*90 Decision will be entered under Rule 50.
Petitioner entered into a "Lease and Option to Purchase" agreement with the R. F. C., with respect to a certain property, in part of which it was at the time conducting its business. Under the agreement, petitioner was to pay "as rent" $ 100,000 in 60 monthly installments, after which it had the "option to purchase" the property for $ 50,000. Respondent disallowed the deduction of the so-called rental payments, on the ground that they did not qualify as rental expenses within the meaning of section 23 (a) (1) (A) of the Internal Revenue Code of 1939. Held that petitioner, through the said payments, was acquiring an equity in the property and that respondent did not err in his determination with respect thereto.
*1387 The respondent determined deficiencies in income tax against the petitioner for the fiscal years ended August 31, 1946 and 1947, in the respective amounts of $ 4,625.01 and $ 12,251.39, and deficiencies in excess profits tax for the fiscal years ended August 31, 1945*91 and 1946, in the respective amounts of $ 7,775.34 and $ 4,421.87. The only question presented is whether payments made under a "Lease and Option to Purchase" agreement were deductible as rent. Another issue presented by the pleadings has been conceded by petitioner.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found as stipulated.
Petitioner is an Indiana corporation, with its principal office at New Albany, Indiana. It keeps its books and files its returns on the basis of a fiscal year ending August 31, and upon the accrual method of accounting. Its tax returns for the fiscal years ended August 31, 1945, 1946, and 1947, were filed with the collector of internal revenue for the district of Indiana.
Petitioner is engaged in the manufacture of hardwood plywood for the radio, television, and furniture industries. The operation of its business consists of purchasing lumber, rotary veneers, and face veneers, and processing the lumber and veneer into plywood panels. Petitioner manufactures custom panels made to order, and does not make a standard size or "stock panel." It manufactures about 18,000,000 square feet of plywood panels per year. During World War II*92 petitioner also was supplying aircraft plywood for war contracts.
John T. Breece was president and general manager of petitioner until his death in October 1946. His sons, George W. and James E. Breece, prior to their father's death, were vice presidents of petitioner, but devoted only a part of their time to its business. Subsequent to their father's death, however, both sons devoted all of their time to petitioner's business, George Breece as president, and James Breece as treasurer and general manager.
On March 31, 1937, Breece Veneer and Panel Company, a partnership, leased about 30 per cent of the buildings, equipment, and machinery in a plant in New Albany, by written agreement, from the New Albany Veneering Company for $ 700 a month. The other 70 per cent of the premises, machinery, and equipment in the plant was leased by Gunnison Housing Corporation, hereinafter referred to as *1388 Gunnison. A lumber yard, railroad trackage, driveways, and a lumber cooling shed were used jointly by the partnership and Gunnison. On September 30, 1937, Breece Veneer and Panel Company, the partnership, assigned its rights in the lease to petitioner. Prior to the assignment to petitioner*93 by the partnership on September 30, 1937, the New Albany Veneering Company had assigned all of its "right, title and interest in and to" the lease to the Reconstruction Finance Corporation, hereinafter referred to as the R. F. C.
On November 27, 1941, John T. Breece, as president of petitioner, in a letter to the R. F. C. pertaining to the New Albany plant, stated that petitioner was "interested in the purchase of our end of the property, including the new power plant at a price of $ 100,000.00, paying $ 6,000.00 cash, and the balance in equal monthly payments over the next seven years, at 4 1/2 per cent interest on the unpaid balance."
On October 9, 1943, John Breece wrote to Paul Marinangeli, examiner for the R. F. C., at its office in Chicago, as follows:
On my return from New York, I find your letter of October 4. I will make it a point to be here on October 13.
I am slightly interested in the proposition that you and your associate talked to me about when I was last in Chicago, that is, a rental proposition with a purchase clause, the excess rent to be applied against the purchase price. You might come with a definite program. Of course, it depends entirely on what the program*94 would be whether we would be interested.
After a meeting with Marinangeli and other R. F. C. officials in Chicago relative to the New Albany plant, John Breece submitted a proposition pertaining to the leasing of the plant, by a letter dated October 14, 1943. Breece's proposition was that petitioner lease the premises, machinery, and equipment for a period of 5 years, commencing November 1, 1943, at an annual rental of $ 20,000, payable in 12 monthly installments. Petitioner, as lessee, was to have the right of renewal upon termination of the 5-year lease for a period of 3 years, at the same rental, upon giving the R. F. C. 90 days notice in writing prior to the expiration of the lease. It was further proposed that the lease contain an option giving petitioner the right to purchase the real estate, machinery, and equipment covered by the lease, at the end of the fifth year, for $ 50,000 in cash; or, in the event it should exercise the right to extend the lease for the additional 3 years, as therein provided, petitioner should have the option to purchase at the end of the sixth year for $ 50,000, at the end of the seventh year for $ 37,500, and at the end of the eighth year for *95 $ 25,000. In the event petitioner failed to exercise any of the options to purchase, as provided therein, the lease was to terminate and all rights of the petitioner under the lease were to be null and void at the end of the eighth year. It was further proposed that petitioner, during the term of the proposed lease, would furnish the R. F. C. with adequate fire and extended *1389 coverage insurance and public liability insurance with limits of $ 50/$ 50,000, "protecting the lessor at lessee's expense." Petitioner was also to pay all taxes assessed against the premises as they became due and payable, and to make necessary repairs and maintain the real estate, machinery, and equipment in good physical condition. All taxes, insurance premiums, and rents were to be prorated as of November 1, 1943, which was to be the effective date of the lease. Petitioner also was to have the right to sublet any portion or part of the real estate and machinery upon the written consent of the R. F. C. Finally, it was proposed that if petitioner should exercise any of the options to purchase as provided in the proposed lease, the R. F. C. was to convey the real estate by quitclaim deed or special*96 warranty deed, accompanied by an abstract covering the real estate, and the machinery and equipment were to be conveyed by the usual bill of sale.
