*37 Decision will be entered under Rule 50.
1. A sum received by the petitioner in the taxable year constituted the purchase price of an option and was not rental income in that year.
2. A delinquency penalty was properly determined for a year for which it was later ascertained that no tax was due because a net operating loss for a subsequent year was allowable as a carry-back to the taxable year. Cf. Manning v. Seeley Tube & Box Co. of New Jersey, 338 U.S. 561">338 U.S. 561.
*812 The respondent has determined deficiencies in the petitioner's income tax liability for the taxable years ended September 30, 1945, 1946, and 1947 in the amounts of $ 645.52, $ 1,571.20 and $ 39,011.89, respectively, *38 and a 25 per cent delinquency penalty amounting to $ 161.38 for the taxable year ended September 30, 1945. Some of the issues raised in the pleadings have been settled by the parties. Two issues remain for decision: (1) whether the sum of $ 120,000 paid to petitioner in the taxable year 1947 constituted taxable income when received; and (2) whether the respondent erred in determining a 25 per cent delinquency penalty for the taxable year 1945. Our decision on the first issue will determine the amount of the net operating loss for 1947 which may be used as a net operating loss carry-back for the taxable years 1945 and 1946.
FINDINGS OF FACT.
The petitioner was organized as a corporation under the laws of Florida on October 1, 1942. Its income is computed in its books of account and in its tax returns on the accrual basis and for a fiscal year ending September 30. For the fiscal years ended September 30, 1945, September 30, 1946, and September 30, 1947, the petitioner filed its tax returns with the collector of internal revenue for the district of Florida at Jacksonville.
In 1946, all of petitioner's outstanding capital stock was owned by Vincent and Margot Valcarce, hereinafter*39 referred to as Vincent and Margot, who are husband and wife. Vincent owned two-thirds of the stock which he acquired in 1942 and Margot owned the remaining third which she acquired in 1943. Vincent is a citizen of Cuba and does not speak English. Margot is a naturalized citizen and speaks English fluently.
*813 The petitioner owned and operated a hotel known as the Royalton Hotel located in Miami, Florida, which it purchased in 1942. Margot and her two sisters were active in the management of the hotel until 1943 when it was leased and managed by the Navy Department as quarters for Navy personnel. In 1946, when the petitioner reacquired possession from the Navy, Vincent and Margot no longer desired to operate the hotel because one of Margot's sisters who was active in its management had died and, in addition, Margot was expecting a child.
On October 31, 1946, the petitioner leased the hotel property to Flagler Leases, Inc., for a 99-year term commencing November 1, 1946, for $ 14,000 annual rental, plus the lessee's agreement to pay taxes, assessments, insurance, and water rents imposed on the property and to make repairs and to rebuild or repair the property in case of *40 destruction by casualty. In addition to provisions for leasing the property, the lease indenture contained an "Option to Purchase" section which provided that in consideration of the sum of $ 120,000 received upon execution of the lease indenture, the lessor gave the lessee an option to purchase the fee simple title to the property for $ 500,000 during the period commencing November 1, 1960, and ending October 31, 1965. The $ 120,000 sum was to be applied to the purchase price of the fee simple title if the option was exercised.
This section also provided that the option was "co-existent with the lease and demise herein made" and the $ 120,000 sum would be forfeited to the lessor as damages if the lessee defaulted in any of the terms, covenants, and conditions of the lease. The section of the lease indenture containing the mutual covenants of the lessor and lessee contained a similar provision. This section expressly provided that the lease was not "co-existent with" the option, and remained in effect if the option was not exercised.
The lease indenture contains no provision restricting the petitioner's use or disposition of the $ 120,000 sum. Nor is there any provision for the*41 return of the sum to the lessee except that it is to be applied to the purchase price if the lessee exercises the option.
On the lessee's books of account, the $ 120,000 sum was charged to an account entitled "Option to Purchase" and was still carried in this account as of March 1, 1951.
The lease and option provisions of the indenture were still in effect at the time this proceeding was heard.
In negotiating the lease and option, the lessor contemplated using the $ 120,000 sum to retire the mortgage on the hotel. The balance due on the mortgage on September 30, 1945, 1946, and 1947 was as follows:
| Date | Balance due |
| September 30, 1945 | $ 115,396.00 |
| September 30, 1946 | 110,795.74 |
| September 30, 1947 | 85,416.89 |
*814 The annual installments of principal and interest were approximately $ 10,000.
Since October 31, 1946, the petitioner's activity has been confined to the collection of rents from the lessee of the hotel property. The petitioner incurred and reported a net operating loss of $ 17,181.67 for the taxable year 1947.
The petitioner purchased the hotel property at a cost of $ 163,275.54, allocable as follows:
| Land | $ 42,726.11 |
| Furnishings | 13,734.16 |
| Building | 106,815.27 |
| $ 163,275.54 |
*42 On September 30, 1946, the petitioner's adjusted basis for the hotel property was as follows:
| Land | $ 42,726.11 |
| Building | 106,815.27 |
| Furnishings | 27,911.23 |
| Total | $ 177,452.61 |
| Less depreciation reserve | 28,859.48 |
| Net depreciated value | $ 148,593.13 |
On its Federal tax returns, the petitioner claimed deductions for depreciation upon the basis of a remaining useful life of 20 years for the hotel building and of 10 years for the furnishings.
The rental paid by the Navy Department during its occupancy of the hotel from 1943 to 1946 was $ 32,500 a year. The Navy Department paid all operating costs, including repairs, and the petitioner paid the taxes and insurance which approximated $ 10,000 annually.
