*1197 1. INCOME. - Held that the net fair market value of the building erected by the lessee on leased premises owned by petitioners constituted income to petitioners in the year of the forfeiture of the lease and their repossession of the leased premises with the building thereon. Helvering v. Bruun,309 U.S. 461">309 U.S. 461, followed; held, further, that such income constituted ordinary income rather than capital gain.
2. Id. - Held that delinquent taxes accrued prior to forfeiture of the leases, which petitioners were compelled to pay in a year subsequent thereto, and legal fees incurred in connection with securing repossession of the leased premises, do not constitute a proper offset against the fair market value of the new building in arriving at the amount of the net gain realized through acquisition of that building in the taxable year.
3. DEDUCTION. - Held, that where no part of such taxes and fees was paid during the taxable year, petitioners are not entitled to deductions thereof from gross income for that year.
4. Id. - Where the terms of a will provided for the current distribution to the beneficiaries of the net income of the trust*1198 created thereby, held, that the income of the trust realized in the taxable year through its acquisition of the building erected by the lessee, is deductible by the fiduciary, under section 162(b) of the Revenue Act of 1934, whether such income is distributed or not.
5. DELINQUENCY PENALTY, approved where no return was ever filed.
*1307 In each of the above entitled proceedings the Board heretofore entered its decision of no deficiency in income tax for the year 1934, pursuant to its memorandum opinion holding that petitioners did not derive taxable income in that year by reason of their repossession of certain leased premises which had been improved by the lessee. Such holding obviated the Board's consideration of the several alternative issues raised by the pleadings. That decision was reversed and set aside by mandate of the United States Circuit Court of Appeals for the Sixth Circuit on authority of Helvering v. Bruun,309 U.S. 461">309 U.S. 461, and the cases were remanded to the Board for further proceedings.
In these consolidated*1199 proceedings the respondent has determined income tax deficiencies for the calendar year 1934 in the amount of $39,386.42 in Docket No. 92816 and in the amount of $20,040.94 in Docket No. 92817, and has added 25 percent to each deficiency for delinquency in filing returns.
Both petitioners allege that the respondent erred: (1) In taxing to them, as income for 1934, the fair market value of a building erected by a lessee on premises leased to the lessee by each of the petitioners, which premises were repossessed by the respective petitioners on forfeiture of their respective leases in the taxable years; and (2), in the alternative, if the fair market value of the building is held to be so taxable, respondent erred (a) in his determination of the amount of such market value, (b) in failing to credit petitioners with the value of certain old buildings removed by the lessee from the leased premises to permit the erection of the new building here involved, (c) in failing to allow petitioners credit for delinquent taxes accruing to the lessee on the new building prior to forfeiture, which taxes petitioners were compelled to pay after the forfeiture of the leases, (d) in failing to allow*1200 petitioners credit for legal and other expenses and costs incurred by them in repossessing the leased premises and the new building thereon, (e) in not basing the income tax on 30 percent of the fair market value of the building, it being alleged that the lease agreement and the building on the leased premises constituted a capital asset held by petitioners for more than ten years, (f) and in failing to allow petitioners credit for the distribution of the fair market value of the building to beneficiaries under the respective wills of Austin C. Brant, deceased, and Harriet Frances Whiting, deceased. The petitioner in Docket No. 92816 also *1308 assigns error in the respondent's determination of a 25 percent delinquency penalty.
In Docket No. 92816 the petitioner assigns an additional error as to which the parties have stipulated that, should the Board find that the Brant estate derived income in 1934 in the amount of $79,945.02 representing the fair market value of that part of the new building erected by the lessee on the Brant estate's premises, then a deduction of $50,000 is allowable against such income.
The facts are in part stipulated and in part shown by documentary*1201 evidence introduced at the hearing. The facts stipulated are included herein by reference, but only such of them as are deemed necessary to consideration of the issues are set out herein.
FINDINGS OF FACT.
Austin C. Brant died on October 12, 1928, and Harriet Frances Whiting died on September 8, 1915, each a resident and citizen of Canton, Ohio.