In their original discussions on a proposed lease, Marinangeli and John Breece contemplated petitioner's taking over Gunnison's lease with the R. F. C., and calculated the rent from Gunnison on the basis of $ 700 per month, or $ 8,400 per year. In a letter dated October 18, 1943, Marinangeli suggested certain changes in the proposed lease pertaining to the subleasing arrangements with Gunnison. He pointed out that the R. F. C. had had a proposal from Gunnison to lease the premises and machinery, commencing November 1, 1943, at a minimum rental of $ 500 per month and a percentage on net sales per month, calculated as follows:
| Net sales per month | Rental | Rental | |
| per cent | amount | ||
| Base | $ 50,000 | 1 | 1 $ 500.00 |
| Next | 25,000 (or fraction) | 1 1/4 | 312.50 |
| Next | 25,000 (or fraction) | 1 1/2 | 375.00 |
| Next | 25,000 (or fraction) | 1 3/4 | 437.50 |
| Next | 25,000 (or fraction) | 2 | 500.00 |
| Next | 25,000 (or fraction) | 2 1/4 | 562.50 |
| Next | 25,000 (or fraction) | 2 1/2 | 625.00 |
| Maximum per month | $ 3,312.50 |
Marinangeli *97 also called attention to the fact that, in view of Gunnison's prospects for securing several large Government contracts, it would be very likely that the annual rental based on the graduated scale, set out above, would greatly exceed the average of $ 8,400 used in their previous calculations. He further stated that it was the R. F. C.'s opinion that the lease and option to purchase should provide for the payment to the R. F. C. of the excess rental paid by Gunnison over $ 8,400 in any one year, such payment to be applied to petitioner's account of rental due under their proposed lease on the final or fifth year, or if such rent was sufficient to pay more than the fifth year, *1390 then such excess should be applied to the account of the fourth year. Marinangeli concluded as follows:
The changes suggested herein are all in your favor, inasmuch as it gives you the prospect of obtaining substantially increased rents from Gunnison Housing Corporation that would be applied as part payment of the 5th and possibly the 4th year's rental due from you, and would thus reduce the eventual cost to you of the premises, in the event you elect to exercise the option to purchase this property*98 at the end of the 5th year or thereafter for the option price stipulated in your proposal. We shall appreciate it if you will give this matter your immediate consideration and let us know as soon as possible whether the suggested changes meet with your approval. On receipt of your concurrence, we shall immediately refer the matter to the Board of Directors of this Corporation for their consideration.
On October 20, 1943, John Breece wrote to Marinangeli in regard to the subleasing proposal with Gunnison. He indicated that the proposition set forth by Marinangeli did not take into consideration the fact that petitioner required more space than it had at that time, and that without the acquisition of more space on petitioner's part, he doubted very much if it would be interested in the leasing proposition at all. However, he made it clear that petitioner did not want to do anything that would handicap Gunnison, and felt that when the "deal" had progressed to a point where there was some assurance it would go through, petitioner and Gunnison could work out their own arrangement, which they would submit to the R. F. C. for approval.
A "Lease and Option to Purchase" agreement was drawn*99 up by the R. F. C. and submitted to petitioner, along with an abstract of title, on November 22, 1943. The title to the property and the form of the agreement were approved by Telford Orbison, petitioner's attorney. On November 30, 1943, the agreement was approved by petitioner's board of directors and its shareholders at special meetings held for that purpose. The agreement was executed, subject to certain changes, and returned to the R. F. C. on December 1, 1943. The changes requested were, first, that petitioner wanted a provision inserted to the effect that buildings 11 and 11-A of the plant, which had been used by Gunnison under its lease with the R. F. C., were not to be used by Gunnison in the future, but that petitioner should have the right to make use of these buildings. Second, that that part of the agreement which provided that the R. F. C. should have the option, in the event the premises were rendered untenantable by fire, flood, or other casualty, of terminating the agreement or repairing the premises within 60 days, should further provide that in the event the R. F. C. elected not to repair the premises, the petitioner should have the right to the proceeds of *100 the insurance in the event it exercised the option to purchase, provided it made all the payments required on its part.
