Robert A. Taft, Esq., pro se.

L. W. Creason, Esq., for the respondent.

Deficiencies determined by the Commissioner amounting to $527.38 for 1927 and $419.07 for 1930, result from his disallowance of deductions in the sums of $1,266.67 for 1927, and $3,333.33 for 1930, claimed by petitioner as aliquot proportions of an amortizable payment of $50,000 for a 15-year lease of real estate. The cases were consolidated for hearing.

FINDINGS OF FACT.

The petitioner is a lawyer, a resident and citizen of Cincinnati, Ohio.

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On June 10, 1927, Joseph R. Peebles' Sons Company (hereinafter sometimes called The Company), a corporation under the laws of the State of Ohio, was the owner of a certain lot in the city of Cincinnati upon which there was a building then occupied by tenants of The Company. At about that time the petitioner entered into negotiations with The Company with reference to said lot and made a proposition to it in writing in which he said: "I hereby offer to purchase [said lot] for the sum of $185,000.00 on the following terms: 1. To pay $50,000.00 in cash; 2, to pay $25,000.00 at the end of five years; $25,000.00 at the end of ten years; and 3, the balance of $85,000.00 to be the privilege of purchase at the end of the lease." This offer resulted in the payment by petitioner to The Company of $50,000.00 cash, and the execution by the petitioner and The Company of a document dated July 9, 1927, called by them a lease. This document was offered in evidence and is incorporated herein by reference, the material parts of which are as follows:

THIS AGREEMENT OF LEASE WITNESSETH: The Lessor in consideration of the rents and covenants hereinafter stipulated to be paid and performed by the Lessee and his assigns, does hereby grant, demise and lease unto said Lessee, his executors, administrators and assigns, the following described premises. [Describing the lot in question.]

TO HAVE AND TO HOLD the same, with the appurtenances, unto the said Lessee, his executors, administrators and assigns, for and during the full term of fifteen (15) years, beginning July 10, 1927, and to be fully completed and ended on July 9, 1942, on the following terms, to-wit:

Said Lessee, his heirs and assigns, yielding and paying therefor, during the said term $6,750.00 annually, payable quarterly on the 10th day of October, January, April and July, the first payment to be made October 10, 1927, as rent, and all taxes and assessments levied on said premises, and insurance.

Said Lessee, his heirs or assigns, may purchase said premises at any time upon payment of the sum of $135,000.00, and the payment of all arrearages under this lease. If so purchased, a general warranty deed will be given by the Lessor, its successors or assigns.

And said Lessee, for himself, his executors, administrators and assigns, does hereby covenant and agree with said Lessor, its successors and assigns, that he will pay said rents, taxes, assessments and insurance, in manner as aforesaid, and this although said premises shall be destroyed or rendered untenantable by fire or unavoidable accident; that he will not do or suffer any waste therein, nor use said premises for any unlawful purpose, nor assign this lease, unless the assignee expressly assumes the covenants thereof, in writing, direct to the Lessor; and at the end of the term he will deliver up said premises in as good order and condition as they now are, or may be put by said Lessee, reasonable use and ordinary wear and tear thereof excepted; and that for said rents, taxes and assessments to be paid by said Lessee

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a lien

is reserved upon the premises hereby leased in favor of the Lessor prior and preferable to all other liens; that the Lessee will keep the buildings insured in the sum of $20,000.00 ; if said buildings shall be damaged

or destroyed by fire, tornado or wind storm the recovery thereon shall be applied to restoring the same or, at the option of the lessee, shall be paid to the Lessor as a partial payment on account of the privilege of purchase herein contained, and rents shall thereafter be ratably reduced.

PROVIDED, HOWEVER, The Lessee shall have the privilege of making payments on account of the privilege of purchase on any rent-paying day, in sums of $5,000.00 and multiples of $5,000.00, and shall be obligated to and hereby agrees to make a payment on account of said privilege of purchase, in the sum of $25,000.00 on or before July 10, 1932, and a further payment, on account of the privilege of purchase in the sum of $25,000.00, on or before July 10, 1937. The Lessee shall be entitled to an abatement of the rent hereinbefore provided in the sum of $50.00 per annum for every $1,000.00 paid on account of the privilege of purchase. The Lessor will pay the boulevard light assessments and the installment of taxes due and payable in December, 1927, or January, 1928, and the Lessee shall pay all other assessments and the taxes thereafter.