Joseph M. Blake was, on February 28, 1934, duly appointed by the Probate Court of Stark County, Ohio, and is now the duly qualified and acting administrator de bonis non with the will annexed of the estate of Austin C. Brant, deceased. He was also duly appointed by the same court, on June 28, 1923, and is the duly qualified and acting administrator de bonis non with the will annexed and trustee under the will of the estate of Harriet Frances Whiting, deceased.
On the 18th of February 1919 Austin C. Brant executed a 99-year lease to Charles W. McLaughlin covering the south half of the west half (100 ft. by 33 ft.) of lot number 33 in the city of Canton, Ohio. On February 25, 1919, Ralph S. Ambler, the then executor and trustee under the will of Harriet Frances Whiting, and the beneficiaries under that will, also executed a 99-year*1202 lease to Charles W. McLaughlin covering the south half of the east half (100 ft. by 33 ft.) of the same lot 33. Various assignments of both leases were thereafter made by the lessee and his assignees, but the Canton Fireproof Building Co. became the final lessee under the two leases.
The two leases were practically identical in terms and provisions, with the exception of the amounts of rentals to be paid and the descriptions of the leased premises. They each provided for rentals in definite stated amounts of money per annum during the running of the lease, which were to be paid quarterly by cash in advance on the first day of certain months in each year. As a further consideration the lessee was to pay all taxes and public charges of every kind levied or assessed upon the leases and the real property covered by them, including all buildings them existing or thereafter placed on the leased premises. The lessee was granted the right to remove from *1309 the leased premises any or all of the buildings thereon and to erect thereon in the "stead" of such buildings, at his sole cost, another building, or other buildings, of such kind as he should see fit, provided such buildings*1203 should be of a value when completed of not less than a stated amount. The lessee was also given the right to erect a single building on both of such leased premises without separating such building with respect to those premises. The lessee was not required under the terms of the leases, or either of them, to erect any buildings on the leased premises and there was no provision in the leases, or either of them, that the value of any new building which might be erected should constitute any part of, or additional, rent. In case of default on the part of the lessee in the payment of rentals or in the performance of any covenant or agreement in the lease contracts, the lessors were given the right, after giving a specified notice, to enter upon and take possession of the leased premises, with all improvements and buildings thereon, and to terminate the leases. The leases further provided that upon the expiration of the full terms of the leases, and if neither of certain options set forth in the leases but not material here were exercised, all the buildings constructed by the lessee upon the leased premises would become the absolute property of the lessors and that the lessee would*1204 thereupon surrender full possession to the lessors.
In order to erect a new building upon the leased premises it was necessary for the lessee, under the permissive provisions of the lease, to remove certain old buildings from the premises leased from the Whiting estate trust. The depreciated value of the buildings so removed was $2,875.25. Under the permissive provisions of the two leases, at its own expense and during the years 1924 and 1925, the lessee erected on the lands embraced in the two separate leases a single new building of eight stories, constructed of brick, concrete, and steel, and resting on foundations sunk into the earth the depth necessary to support the building.
In 1934 the leases were forfeited by the lessee and the lessors thereupon became the owners of the new building on the leased premises. By a decree of the Court of Common Pleas of Stark County, Ohio, entered July, 6, 1934, in an action in which the petitioners as lessors were defendants and in which the right of petitioners to the possession of the building because of the forfeiture of the leases was disputed by the plaintiff and the lessee, the Brant estate and the Whiting estate trust each acquired*1205 possession of that part of the new building erected by the lessee on the leased real estate owned severally by each such estate.
The fair market value of that part of the new building erected on the leased premises of the Brant estate was $79,945.02 at the time of its repossession by that estate in July 1934. The fair market value *1310 of that part of the new building erected on the leased premises of the Whiting estate trust was $53,296.68 at the time of its repossession by that estate trust in July 1934.