*1391 In order to avoid any misunderstanding, the R. F. C. deemed it advisable that the agreement be re-executed, instead of making the changes on the one already signed by petitioner. To that end, on December 3, 1943, the R. F. C. sent petitioner copies of the agreement, with the changes made as requested by petitioner, for re-execution, which was done on December 9, 1943. The effective date of the agreement remained December 1, 1943.
The premises covered by the agreement consisted of approximately 21 acres of land on the bank of the Ohio River. Four acres were unoccupied and the remainder contained 17 buildings, with a total of 271,000 square feet of floor space. One large 3-story building was known as the main building. It was of brick construction, with a cement first floor, wooden second and third floors, and a composition roof. Other buildings on the property included a part 3-story and part 4-story building of the same construction as the main building, though smaller; a 2-story boiler room building, with metal clad walls and roof; and 9 lumber drying*101 kilns of brick construction, with cooling sheds attached. The property was served by the Southern Railroad, whose main line from Louisville, Kentucky, to St. Louis, Missouri, ran between the 2 larger buildings of the plant. There were also 2 side tracks into the property. The agreement also covered the machinery and equipment located on the premises, which consisted of cutoff saws, rip saws, variety saws, molders, planers, sanding equipment of all types, glue pressers, and glue spreaders, as well as certain office equipment, such as typewriters, desks, and adding machines. An inventory of the machinery and equipment, containing a brief description thereof, was attached to the agreement.
The agreement was to run for a term of 5 years from December 1, 1943, with the right in the petitioner to extend the term for an additional 3 years, upon giving the R. F. C. written notice of its intention to do so 90 days prior to November 30, 1948, the termination date of the agreement. Petitioner, in consideration "of the leasing" of the premises, machinery, and equipment, agreed to pay "as rent" the sum of $ 100,000, in 60 monthly installments, payable in advance, on the 1st day of each month*102 of the term of the agreement; and in the event the petitioner exercised its right to extend the agreement for an additional 3 years, it agreed to pay "as rent" for the additional period the sum of $ 60,000, in 36 monthly installments, payable in advance, on the 1st day of each month of the additional term. Petitioner further agreed to pay all general taxes for 1943 and subsequent years; all installments of assessments, water rates and other levies, charges, and encumbrances due and payable in 1943 and subsequent years, together with interest, penalties, and charges thereon, if any, and all special taxes, assessments, interest, and penalties thereafter levied during the *1392 term of the agreement or extension which were not then in collection or for improvements which were not then completed. Petitioner also was to provide at its own expense, to maintain in full force and effect at all times during the term of the agreement or extension thereof, and to deliver to the R. F. C. any policy or policies of fire and other insurance which the R. F. C. might from time to time require upon the buildings, machinery, and equipment at that time situated or thereafter constructed or placed*103 in or upon the premises, and such policy or policies of insurance were to be in all respects satisfactory to the R. F. C. Petitioner also was promptly to sign and deliver to the R. F. C., if required to do so, all other insurance policies issued during the term of the agreement which covered any of the premises, machinery, and equipment.
During the years 1943 through 1947, fire and extended coverage insurance was carried in the name of R. F. C. as the named insured in the total amount of $ 325,000 on the property covered by the agreement. Petitioner remitted $ 440 per month to the R. F. C. to pay the premiums on the above insurance and also to pay the taxes on the property.
The agreement further provided that petitioner was to permit Gunnison to remain on the premises and to continue to use the machinery and equipment which it was currently using, and petitioner was restricted from terminating Gunnison's month-to-month tenancy, without first securing the written consent and approval of the R. F. C. The buildings which were being used by Gunnison, and which Gunnison was to continue to use, were enumerated and set forth in the agreement. With respect to the space occupied by Gunnison, *104 petitioner was to pay to the R. F. C. all rentals in excess of $ 500 per month received from Gunnison, and such excess rentals were to be applied by the R. F. C. on account of the rental required to be paid on the final or fifth year of the agreement; in the event the excess rentals were sufficient to pay more than the fifth year's rental, then the excess rentals were to be applied on account of the fourth year's rental. In the event Gunnison vacated the premises and the vacated portion was sublet to another tenant or tenants, petitioner was to pay to the R. F. C. all rentals in excess of $ 500 a month paid by such other tenant or tenants, in the same manner and for the same purposes set forth above. In the event the agreement was extended for the additional 3 years, as provided for, petitioner was to pay the excess rentals collected during the extended period to the R. F. C. to be applied on account of the rental required to be paid for the third year of the additional term; and if petitioner abandoned or vacated the plant, it was agreed that all excess rentals from subleasing paid to the R. F. C. should be considered additional rent to the R. F. C. and might be used in payment*105 of the expenses of rerenting and collection.