The Lessor * * covenants with the Lessee that said Lessee paying the rents, taxes and assessments, and observing the covenants of this lease on his part, shall have possession of said premises during said term, excepting leases to the Hathaway Stamp Company and The Herman Bumiller Company, which expire January 31, 1929, which Lessee assumes and agrees to carry out. [Subject to certain terms relating to a party wall, immaterial

here.]

At the time of the execution of this document, J. E. McClain was president of the Joseph R. Peebles' Sons Company, and as such corporate officer executed the document on behalf of the company. McClain at the time was of the opinion that the "privilege to purchase", as used in the document, was actually an obligation to purchase, and that was the purpose and effect contemplated by him at the time; and the company, in connection with the determination of the profit (or loss) of the company for the fiscal year ending April 30, 1928, on account of the execution of the document and the consummation of said agreement, through its president, contended that the agreement should be considered a sale and not a lease for purposes of its Federal income tax liability, and its tax liability for that year was determined on that basis.

Upon executing the document dated July 9, 1927, petitioner took over the premises and the tenants of The Company in the building became the tenants of petitioner and thereafter paid rent to petitioner and not to The Company. The payment of $25,000 provided in the document called a lease of July 9, 1927, to be paid on July 10, 1932, was paid by petitioner to The Company.

Until about the end of 1930, mortgages were taxed in Ohio at a very high rate, so that as a rule a resident of Ohio did not care to own a mortgage. To execute a lease with privilege to purchase was more desirable than to sell property outright with a mortgage for deferred payments on this account.

Petitioner insists that the transaction was not a bargain and sale, but only a lease for 15 years and that, therefore, he is entitled to have the $50,000 initial payment for the lease amortized over the life of the lease and deducted from gross income. As an alternative proposition petitioner insisted that if the transaction is held a sale, then he should have proper deduction for depreciation for the building. In the 60-day letter attached to the petition in Docket No. 66118, the Commissioner says: "(B) Depreciation allowable 4% on $20,000.00. Rate and value established in prior reports." There was no evidence as to the value of the building or of its probable useful life.

OPINION.

SEAWELL: We seek here to know and correctly to determine the true character and meaning of the transaction between the petitioner and Joseph R. Peebles' Sons Company in reference to the lot in Cincinnati mentioned in the papers and other evidence offered at the trial. It seems well settled that calling it a "lease" does not make it such, if, in fact, it is something else. Heryford v. Davis, 102 U. S. 235. "Leases" of personalty with the privilege of purchase are held conditional sales. Corbett v. Riddle, 209 Fed. 811; Burroughs Adding Machine Co. v. Bogdon, 9 Fed. (2d) 54; Hervey v. Rhode Island Locomotive Works, 93 U. S. 664. "Leases" in reference to realty receive a like construction and upon the facts may be held to be sales. Alexander W. Smith, Jr., Executor, 20 B. T. A. 27; Jefferson Gas Coal Co. v. Commissioner, 52 Fed. (2d) 120; Herold v. Commissioner, 42 Fed. (2d) 942.

Taking the instrument (of July 9, 1927) by its "four corners and considering it in the light of the attending facts, we discover that its execution was preceded by an unequivocal offer of the petitioner to "purchase " the property at the price of $185,000. In the case of E. G. Robertson, 19 B. T. A. 534, the negotiations preceding the contract in the form of a lease included an oral agreement to purchase the land on the part of the lessee. This was considered

by the Board as important and in the opinion it is said: "The intent of the parties to these transactions being to accomplish sales, we think the law must give such effect to them regardless of the forms employed."