In the notice of deficiency, the respondent determined that the $ 120,000 received by the petitioner from Flagler Leases, Inc., upon execution of the 99-year lease and option to purchase, was taxable income to the petitioner in the year of receipt, namely, the taxable year ended September 30, 1947. The adjustment was explained as follows: "Rental income not reported in original return filed."
The petitioner filed its income tax return, Form 1120, for the taxable year ended *43 September 30, 1945, with the respondent on October 2, 1946. This return was due on or before December 15, 1945. There was no reasonable cause for the delinquent filing.
The petitioner is entitled to a net operating loss deduction in the taxable year ended September 30, 1949, in the amount of $ 725.55.
The petitioner is entitled to a net operating loss deduction in the taxable year ended September 30, 1946, for a loss carry-back from the taxable year ended September 30, 1948, in the amount of $ 3,286.83.
*815 The petitioner is entitled to a net operating loss deduction in the taxable years ended September 30, 1945, and September 30, 1946, for a loss carry-back from the taxable year ended September 30, 1947.
The sum of $ 120,000 received upon the execution of the lease indenture constitutes the purchase price of an option. This sum was to be applied to the purchase price of the property and was not in excess of the adjusted basis of that property.
OPINION.
The primary issue before us is whether the sum of $ 120,000 received by the petitioner in its taxable year 1947 constituted income when received. The petitioner contends this sum represented the purchase price of an option*44 and is not taxable until the option is terminated since the sum is to be applied on the purchase price of the property if the option is exercised and the sum is not in excess of the adjusted basis of the property. See Virginia Iron Coal & Coke Co., 37 B. T. A. 195, affd. 99 F.2d 919">99 F. 2d 919, certiorari denied 307 U.S. 630">307 U.S. 630. The respondent contends the sum was prepaid rental disguised as an option payment which the petitioner lessor was under no obligation to return and hence is taxable income. See North American Oil Consolidated v. Burnet, 286 U.S. 417">286 U.S. 417, and Gilken Corp., 10 T. C. 445, affd. 176 F.2d 141">176 F. 2d 141.
The petitioner submitted in evidence the testimony of the signatories for the lessee and lessor corporations and the attorney who drafted the lease. Each testified that the sum represented the purchase price of the option and was paid and received for that purpose and for no other purpose. They testified that the option was incorporated in the instrument, not to defer the tax incidence upon the receipt of the*45 $ 120,000 sum, but to satisfy the demands of the lessee.
The clear, forthright testimony of the witnesses was corroborated by the terms of the instrument which clearly and unambiguously state that the sum was in payment for the option. The respondent submitted no evidence that in any way contradicted this testimony, or other evidence sufficient to establish that this sum was something other than what it purports to be.
We have considered such factors as the length of time that expires before the option commences, the length of the lease term, the comparison between the amount of cash paid annually as rent and the option price of the property, the provisions whereby the option terminates upon expiration of the lease, and the provision that the purchase price of the option is forfeited to the petitioner if the lessee breaches the lease. While these factors may lend support to respondent's argument, they are insufficient to overcome the positive evidence offered by the petitioner.
*816 It follows that the sum received by petitioner for the option does not constitute taxable income in 1947 since it may be applied on the purchase price of the property and is less than the adjusted*46 basis of the property in the hands of petitioner. Virginia Iron Coal & Coke Co., supra.
The respondent has determined a 25 per cent delinquency penalty against petitioner for failure to file its income tax return for the taxable year 1945 within the prescribed time. Section 291, Internal Revenue Code. The petitioner does not deny that its income tax return for the taxable year 1945 was due on or before December 15, 1945, and was not filed until October 2, 1946, and that there was no reasonable cause for the delay. However, the petitioner contends that if the sum of $ 120,000 is not, as we have held, taxable income for the taxable year 1947, then there is a net operating loss for 1947 which, when properly carried back to the taxable year 1945, leaves no tax due. From this it argues that since there is no tax due for that year, there can be no penalty.
We find no merit in petitioner's argument. The obligation to file a timely return is mandatory on a taxpayer and his failure to do so without reasonable cause requires the imposition of a penalty. The fortuitous circumstances which permit the carry-back of net operating losses of later years cannot*47 serve to excuse the earlier delinquency. Our conclusion here finds support in the decision of the Supreme Court in Manning v. Seeley Tube & Box Co. of New Jersey, 338 U.S. 561">338 U.S. 561. There it was held that while a net operating loss carry-back may serve to eliminate a deficiency for a previous year, the interest which had theretofore accrued on such deficiency was not eliminated.
Further support for the conclusion here reached may be found in the report of the Senate Finance Committee accompanying the Revenue Act of 1942, * wherein it is stated:
A taxpayer entitled to a carry-back of a net operating loss or an unused excess profits credit * * * will not be able to determine the deduction on account of such carry-back until the close of the future taxable year in which he sustains the net operating loss or has the unused excess profits credit. He must therefore file his return and pay his tax without regard to such deduction, and must file a claim for refund at the close of the succeeding taxable year when he is able to determine the amount of such carry-back. [Emphasis added.]
*48 We, therefore, sustain the respondent's determination of a 25 per cent delinquency penalty against the petitioner for failure to file an income tax return for its taxable year 1945 within the prescribed time. Section 291, supra.
Various adjustments which the parties have agreed to and which will follow from our findings will be settled under Rule 50.
Decision will be entered under Rule 50.
Footnotes
*. S. Rept. No. 1631, 77th Cong., 2d Sess., 1942 -- 2 C. B. 504, 596↩.