*1393 The agreement further provided that petitioner was to have the "right and option * * * to purchase" all of the premises, machinery, and equipment included therein, by giving 30 days' written notice upon the expiration of the fifth year, or upon the expiration of the sixth, seventh, or eighth year of the agreement, if extended, for $ 50,000 cash at the end of the fifth year, $ 50,000 cash at the end of the sixth year, $ 37,500 cash at the end of the seventh year, and $ 25,000 cash at the end of the eighth year. In the event petitioner should exercise its "option to purchase," it was agreed that petitioner was to take the premises, machinery, and equipment subject to "(1) existing leases, if any; (2) general taxes and special assessments which the Lessee hereinabove covenants to pay; (3) mechanic's lien claims, if any, where no notice thereof appears of record; (4) questions of survey; (5) building line and building restrictions of record; (6) zoning and building laws or ordinances; (7) party wall rights or agreements; (8) roads and highways; (9) covenants, conditions, exceptions, reservations, restrictions or easements of record; *106 (10) rights of parties in possession and of all parties claiming by, through or under the Lessee; and (11) any and all unpaid water rates and taxes." In the event petitioner should exercise the option and pay the price scheduled in the agreement, the R. F. C. was to convey to petitioner title to the machinery and equipment by bill of sale, without representation or warranty, and title to the real estate by quitclaim deed, subject to taxes and all assessments and installments thereof and interest and penalties thereon, which by the terms of the agreement petitioner was obligated to pay, and subject to all taxes and assessments the lien of which might attach subsequent to the date of the agreement. At the time of delivery of the quitclaim deed, the R. F. C. was to furnish petitioner the continuation of abstract described in the agreement continued to the date of the delivery of the deed. Petitioner was to pay for any and all recordation, transaction, transfer, conveyance, or other taxes upon any deed or other instrument executed under the terms and provisions of the agreement, together with any and all revenue, documentary, or other stamps, required for any purpose to be affixed to*107 any such deed, bill of sale, or instrument.
It was further provided that if upon the loss of the premises, machinery, and equipment, by fire, flood, or other casualty, the R. F. C. terminated the agreement and would not repair the premises, machinery, and equipment, it was to pay to petitioner out of any moneys paid in settlement of any insurance claim arising out of such loss, all sums in excess of $ 150,000 on or prior to November 30, 1948; $ 170,000 subsequent to November 30, 1948, and on or prior to November 30, 1949; $ 177,500 subsequent to November 30, 1949, and on or prior to November 30, 1950; $ 185,000 subsequent to November 30, 1950, and on or prior to November 30, 1951; provided, however, that at the time of *1394 determining such excess each of the said amounts specified should be decreased by the total amount of "rent" paid under the agreement up to the date of its termination.
No assignment or transfer of the petitioner's interest under the agreement was to be binding upon the R. F. C., unless the assignment or transfer was first approved in writing by the R. F. C.
Under the terms of the agreement, petitioner was required to keep the machinery and equipment in good*108 repair at its own expense, and to permit the R. F. C. free access to the premises for the purpose of examining or exhibiting them, or for making any needful repairs or alterations which the R. F. C. might see fit to make. Petitioner was not to permit the premises to be used for any purpose that would increase the rate of insurance thereon, nor for any other purpose than that specified in the agreement; to overload the floors of the buildings with machinery or goods; to allow the premises to be occupied in whole or in part by any other person; to sublet the whole or any part of the premises, except as provided in the agreement; to assign the lease, without the written consent of the R. F. C.; to permit any transfer, by operation of law, of its interest in the premises acquired through the agreement; to allow the premises to be used for any unlawful purpose or for any purpose that might injure the reputation of the buildings or increase the fire hazard of the buildings or disturb the tenants of the neighborhood; to permit the premises to remain vacant or unoccupied for more than 10 consecutive days; to allow any signs, cards, or placards to be painted or placed on the buildings; nor*109 to permit any alteration of, or addition to, any part of the premises, except by written consent of the R. F. C. All alterations and additions to the premises were to remain for the benefit of the R. F. C., unless otherwise provided in the required consent. Petitioner was not to permit any mechanic's lien or liens to be placed upon the premises or on any building or improvement thereon during the term of the lease, and in case of the filing of any such lien, petitioner was to pay it promptly. If default in payment of a lien should continue for 30 days after written notice from the R. F. C. to the petitioner to pay it, the R. F. C. was to have the right and privilege of paying the lien, or any portion thereof, without inquiry as to its validity, and any amount so paid was to be considered additional indebtedness under the agreement and was to be repaid to the R. F. C. immediately upon rendition of a bill therefor. Petitioner was at all times to protect and indemnify the R. F. C. against all loss, cost, damage, or expense arising out of or from any accident or other occurrence on or about the premises causing injury to any person or property. Petitioner was also to keep the R. *110 F. C. harmless and indemnified against any damages or charges imposed for any violation of any laws or ordinances, *1395 whether occasioned by petitioner's neglect or those holding under petitioner.
