had passed to the petitioner and Maritime, subject to the leases in question.
The petitioner in its income tax return for the fiscal year ended February 29, 1932, reported no income from the erection of the building and the joint acquisition of title thereto.
The respondent in his audit of the petitioner's income tax return increased petitioner's net income by the sum of $32,246.22, which represented the portion for the fiscal year ended February 29, 1932, of one-half of the depreciated value of such building computed on the basis of a 40-year life and spread over the*1076 first lease period only. The respondent's computation was based on his determination that the first lease period expired on May 4, 1950, whereas the actual date of expiration was January 31, 1951. When restated to give effect to additional depreciation for nine months, the portion for the fiscal year ended February 29, 1932, on respondent's theory, of one-half of the depreciated value of such building computed on the basis of a 40-year life and spread over the first lease period only, would be $29,913.76.
The notice of deficiency contains the following statement:
The lease was for a term of twenty-one years, and the building was completed on May 1, 1931. The Bureau holds that where a lessor is to obtain a building at the end of a lease, under the provisions of the lease, that such a building when constructed becomes the property of the lessor at the time of construction subject to the beneficial use by the lessee during the period of the lease.
OPINION.
VAN FOSSAN: This case presents a question which, in its various phases, has been the subject of divergent opinions by this Board and the courts. 1 Broadly stated, the cases involve the determination of the time when, *1077 if ever, a lessor of property realizes income by reason of the erection by a lessee, of permanent improvements on lessor's land.
In the instant case the petitioner contests the action of respondent in holding that income was realized in the fiscal year ended February 29, 1932, because of a building theretofore erected on land owned by petitioner by a lessee under a lease for 21 years, dated October 24, 1929.
The most recent pronouncement on the subject is found in , in which the Supreme Court reversed the Court of Claims, which had affirmed the Commissioner's *120 action in*1078 adding to the lessor's income, during the year of installation, one-tenth of the depreciated cost of improvements made by a lessee under a ten-year lease, the lease providing that the improvements should become the property of the lessor.
In the Blatt case the Court observed that they were not called on "to decide whether under any lease or in any circumstance, income is received by lessor by reason of improvements made by lessee, nor to choose, for general approval or condemnation, any of the theories expounded by the United States." It thereupon addressed itself to the question whether, under the lease there involved, one-tenth of the agreed "estimated depreciated value" as of the end of the ten-year term, was income to the lessor in the first year of the term. In considering this question the Court first took occasion to observe that the facts found were not sufficient to sustain the holding of the lower court to the effect that the making of the improvements by lessee was payment of rent. Likewise, it was stated that:
The findings fail to disclose any basis of value on which to lay an income tax or the time of realization of taxable gain, if any there was. The figures*1079 made by the commissioner are not defined. The findings do not show whether they are intended to represent value of improvements if removed or the amount attributable to them as a part of the building.
After thus ruling the findings of fact insufficient, the Court proceeded with the following observations:
Granting that the improvements increased the value of the building, that enhancement is not realized income of lessor. So far as concerns taxable income, the value of the improvements is not distinguishable from excess, if any there may be, of value over cost of improvements made by lessor. Each was an addition to capital; not income within the meaning of the statute. Treasury Regulations can add nothing to income as defined by Congress.
But, assuming that at some time value of the improvements would be income of lessor, it cannot be reasonably assigned to the year in which they were installed. * * * It may be assumed that, subject to the lease, lessor became owner of the improvements at the time they were made. But it had no right to use or dispose of them during the term. Mere acquisition of that sort did not ammount to contemporaneous realization of gain within the*1080 meaning of the statute.
Bearing in mind the specific question under consideration, as stated by the Court in the Blatt case, and albeit the findings of the lower court were held to be insufficient to support its decision, we interpret the above opinion to constitute a complete disapproval of the action of the Commissioner in holding that a lessor realizes income in the year of installation of permanent improvements by a lessee.
It is a necessary corollary of this holding that the Commissioner is not justified in spreading the "estimated depreciated value" or any other comparable amount over the term of the lease. If a pro rata *121 part was not income in the first year it is not income in the next or any succeeding year short of the final year of the term. The question whether income is realized at the termination of the lease we need not now decide.
The above conclusion is dispositive of the present case. In this, as in the Blatt case, there is no basis for a holding that the improvements were in the nature of rent. Nor, in our view, is it necessary to dwell on the fact, here present and conceivably very important in certain contingencies, that upon the*1081 termination of the lease the lessor was under obligation to demolish and remove the building from the leased land.
The action of respondent is disapproved.
Reviewed by the Board.
Decision will be entered under Rule 50.
Footnotes
1. ; ; ; reversed ; ; ; ; ; ; reversed by Supreme Court, . ↩