Subsequent to 1934 Joseph M. Blake, attorney, rendered statements of account in the amount of $9,000 to the Brant estate and in the amount of $6,000 to the Whiting estate trust for legal services rendered from December 2, 1931, through July 6, 1934, in connection with the contested litigation to which those estates were parties and in which there was rendered the decree awarding repossession of the leased premises and possession of the building thereon to those estates, respectively. Such legal fees were not paid during the year 1934, nor at any time up to the hearing on these proceedings.
The taxes assessed on the land values of the leased premises were paid, *1206 but the lessee failed to pay taxes for the years 1930 to 1934, both inclusive, on the taxable value of the new building it had erected on the leased premises. After the Brant estate and the Whiting estate trust had repossessed the leased premises and the building thereon, the county auditor, under authority of a decree of the Common Pleas Court of Stark County, Ohio, entered on January 24, 1936, thereafter assessed the Brant estate with $9,394.59 and the Whiting estate trust with $9,394.54 on their respective interests in the new building. In 1936 the Brant estate paid the amount of its assessment in cash and the Whiting estate trust, in the same year, paid its assessment, partly in cash and the balance by its notes. The taxes so paid were not claimed or allowed as a deduction in any income tax return made by either of the two estates.
The will of Harriet Frances Whiting empowered her executor and trustee to sell her real estate and distribute the net proceeds equally between the designated devisees or "to rent the same * * * and after the payment of taxes and other necessary expenses to divide equally the net rentals among * * * (the designated) devisees, as often as such division*1207 can practically be made." (Parenthesis ours.) The executor and trustee was given no discretion to either distribute or accumulate such net income. At all times material here, the premises covered by the above mentioned lease of the Whiting estate trust constituted that trust's sole asset and the rental income therefrom from June 1923 to and including 1934 was collected by Joseph M. Blake, in his capacity as trustee, who in that year distributed the same to the five living beneficiaries who were the only persons entitled to the distribution of the income of that trust during 1934.
On or before March 15, 1935, the Brant estate filed with the collector of internal revenue at Cleveland, Ohio, two tax returns for the calendar year 1934; one, an individual income tax return on Form 1040, reported a gross income of $10,853.13 and deductions for interest *1311 and taxes paid and for $4,938.58 distributed to the beneficiaries of the Brant estate; the other, a fiduciary return on Form 1041, reported the beneficiaries' distributable shares of income in the amount of $4,938.58 taxable to the beneficiaries of that estate. Neither return reported any tax due and none was paid. Neither*1208 return included any amount as gain from the acquisition, by the Brant estate in 1934, of that part of the new building erected by its lessee on its leased premises.
The Whiting estate trust has never filed an individual income tax return or a fiduciary return for the calendar year 1934, for the reason that it believed that no return was required.
OPINION.
TYSON: Pursuant to the mandate of the United States Circuit Court of Appeals for the Sixth Circuit, and upon authority of Helvering v. Bruun,309 U.S. 461">309 U.S. 461 (see also Lewis v. Pope Estate Co., 116 Fed.(2d) 328), we hold that the net fair market value of that part of the new building erected by the lessee on the leased premises of the Brant estate and the Whiting estate trust, at the time of their repossession of such premises in 1934, constituted taxable income to them, respectively, in the taxable year 1934.
The first issue having been so dicided, we must now consider the several alternative allegations of error, in both proceedings, hereinbefore designated (a) to (f), inclusive, and also the allegation of error in Docket No. 92816 in the respondent's determination of a 25 percent*1209 delinquency penalty.
The question of value raised by alternative issue (a) has been settled by stipulation of the parties. The fair market value of that part of the new building erected by the lessee on the leased premises of the Brant estate was $79,945.02 at the time of the repossession of such premises in 1934. The fair market value of that part of the new building erected by the lessee on the leased premises of the Whiting estate trust was $53,296.68 at the time of the repossession of such premises in 1934.