If petitioner abandoned or vacated the premises prior to the termination of the agreement, the R. F. C. reserved the right to relet the premises for such rent and upon such terms as it might see fit; and if a sufficient sum was not realized monthly after paying the expenses of such reletting and collecting to satisfy the "rent," as reserved in the agreement, petitioner agreed to satisfy and pay all such deficiency monthly, during each month of the remaining period of the agreement. It was further provided that upon termination of the agreement by lapse of time or otherwise, petitioner would yield up immediate possession to the R. F. C., or, failing to do so, would pay as liquidating damages for the whole time such possession was withheld the sum of $ 50 per day; but such provision was not to be held as a waiver by the R. F. C. of any right of re-entry, as set forth in the agreement. Petitioner was also restricted by the terms of the agreement from keeping or using any flammable or*111 explosive liquids on the premises, except those which might be necessary for use in its business.
Article 15 of the agreement provided as follows:
If default be made in the payment of the above rent, or any part thereof, or in any of the covenants herein contained to be kept by the Lessee, it shall be lawful for Lessor at any time, at Lessor's election, without notice, to declare said term ended and to re-enter said premises, or any part thereof, with or without process of law, and to remove Lessee or any persons occupying the same, without prejudice to any remedies which might otherwise be used for arrears of rent, and Lessor shall have at all times the right to distrain for rent due and shall have a valid and first lien upon all personal property which Lessee owns or may hereafter acquire or have an interest in, whether exempt by law or not, as security for payment of the rent herein reserved.
Three amendments were subsequently made in the agreement. The first was to alter the description of the boundaries, in order that a few feet of property which belonged to an adjoining landowner could be transferred to him to clear a cloud on his title. The second amendment, dated November*112 30, 1945, was made to reduce the "purchase price" under the "option to purchase" section of the agreement by $ 1,450, due to the sale of 5 pieces of machinery from the plant for that price to the stockholders of petitioner, for removal to a veneer plant at Harvey, Louisiana. The third amendment, dated April 17, 1947, was made to reduce the "purchase price" under the "option to purchase" section of the agreement by $ 500, due to the sale of 2 pieces of machinery for that price by the R. F. C. to a third party in New Albany. Petitioner was not using the equipment and the sale was made with its approval.
On June 19, 1944, petitioner and Gunnison signed a subleasing agreement, dated December 1, 1943. The sublease was to run for a *1396 period of 2 years and included the buildings, equipment, and machinery to be retained by Gunnison, as set forth in the agreement between petitioner and the R. F. C. The rental arrangement was similar to that outlined by Marinangeli in his letter of October 18, 1943, to John Breece, namely, a minimum rent of $ 500 per month and an additional sum based on specified percentages of Gunnison's net monthly sales in excess of $ 50,000 per month. The *113 R. F. C. requested that the sublease between Gunnison and petitioner be assigned to it as additional security to its lease with petitioner. Assignment was made to the R. F. C. under date of December 2, 1943.
Petitioner's production was interrupted as a result of a flood in the spring of 1945. It was concerned by the fact that annual floods similar to the one in 1945 rendered one-third of the entire area of the plant unusable, namely, the entire basement floor. To protect itself from future losses due to floods, it was petitioner's plan to give up the entire basement, which would necessitate its taking over space that Gunnison was occupying. Petitioner therefore requested modification of the paragraph in its agreement with the R. F. C. which required it to sublease part of the premises and equipment to Gunnison, to allow petitioner to take over the whole plant and not renew its sublease with Gunnison. The R. F. C. agreed to permit petitioner to terminate its sublease with Gunnison as of December 1, 1945, the termination date of the sublease, with the provision that an extension of 6 months, which was provided for in the sublease, be given to Gunnison, in the event it requested *114 such an extension. On July 27, 1945, Gunnison notified petitioner of its intention to exercise its right to extend the terms of the sublease to June 1, 1946. On May 1, 1946, petitioner and Gunnison renewed the December 1, 1943, sublease, on a month-to-month basis, for a further period of not more than 5 months from June 1, 1946, for $ 3,000 per month for the first 4 months and $ 4,000 for the fifth month. On October 22, 1946, the December 1, 1943, sublease, as renewed by the May 1, 1946, agreement, was extended on a month-to-month basis, at a rental of $ 4,000 per month. In accordance with the terms of the sublease agreement of October 22, 1946, Gunnison canceled its sublease effective as of December 31, 1946.
During the negotiation of the agreement with the R. F. C. petitioner consulted with attorneys and accountants for the R. F. C. regarding all phases of the "Lease and Option to Purchase." The matter of the monthly rentals was discussed, and petitioner was informed by counsel that it "could charge off these annual rents, rental figures, as rent."
Prior to December 1, 1943, when it entered into the "Lease and Option to Purchase" agreement with petitioner, the R. F. C. had made*115 efforts in numerous ways to sell the New Albany plant. In a letter dated September 21, 1942, to a prospective purchaser of the plant, Marinangeli wrote:
*1397 We do not have an approved release price from our Washington office for the sale of the property, machinery and equipment. However, we believe that the Corporation would give consideration to an offer of $ 175,000.00 for the property, machinery and equipment in question.