In the instant case the "lease " complied with the terms of the written "offer to purchase" in that the purchase price named therein, $135,000, added to the initial amount of $50,000 paid, makes exactly the $185,000 mentioned in the offer. The rental provided for in the lease after the payment of the $50,000 amounts to just 5 per cent per annum on the deferred payment of $135,000, a fair rate of interest on a loan with safe collateral. The provision of the contract of lease calling for an abatement of the "rent" in the sum of $50 per annum for every $1,000 paid on account of the privilege to purchase discloses the plan to continue a 5 per cent interest charge on the balance remaining due on the contract throughout. The rental value of the property, considered as a mere leasing proposition, was not rendered less by reason of the payments made; but considered as a contract of purchase of the property, of course, the interest should not be charged on deferred payments after they have been met and paid. It is further provided in the lease that if the building should be damaged by fire, tornado or windstorm, the recovery thereon shall be applied to restoring the same, or, at the option of the lessee, paid to the lessor as a partial payment on the privilege to purchase; and the rents thereafter shall be ratably reduced. It accordingly appears that for every payment on the balance owing on the contract there shall be a reduction of rent "; while, although the building on the property might be totally destroyed with insufficient insurance funds to restore it to a condition of productivity, there is no provision of abatement of rent.

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Another significant indication of the intention of the parties is the binding obligation of the petitioner, in any event, to pay, in addition to the initial payment of $50,000, the sum of $25,000 on July 10, 1932 (which was paid), and also $25,000 on July 10, 1937, a total of $100,000. Moreover, the petitioner is further obligated under the lease, to continue to pay the 5 per cent per annum on whatever amount of the original $185,000 remains unpaid until 1942, whether he decides to exercise, or not to exercise, his privilege to purchase in the meantime.

Considering all these facts and circumstances, it is not strange that the president and the representative of The Company, at the time, considered the transaction a sale, as he testified; nor that the petitioner himself should have testified, as he did in substance, that

when the agreement was executed in 1927, he supposed that in 1942, with the stipulated payments having been made, the payment of the further sum of $85,000 would appear so advantageous to him that, of course, he would make it and take over the fee simple title to the property. It would appear difficult, in fact, to reach any other conclusion than that at the time of the execution of the paper dated July 9, 1927, and by it, considered in connection with the written offer of the petitioner to purchase, the parties intended a sale. Petitioner says, however, that while in Ohio leases with privilege to purchase, and perpetual leases are frequently referred to as sales, and while heavy initial payments and other fixed payments make more probable the exercise of the privilege to purchase, they do not compel such exercise, and that he has not yet elected to be a purchaser in this case and is consequently a lessee. In support of his position he cites article 130 of Regulations 74, and Weiss v. Wiener, 279 U. S. 333; Alameda Park Co., 10 B. T. A. 1115; and Baton Coal Co., 19 B. T. A. 169.

The regulation referred to has no application, if the transaction we have under review was in fact a sale. In Weiss v. Wiener, supra, there was no contention that the lessee of the long term leases was really the owner of the buildings which he held under the leases. The Circuit Court of Appeals, however, said: "For every practical purpose they are his buildings, and in our opinion they are his capital so far as they are consumed in his business." With this conclusion the Supreme Court did not agree and it reversed the Circuit Court of Appeals, saying: "He [Weiner, holder of the lease] must show an interest in the property and a present loss to him to make the statute apply." Wiener sought not to spread the cost of his leases over their terms, in aliquot part deductions, as the petitioner in the instant case does, but to obtain obsolescence on buildings he held under lease contracts. Likewise, in Alameda Park Co., supra, there was no contention as to the nature of the transaction called a lease, but the lessee sought to deduct as operating expenses in 1917 all its income for that year which it had paid over under its contract of lease to the creditors of its lessor incurred by the lessor for certain capital expenditures. What would have been the result in the Board and in the District Court of Appeals, if the contention had been made that the transaction was, in fact, a sale, we need not here speculate. In Baton Coal Co., supra, there was no option or privilege to purchase in the contract of lease which had reference to the mining of coal and by its terms remained in force until the exhaustion of the coal vein estimated to be within 10 or 12 years. These authorities and contentions of the petitioner do not convince us of error in the action of the Commissioner and he is sustained on this point.