The principle involved in alternative issue (b) is controlled by Helvering v. Bruun, supra, wherein it was held that an offset of the unamortized cost of old buildings at the time they were removed to make way for the erection of a new building by the lessee, was allowable to determine the net fair market value of the new building to the lessor at the time of repossession and thus the amount of the net gain realized by the lessor at that time. As to the Whiting estate trust the parties have stipulated that the depreciated value of the old buildings removed from its premises by the lessee was $2,875.25. Accordingly, we hold that the net fair market*1210 value of the part of the new building erected on the premises of the Whiting estate trust*1312 was $50,421.43 (i.e., $53,296.68 less $2,875.25) at the time of that trust's repossession of its leased premises. As to the Brant estate there is no proof of the removal of any old building from its premises by the lessee. Accordingly, we hold that the net fair market value of the part of the new building erected on the premises of the Brant estate was $79,945.02 and thus the amount of the net gain realized by the lessor at that time. However the parties have stipulated that the Brant estate is entitled to an allowable deduction of $50,000 from such income.
While in their assignments of errors (c) and (d) petitioners claim the taxes and attorneys' fees merely as an offset against the value of the new building in arriving at the net fair market value thereof, they nevertheless, on brief, apparently claim in the alternative that the attorneys' fees and taxes constitute ordinary deductions from gross income for the taxable year 1934. We are of the opinion that there is no merit in either of those claims. In *1211 Mary E. Evans,42 B.T.A. 246">42 B.T.A. 246, 254-256, it was held that attorneys' fees incident to the forfeiture and cancellation of a lease did not constitute an offset against the value of the building erected by the lessee, as contended by respondent, but instead constituted an ordinary deduction from gross income for the year in which paid. In the same case it was held that taxes accrued prior to forfeiture of the lease, which under the terms of the lease the lessee was obligated to pay and which were paid by the lessor subsequent to forfeiture, constituted an ordinary deduction from gross income for the year in which paid. Upon authority of that case, we hold that the attorneys' fees and taxes incurred and paid by petitioners under the circumstances herein are deductible, if at all, only as ordinary deductions from gross income for the year in which paid or accrued, and, further, that such fees and taxes do not constitute an allowable offset in arriving at the net fair market value of the building for determining the net gain realized at the time the building was acquired by petitioners. In the instant cases the record is devoid of any showing as to the accounting basis used*1212 by either of the petitioners. If each petitioner was on the cash basis the taxes and legal expenses involved herein, not having, been paid during the taxable year 1934, would not be deductible from gross income in that year, and, since it is not shown that petitioners were on the accrual basis, we need not discuss the question of when the taxes and legal expenses may have accrued as liabilities of petitioners. On this record we hold that petitioners are not entitled to deduct from gross income for the taxable year 1934 the taxes and legal expenses involved herein.
Alternative issue (e) involves petitioners' claim that the taxable income realized in 1934 through their acquisition of the new building upon the forfeiture of the lease, should be taxed as a capital gain instead of ordinary income, it being alleged that the lease agreement *1313 and the new building erected on the leased premises by the lessee constituted a capital asset held by petitioners for a period of over ten years.
In Helvering v. Bruun, supra, the Supreme Court held that upon forfeiture of the lease a new building erected by the lessee was not merely an accretion to the lessor's*1213 original capital asset, but, instead, constituted a realized measurable gain taxable to the lessor. In Hort v. Commissioner,313 U.S. 28">313 U.S. 28, where the lessor owned both the land and the building thereon subject to a lease and in consideration for the agreed cancellation of the lease the lessee made a cash payment to the lessor, the Court held that the full amount of such cash payment was in substitution of rent and constituted ordinary income to the lessor.
In the Bruun case, supra, the cancellation of the lease resulted in the lessor's acquisition of property, the value of which constituted income. In the Hort case, supra, the cancellation of the lease resulted in the lessor's receipt of cash, which constituted the amount of gain realized. In neither case was there a sale or other disposition by the taxpayer of a capital asset; instead, the lessor was in receipt of "a substitute for rental payments" constituting ordinary income and the same is true in the instant proceedings. We hold that the gain here in question was taxable as ordinary income as determined by respondent.