At August 31, 1943, petitioner had current assets of $ 189,830.72, and current liabilities of $ 151,563.16. All of its current assets but $ 735.77, which was cash, were represented by accounts receivable and inventory items. Its fixed assets were $ 49,790.44, less reserves for depreciation of $ 20,304.48, leaving a balance of $ 29,485.96. It had prepaid expenses of $ 1,842.62. Petitioner's net worth on August 31, for the years 1943, 1944, 1945, 1946, and 1947, was $ 69,596.14, $ 81,028.40, $ 174,838.20, $ 306,103.22, and $ 464,897.22, respectively. Petitioner started getting war contracts in the latter part of 1944, and prior to that its business "was beginning to get pretty good" and it could sell just about anything it produced.
The New Albany *116 Marquetry Company was a partnership, consisting of substantially the same individuals who controlled petitioner, and was engaged in the manufacture of marquetry, which is a decorative wood that is inserted in plywood panels. The partnership occupied space in the New Albany plant, from April 1944 to August 1946, for which it paid $ 2,500 rent per month to petitioner. The New Albany Marquetry Company's net worth on September 30, 1943, was $ 42,173.21, of which $ 21,913.87 was in cash.
On December 16, 1944, petitioner purchased United States Treasury notes, Series C, bearing 1 1/4 per cent interest, to become due in 1947, in the amount of $ 50,000. On January 25, 1945, petitioner purchased United States certificates of indebtedness, Series E notes, bearing interest of 7/8 per cent, dated June 1, 1945, in the amount of $ 50,000. On December 3, 1945, it purchased Treasury bonds, bearing 2 1/2 per cent interest, in the amount of $ 25,000.
On March 30, 1946, R. M. Tomlison, secretary of petitioner, wrote the following note and attached it to a copy of the agreement between petitioner and the R. F. C.:
Note:
When this contract is completed, and deeds made out to B/V & Panel Co -- *117 try to obtain from RFC copies of Local & State Property Tax Schedules of Real & Personal Property to aid in filing same under B/V & Panel.
R. M. Tomlison3/30/46
On July 1, 1947, petitioner notified the R. F. C. of its desire to exercise its "option to purchase," as follows:
According to our records there is only one more payment of approximately $ 1,700.00 due you on the rental in our lease and option to purchase dated December 1, 1943. After that the contract calls for our option to purchase this property for $ 50,000.00 less certain amounts credited to the figure which reduces it to approximately $ 48,000.00.
*1398 It is our desire to execute this option and pay the Reconstruction Finance Corp. in full and to obtain the clear deed to the entire property. We would like to have you start work on this at once and consummate all details before August 31, 1947 at the very latest. We have the cash facilities for handling this at any time and we would be glad to come to Chicago to facilitate matters, and would like to hear from you as to just what procedure is necessary to get this all closed up.
In an acknowledging letter dated July 8, 1947, the R. F. C. included the following*118 statement to show the net amount required to pay the balance of the "five year rental provided for in the lease and the purchase option price":
| Rental for 5 years at $ 20,000.00 per year | $ 100,000.00 | |
| 44 monthly rental payments of $ 1,666.66 each, | ||
| received December 1943 to July 1947, inclusive | $ 73,333.04 | |
| Rental applied on fifth and fourth years of lease, | ||
| representing excess rentals collected by Breece from | ||
| Gunnison Homes, Inc | 24,957.96 | |
| 98,291.00 | ||
| Balance of rental due on lease | 1,709.00 | |
| Purchase price as per amendment dated April 17, 1947 | 48,050.00 | |
| Balance remaining in tax and insurance deposit | ||
| account | 4,635.56 | |
| Balance due on purchase option | 43,414.44 | |
| Total due for rent and purchase option | $ 45,123.44 |
On July 30, 1947, petitioner secured a quitclaim deed to the property by the payment of $ 45,123.44, as set forth in the statement from the R. F. C. After the "option to purchase" was exercised by petitioner on July 30, 1947, the cost of the property was recorded on the books of petitioner as follows:
| Land | $ 1,000 |
| Buildings | 25,000 |
| Machinery and equipment | 22,050 |
| $ 48,050 |
On its returns for the fiscal years ended August*119 31, 1945, 1946, and 1947, petitioner deducted $ 19,999.92, $ 27,499.92, and $ 33,042.26, respectively, as rental payments made under the December 1, 1943, agreement with the R. F. C. Respondent determined that the amounts were not deductible under section 23 (a) (1) (A) of the Internal Revenue Code of 1939.
By and through the monthly "rental" payments, petitioner was acquiring and building up a substantial and dominant equity interest in the New Albany plant and equipment, and it was intended by petitioner and the R. F. C. that it would.
*1399 OPINION.
