*85 Decision will be entered under Rule 50.
1. Petitioner's decedent owned certain real property which she had inherited from her husband. During 1946 she began negotiations with one William S. Bein relative to his acquisition of the property. These negotiations culminated in the execution of two instruments, a "Contract to Lease With Privilege of Purchase" and a subsequently executed instrument purporting to be a lease with privilege to purchase. Held: On the basis of the facts, the negotiations between decedent and Bein resulted in Bein's becoming a lessee with the privilege to purchase, and not in a sale of the property involved.
2. In accordance with the contract of July 5, 1946, Bein paid decedent the amount of $ 25,000. Held: The $ 25,000 was received by decedent under a claim of right with no provision for its repayment and no restriction as to its disposition and is, therefore, includible in her taxable income for the year in which it was received.
*428 This case involves income tax for the calendar year 1946. Respondent determined a deficiency in the amount of $ 8,785.30. The petitioner claims that the decedent erroneously reported an amount of $ 25,000 as income and that there was an overpayment of $ 3,322.86. Respondent, with leave of the Court, amended his original answer to conform to the proof adduced at the trial and asserted a deficiency in the amount of $ 27,014.26. At the hearing petitioner conceded the correctness of respondent's action with respect to certain items set forth in the petition. There remains only the issues arising out of the disposition by petitioner's decedent of certain real property.
FINDINGS*87 OF FACT.
The petitioner is the executor of the Estate of Mary G. Gordon, Deceased. Its principal office is in Middletown, Ohio. The income tax return for the period here involved was filed with the collector of internal revenue for the first district of Ohio. The notice of deficiency was mailed to petitioner on January 23, 1950.
Mary G. Gordon (hereinafter sometimes called "decedent") was the owner, by inheritance from her husband, of certain real property in the city of Middletown, Ohio, known as the Gordon Theater property. At the time this property was inherited by decedent, the probate court appraised it and fixed its value at $ 70,000. This value was used for state inheritance tax purposes.
Prior to the taxable year, the building on the property had been virtually destroyed by fire. All that remained were some stores and apartments which had been saved because of a fire wall located between the theater and the front of the building. During the year 1946 negotiations were begun with one William S. Bein, operator of several motion picture theaters in Cincinnati, Ohio, relative to his acquisition of this property on some basis. Bein was not interested in acquiring *429 *88 it by lease in the then condition. The negotiations continued over a period of time during which several methods of procedure were discussed, both verbally and by correspondence. The methods proposed and discussed included an outright sale of the property, a lease arrangement involving a remodeling of the property by the decedent, and a transaction calling for an option and privilege of purchase arrangement.
While the transaction was being thus discussed, and prior to its consummation, one Virgil T. Clark, a certified public accountant, was consulted regarding the tax consequences which would result from the various transactions under consideration. Particular attention was given to that involving the outright sale of the property and the transfer of title. Because of the capital gain involved in such transaction, together with decedent's advanced age, Clark advised that, from a tax standpoint, an outright sale would be most disadvantageous.
Negotiations continued until July 5, 1946, when an instrument designated "CONTRACT TO LEASE WITH PRIVILEGE OF PURCHASE" was executed by Bein and decedent. By letters addressed to "Mr. William S. Bein, Purchaser," the closing date recited *89 in this instrument was later extended to November 8, 1946, because of a delay in having a survey made and acquiring title insurance. This contract provided, in part, as follows:
The lease with privilege to purchase the above captioned real estate shall be for a term of 25 years beginning October 1, 1946.
The purchase price to be $ 125,000.00 payable as follows: $ 25,000.00 on or before October 1, 1946, and interest computed at the rate of 4 1/2% per annum, payable quarterly in the arrears on the balance due of the purchase price, namely $ 100,000.00 during the term of the lease.
It is understood and agreed that the lessee may exercise the privilege of purchase at any time at the expiration of six months after the death of Mary G. Gordon without premium or penalty.
The lessee shall keep the premises and chattels insured with fire and extended insurance for not less than $ 100,000.00 with loss payable clause to the lessor, the lessee, as their respective interests appear, upon total or partial destruction of property; the proceeds of the insurance shall be promptly used by lessee for the restoration of the damage caused by the casualty.
Lessee shall insure said premises with public *90 liability insurance covering the interest of lessor, lessee, in the amount of $ 25,000 to $ 500,000 limits.
The lessee further agrees to pay all real estate taxes and assessments, if any, beginning with the installment ordinarily due and payable in June 1947 and thereafter.
* * * *
Lessee shall have the right to remove the present building and improvements located upon the premises herein agreed to be leased at any time during the term of this lease, and to remodel and/or rebuild a new structure at a cost not less than the value of the building and improvements located upon said premises at the time of such demolition. * * *
* * * *
*430 The amount of $ 125,000 was the consideration used in all of the negotiations either written or oral. This amount was also used in the calculation of commissions to be paid the real estate brokers.
The instrument executed as of November 7, 1946, and designated as "THIS INDENTURE OF LEASE" recites a consideration of $ 100,000, although immediately prior thereto Bein paid the amount of $ 25,000 to decedent. The terms of the instrument provided for a payment of $ 1,125 each 3 months while the same was in force. The amount represented a yield*91 per annum of 4 1/2 per cent on $ 100,000.
In the contract of July 5, 1946, this quarterly payment was designated as "* * * interest computed at the rate of 4 1/2% per annum, payable quarterly in the arrears on the balance due of the purchase price, namely, $ 100,000.00 during the term of the lease." In all other respects this agreement contained provisions similar to those in the subsequent agreement of November 7, 1946.