Alternative issue (f) involves petitioners' claim for a deduction*1214 of the amount of income, realized through the acquisition of the new building, distributable to the beneficiaries under the respective wills of Austin C. Brant, deceased, and Harriet Frances Whiting, deceased, notwithstanding petitioners' inability to actually distribute such income because it was represented by the value of the new building which was attached to the realty.
The applicable portions of section 162 of the Revenue Act of 1934 are set out in the margin. 1 Where the terms of a will or trust provide *1314 for a distribution of current income, the payment of which can be enforced by the beneficiary as a matter of right, a deduction is allowable to the fiduciary under section 162(b), supra, whether the distribution is made or not. Where under the terms of a will or trust the income thereof may be, in the discretion of the fiduciary, either distributed to the beneficiary or accumulated, a deduction is allowable to the fiduciary, under section 162(c), supra, only in the amount actually paid during the year or credited during the year by an allocation so definite as to be beyond recall. *1215 Commissioner v. Stearns, 65 Fed.(2d) 371; certiorari denied, 290 U.S. 670">290 U.S. 670, and Thomas N. Perkins,33 B.T.A. 606">33 B.T.A. 606, 624.
*1216 In the case of the Brant estate, and with reference to this issue (f), the record shows only that on its return Form 1040 for the year 1934 it took a deduction for the amount of its net income, exclusive of the gain realized from the acquisition of the building, distributed in that year to the beneficiaries of that estate. The fact that certain amounts of income of the estate were distributed is not determinative of the question of whether the Brant estate is now entitled to a deduction for the amount of the income here involved which was not actually distributed. The record fails to disclose the terms of the will of Austin C. Brant, deceased, governing the distribution of the income of that estate and fails to establish that its income was currently distributable and thus deductible under section 162(b), supra, whether distributed or not. Accordingly, we hold that the income in question is taxable to the fiduciary of the Brant estate.
In the case of the Whiting estate trust and with reference to this issue (f), the decedent's will gave her executor and trustee no discretion to either distribute or accumulate the net income of the trust, but directed the distribution thereof*1217 equally to designated living beneficiaries. The net income of the trust for the taxable year 1934 was so distributed by Joseph M. Blake, acting as trustee of that estate, except as to income here involved, which was derived, upon the trust's acquisition of the new building at termination of the lease, as "a substitute for rental payments." Hort v. Commissioner, supra.
We conclude that the net income of the Whiting estate trust was currently distributable by the fiduciary to the beneficiaries within the meaning of section 162(b), supra, and pursuant to that section the fiduciary is entitled to a deduction of the amount of the net income realized by the trust from the acquisition of the new building in 1934. The fact that such income was not severable from the land owned by the trust did not prevent its recognition as taxable gain, and likewise its inseparability for purposes of distribution is immaterial, for, under section 162(b), supra, the deduction is to be allowed whether the income is distributed or not.
*1315 In the case of the Whiting estate trust the respondent determined a 25 percent delinquency penalty, under section 291 of the Revenue*1218 Act of 1934, for failure to file a return. Since no return has ever been filed by that petitioner for the taxable year 1934, the statutory provision as to "reasonable cause" for failure to file a return has no application and the imposition of a delinquency penalty of 25 percent of any income tax due for that year is mandatory. Scranton, Lackawanna Trust Co., Trustee,29 B.T.A. 698">29 B.T.A. 698, 702; affd., 80 Fed.(2d) 519, certiorari denied, 297 U.S. 723">297 U.S. 723.
In the case of the Brant estate, the respondent determined a 25 percent delinquency penalty, under section 291 of the Revenue Act of 1934, for failure to file a return, Form 1040, within the time prescribed by law. The parties have stipulated that the Brant estate did file timely returns, an income tax return Form 1040 and a fiduciary return Form 1041, for the calendar year 1934. The respondent erred in determining a 25 percent delinquency penalty as to the Brant estate.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 162. NET INCOME.
The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that -
(a) * * *
(b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust forits taxable year which is to be distributed currently by the fiduciary to the beneficiaries, * * * but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. * * *
(c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary. ↩