The respondent has disallowed deductions of payments made by petitioner to the R. F. C. under a "Lease and Option to Purchase" agreement, on the ground that the payments were not rental expenses within the meaning of section 23 (a) (1) (A) of the Internal Revenue Code of 1939, 1 which restricts deductions to rentals or other payments for the use or possession of property "to which the taxpayer has not taken or is not taking title or in which he has no equity." Accordingly, the question for decision is whether petitioner was taking title to the property, or was acquiring an equity therein. An affirmative answer forecloses the*120 deductibility of the payments.
The payments in question, like those under consideration in Chicago Stoker Corporation, 14 T. C. 441, have dual potentialities, that is, they may turn out to be payments of purchase price or rent for the use of the property, and, as pointed out in that case, are difficult to catalogue for income tax purposes. It was there stated that if payments are large enough to exceed the depreciation and value of the property and "thus give the payor an equity in the property," it is less of a distortion of income to regard the payments as*121 purchase price and allow depreciation on the property, than to offset the entire payment against the income of 1 year. The Court cited Judson Mills, 11 T.C. 25">11 T. C. 25, and Truman Bowen, 12 T.C. 446">12 T. C. 446. The principle of these cases is that where the taxpayer, as a result of payments which have dual potentialities, acquires something of value under the payments, other than the mere use of the property, he is acquiring an equity and the payments do not, therefore, come within the definition of rent in section 23 (a) (1) (A), supra. See Helser Machine & Marine Works, Inc., 39 B. T. A. 644; Alexander W. Smith, Jr., Executor, 20 B. T. A. 27; and Holeproof Hosiery Co., 11 B. T. A. 547. And it does not matter whether the contract was in the form of a lease or a conditional sale, if under the terms of the contract by which payments were made the taxpayer was acquiring or building up an equity in the property in question.
From the evidence of record, it is, in our opinion, clear that petitioner through the payments made under the agreement *122 was in fact acquiring and building up an equity in the instant property and that such was the thought or intent of the parties, and we have so found as a fact.
*1400 The fact that the agreement did not in words provide for the credit of any of the so-called rental payments toward a stated purchase price does on the surface suggest a distinction between the instant case and a number of decided cases where, by reason of a specific provision, the "rental" payments were to be applied on a stated purchase price. It is our opinion, however, that the distinction is one without a difference. Where under the factual situation presented it appears, as it does in this case, that the amount of "rent" paid prior to the exercise of the option to purchase is a factor in establishing the comparably small final amount required to exercise the said option and acquire title, the rental payments are, in substance, being as effectively applied to the purchase of the property, and the building up of an equity therein, as would be true in the case where the purchase price specified was in an amount which encompassed the "rental" payments as well as the final payment and the agreement specifically *123 provided that the so-called rental payments were, upon the exercise of the option, to apply on the purchase price.
That the R. F. C. would not have sold the New Albany plant and equipment for $ 50,000, or any comparable amount, is not, we think, open to doubt. In 1941, petitioner had made an offer of $ 100,000 for the one-third of the property which it then occupied, but to no avail. And according to a witness, offered by petitioner as an expert, the fair market value of the whole property at the time of the agreement, and including the land at $ 60,000, was $ 376,500, and the replacement cost, likewise including the land at $ 60,000, was $ 575,000. There is significance also, we think, in the fact that the property at the time of the agreement was insured for the principal sum of $ 325,000.
The evidence does show, however, that the R. F. C. was primarily interested in selling the property and, for its own reasons, was willing to sell for a price of $ 150,000 to $ 185,000. Approximately a year prior to the agreement with petitioner, it had suggested, by letter, to a prospective customer that an offer of $ 175,000 might well be favorably received. And by its agreement with the *124 petitioner, it bound itself to sell the property at the end of 5 years, upon the payment of $ 50,000, but only if monthly "rental" payments aggregating $ 100,000 had been received, thereby bringing the total payments for or on the property to $ 150,000; at the end of 6 years, upon the payment of $ 50,000, but only if monthly "rental" payments aggregating $ 120,000 had been received, bringing the total payments for or on the property to $ 170,000; at the end of 7 years, upon the payment of $ 37,500, but only if monthly "rental" payments aggregating $ 140,000 had been received, bringing the total payments for or on the property to $ 177,500; and at the end of 8 years, upon the payment of $ 25,000, but only if monthly "rental" payments aggregating $ 160,000 had been *1401 received, bringing the total payments for or on the property to $ 185,000. The monthly "rental" payments, according to the agreement, were to be net payments, in that petitioner was required to make all necessary payments for maintenance, repairs, and upkeep of the premises and equipment and to pay all taxes and insurance premiums thereon.
Taking into account the property involved, its substantial value, the relatively*125 small final payment required to exercise the option and acquire title, and the growing advantage or interest of petitioner therein or with respect thereto as each additional monthly payment was made, any difference, so far as we can see, between the instant transaction and an admitted conditional sale would be in the words used in drawing up the agreement, and not in the substance or practical effect.