Ray O. Deardorff, an accountant, had assisted decedent in the preparation of her income tax returns since 1941, and he prepared her return for the year 1946. In the return for that year the amount of $ 25,000 which had been received from Bein was reported as income. At the time the return was prepared Deardorff had no knowledge of the transaction other than the instrument dated November 7, 1946. Decedent informed him that she had received $ 25,000. Without further information Deardorff assumed that this amount was income and so reported it in the return. Deardorff also prepared decedent's returns for the years 1947 and 1948, and depreciation was taken on the Gordon Theater property at the rate of $ 680 per year.
Bein took possession of the property and made the*92 quarterly payments in accordance with the terms of both instruments previously entered into. On December 23, 1949, he transferred his interest in the property to one Joseph C. Bullock, in consideration of the payment by him of $ 30,000 and his assumption of the covenants contained in the "lease" agreement of November 7, 1946.
In her transactions with Bein prior to the actual execution of the agreement of November 7, 1946, petitioner's decedent referred to him, Bein, as "purchaser" of the property. In his tax returns for the years between 1946 and 1949, the year of the aforementioned transfer, Bein claimed depreciation on the property. He considered that the quarterly payments were interest payments and accordingly deductible as such on his tax returns. The option to purchase was never exercised and no deed was ever executed.
We make the following additional findings:
The transaction between Bein and decedent in 1946 did not constitute a sale of the property involved. Bein became the lessee of such property with the privilege to purchase.
*431 The $ 25,000 paid to decedent by Bein, pursuant to the contract of July 5, 1946, was received under a claim of right with no provisions*93 for its repayment and no restriction as to the disposition thereof.
OPINION.
We are here asked to determine the proper character to be ascribed to the $ 25,000 received by petitioner's decedent in accordance with her contract agreement of July 5, 1946, with William S. Bein.
Respondent, with leave of the Court, amended his pleadings to conform to the proof and affirmatively alleges that the negotiations between the parties, when considered as an over-all transaction, culminated in the outright sale of the property in question and that decedent is taxable on the profit derived therefrom as a capital gain in accordance with section 111 of the Internal Revenue Code. 1 Should we find, however, that there was no sale in substance, respondent argues in the alternative that the $ 25,000 is includible in decedent's taxable income for 1946, as originally returned by her.
*94 Petitioner, on the other hand, takes the position that during the year under review, Bein became a lessee with an option to purchase; that the amount received by its decedent constituted an advance payment for the option; that as such it is not taxable until the option is exercised and the tax liability definitely ascertained; that this amount was erroneously reported by the decedent as income; and that it is due a refund of the tax paid thereon.
In support of his allegation that there was a sale, respondent cites Robert A. Taft, 27 B. T. A. 808, and contends the factual situation there was in all material respects identical with the one before us here. We do not agree. In that case there were present facts which were much more strongly indicative of an outright sale than in the instant case. We are inclined to agree with the position taken by petitioner in so far as the nature of the transaction itself is concerned. We do not feel that an outright sale was actually consummated. No deed to pass title was ever executed. No mortgage or note was given, and no security was pledged. Moreover, in the absence of an exercise of the *432 option to*95 buy (and the option was never exercised), Bein was in no way bound to complete the purchase or pay the $ 100,000, or any amount on account of the purchase in excess of that which he had already paid.
Respondent argues, however, that the intention of the parties was to accomplish a sale and that the lease arrangement with privilege to purchase was utilized merely to minimize the tax consequences. Therefore, he says, we must determine the resulting tax liabilities by giving effect to this intention irrespective of the form employed to effectuate it.
When all of the relevant facts are considered in the light of the attending circumstances, they lead us to the conclusion that no sale actually took place.
It does not follow, however, that the amount received by decedent is not to be included in her taxable income for 1946, the year in which it was received. Decedent included it in her taxable income for the year in which the deficiency was originally determined and respondent so considered it in making his original determination. Petitioner, in accord with its position set forth above, contends that the amount was erroneously so reported; that such amount was, in fact, the advance payment*96 for the option to purchase; and that it is, therefore, not taxable until such option is exercised. It bases its argument upon Aiken v. Commissioner, 35 F.2d 620">35 F. 2d 620, affd. 282 U.S. 277">282 U.S. 277; Doyle v. Commissioner, 157">110 F. 2d 157; affirming 39 B. T. A. 940, certiorari denied 311 U.S. 658">311 U.S. 658; and Virginia Iron, Coal & Coke Co. v. Commissioner, 99 F. 2d 919, affirming 37 B. T. A. 195, certiorari denied 307 U.S. 630">307 U.S. 630. On examination these cases are found to be inapplicable and clearly distinguishable on their facts from the situation here under review.
Respondent, on the other hand, takes the position that the money was received by decedent under a claim of right; that there were no provisions for its repayment or restrictions as to its disposition; and that, accordingly, it is taxable in the year received.
We feel that respondent's position is well taken. Whatever name or technical designation may be given to the $ 25,000 payment, the fact remains that it was*97 received under a claim of right, that decedent was under no obligation to return it and could dispose of it as she saw fit. We are of the opinion, therefore, that the payment was income taxable to her in the year received. Cf. North American Oil Consolidated v. Burnet, 286 U.S. 417">286 U.S. 417; United States v. Lewis, 340 U.S. 590">340 U.S. 590.
Accordingly, the $ 25,000 received by decedent in 1946 and reported by her was properly includible in her taxable income for that year.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 111. DETERMINATION OF AMOUNT OF, AND RECOGNITION OF, GAIN OR LOSS.
(a) Computation of Gain or Loss. -- The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113 (b) for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.
(b) Amount Realized. -- The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.
(c) Recognition of Gain or Loss. -- In the case of a sale or exchange, the extent to which the gain or loss determined under this section shall be recognized for the purposes of this chapter, shall be determined under the provisions of section 112↩.