Furthermore, the provisions of the agreement covering the disposition of the insurance proceeds in case of loss of the property by fire, flood, or other casualty, offer corroboration, we think, for the conclusion that by and through the monthly "rental" payments petitioner was acquiring and building up an equity in the property, and that it was so regarded and intended by the parties. In the event of such loss, followed by a failure on the part of the R. F. C. to repair or replace the buildings, machinery, and equipment, it was required under the agreement to pay over to petitioner the excess of the insurance proceeds over $ 150,000, if the loss occurred at any time prior to 5 years from the date of the agreement; $ 170,000, if the loss occurred subsequent to 5 years but prior to 6 *126 years; $ 177,500, if the loss occurred subsequent to 6 years but prior to 7 years; and $ 185,000, if the loss occurred subsequent to 7 years but prior to 8 years. But in arriving at such excess, each such amount which the R. F. C. was privileged to retain was to be reduced by the total amount of the "rental" payments which had theretofore been made by petitioner to the R. F. C. under the agreement. Considered in the light of the amount of the insurance carried on the property and the fair market value and replacement cost thereof at the date of the agreement, as testified to by petitioner and which it asks us to accept, the above disposition of the insurance proceeds is, in our opinion, convincingly indicative of the acquisition by petitioner of an equity in the property as each of the periodic "rental" payments was made. 2
*127 In passing, it is to be noted also that even though, by the wording of the agreement, the "option to purchase" did not become available to *1402 petitioner until 30 days prior to the expiration of the fifth year of the agreement, or the sixth, seventh, or eighth year, if the agreement should be extended, and there was no provision for advancing those dates, nevertheless, the parties followed a course of conduct which was some indication of an understanding that the right to close the transaction accrued to petitioner when the $ 100,000 in "rental" payments had been made, regardless of whether the period specified for the exercising of the option had arrived. Almost a year and a half prior to the expiration of the fifth year, petitioner wrote the R. F. C. that the contract "calls for our option to purchase this property for $ 50,000.00," when $ 100,000 in "rental" payments had been completed, and that since it had substantially completed payments aggregating that amount, it desired to exercise its option immediately. The R. F. C. acknowledged petitioner's request and the sale was completed within 30 days thereafter. See, in that connection, Helser Machine & Marine Works, Inc., supra.*128
Based on the opinion of its witness that the fair market value of the property was $ 375,500, and the further opinion that a fair annual rental thereon was $ 45,000, petitioner, on brief, seeks to find in Chicago Stoker Corporation, supra, support for its position here, stating "it is clear that the annual rental payments [$ 20,000] were not large enough to exceed depreciation and the value of the property so as to give the petitioner an equity in the property." The argument, in our opinion, is not well made. In the first place, the "rental" payments were net, after costs of maintenance and repairs and the payment of taxes and insurance premiums, and the price at which it was privileged to buy was neither the $ 376,500, regarded by petitioner as its fair market value, nor even $ 325,000, at which it was insured. In short, by its own contention as to fair market value, it would appear that petitioner, under the agreement herein, was acquiring the property at a bargain price, which would indicate all the more clearly that through its monthly "rental" payments it was building up a very dominant equity interest in the property during the contract period, *129 and in Chicago Stoker Corporation, supra, the dominant or controlling factor was the building up of such an equity. That petitioner was acquiring and building up such an equity interest in the property herein is, in our opinion, even more pronounced than in those cases where the aggregate of the total payments, "rental" or otherwise, required for the purchase of the property approximated the fair market value thereof.
The petitioner cites and relies on Benton v. Commissioner, 197 F.2d 745">197 F. 2d 745, reversing a Memorandum Opinion of this Court entered September 20, 1950. Aside from its pronouncements as to applicable legal principles, the Court of Appeals, in that case and after reviewing the evidence, concluded as a fact that the conduct of the parties throughout *1403 was consistent with a lease and that they had intended the contract as a lease, and that this Court's finding of fact to the contrary was clearly erroneous. As indicated above, the evidence in the instant case will not, in our opinion, permit such a conclusion of fact. The contract was much more than a lease. By and through the so-called rental payments, *130 the petitioner was in fact acquiring and building up a substantial equity in the property, and it was so intended and regarded by the parties, and what was said in Benton v. Commissioner, supra, does not apply here. The payments in question are accordingly not deductible under section 23 (a) (1) (A), supra, and the respondent did not err in disallowing the claimed deductions therefor.
Decision will be entered under Rule 50.
Footnotes
1. Minimum.↩
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) Expenses. --
(1) Trade or business expenses. --
(A) In General. -- * * * and rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.↩
2. Assuming a total loss of the property prior to 5 years from the date of the agreement but after petitioner had paid the entire $ 100,000 in so-called rental payments and a recovery under the policy of the entire $ 325,000, the net result would have been $ 50,000 for the R. F. C. and $ 275,000 for petitioner, which according to the agreement would have given petitioner a recovery out of the insurance proceeds of the $ 100,000 of "rental" payments which had been made, plus the $ 175,000 of insurance proceeds remaining.↩