Opinion
Docket No. 3397.
1945-05-18
LEWIS EUGENE GRIGSBY TRUST, SECURITY-FIRST NATIONAL BANK OF LOS ANGELES AND STEWART P. MACLENNAN, TRUSTEES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
W. L. Nossaman, Esq., for the petitioner. Earl C. Crouter, Esq., for the respondent.
In settlement of its liability for default under a long term lease and pursuant to its offer to release, quitclaim, or assign its leasehold interest in property belonging to petitioner as petitioner might direct, the petitioner's lessee in 1934 did assign the lease to a corporation organized by petitioner to receive it. All of the stock of the corporation belonged to petitioner, and the corporation's sole function was the holding of the lease. The petitioner supervised them subletting of the premises and collected the rents and applied them to its own uses. Upon dissolution of the corporation in 1939, the lease was formally canceled. Held, that petitioner first received surrender of the leased property in 1934, and any income realized by it through acquisition of improvements erected thereon by the original lessee was income realized in 1934 and not in 1939, as determined by respondent. W. L. Nossaman, Esq., for the petitioner. Earl C. Crouter, Esq., for the respondent.
The respondent determined a deficiency in income tax against the petitioner for 1939 in the amount of $17,613. The only question presented is whether the respondent erred in determining that the petitioner realized income in the amount of $70,000 during the taxable year from the repossession of certain leased premises on which a tenant had constructed improvements.
FINDINGS OF FACT.
The proceeding was submitted upon a stipulation of facts and certain documentary and oral evidence. The facts stipulated are found as stipulated.
The petitioner, sometimes referred to as the Grigsby Trust, is a trust created and existing under the will of Lewis Eugene Grigsby, deceased. The return of the petitioner for 1939 was filed on or before March 15, 1940, with the collector for the sixth district of California.
On July 30, 1923, Lewis Eugene Grigsby and Emma Alvina Grigsby, his wife, were the owners in joint tenancy of the south 100 feet of lots 17, 18, 19, and 20, block 65, situated at the northeast corner of Fourth Street and Pine Avenue, Long Beach, California. On that date they executed a lease on the property to the Owl Drug Co., a Nevada corporation, its successors and assigns, for a period of 99 years beginning August 1, 1923. The consideration for the lease was a monthly rental of $2,500 throughout its term and the payment of all taxes and improvement assessments on the property. The lease also provided that the lessee would, at its own cost, not later than August 1, 1928, begin the erection on the property of a building costing not less than $100,000, suitable for commercial purposes, to be known as the Grigsby Building, and that the building would be completed within 9 months from the beginning of construction. It was further provided that after the construction of such building the lessee would, during the terms of the lease, have and keep upon the premises a building equaling in cost the building so constructed, would keep it in good condition and repair, and, in case of loss or damage by fire, earthquake, or other casualty, would with reasonable dispatch by suitable repairs or reconstruction restore it to the condition it had or should have had before such casualty. Damage to or destruction of any building or buildings on the premises by fire, earthquake, or other casualty would not entitle the lessee to surrender possession of the premises or to terminate the lease. At the expiration of the terms of the lease all buildings and improvements on the premises were to become the property of the lessors. The lease provided as follows respecting forfeiture:
This lease is made upon the condition that Lessee shall perform all the covenants and agreements herein set forth to be performed by it; If at any time there be default on the part of the Lessee in the payment of rent, taxes, assessments or other charges and payments by it to be made, or either of them or any part thereof, and if such default shall continue for a period of thirty (30) days, or if there shall be default on the part of the Lessee in the performance or observance of any of the remaining covenants or agreements hereof by it to be observed and performed, and such default being given by the Lessors to the Lessee and to any mortgagee or grantee in trust who shall have given to the Lessors written notice of the existence of the interest held by it in the property, the Lessors shall at any time thereafter without demand or notice (which are hereby waived) have full right, at their election, upon thirty days' notice to enter upon the demised premises and take immediate possession thereof and bring suit for and collect all rents, taxes, assessments, payments or other charges which shall have accrued up to the time of such entry; and thereupon from the time of such entry this lease and all rights herein granted shall become void to all intents and purposes whatsoever, and all improvements made on said premises shall be forfeited to the said Lessors, without compensation therefor to the Lessee; Provided also that for rents due and nonperformance of other conditions the Lessors may sue at once but not enter into possession upon forfeiture, except as above provided.
The Lessee covenants and agrees upon the termination of said demised term, or on the forfeiture hereof, that it will surrender and deliver up said above described premises and property peaceably to the Lessors, their agents or attorneys; and if the said Lessee, its agent, attorneys or assigns, shall hold the said premises, or any part thereof, one day after the same shall be surrendered, according to the terms of this lease, it shall be guilty of unlawful detainer of said premises under the statute and shall be subject to eviction and removal, forcibly or otherwise, with or without process of law.
Respecting assignment thereof, the lease provided as follows:
That it (Lessee) will not, except by way of mortgage of its leasehold estate to secure some actual indebtedness, assign or transfer this lease without written consent of the Lessors during any period when there is an existing default on the part of the Lessee in the performance or observance of the conditions of this lease, or at any time after the loss, destruction or removal of any building upon the premises and before the complete repair or reconstruction of the same, but Lessee may, except in the above enumerated instances, transfer or assign this lease, without the consent of the Lessors, to any person of the Caucasian race, or any firm or corporation who shall expressly assume the Lessee's engagements hereunder to the Lessors by written instrument filed forthwith for record in the Recorder's office of said County and an original copy thereof delivered to the Lessors. From and after the time, however, of the making of any such assignment in conformity with the foregoing provisions, there shall exist no further liability under this lease against the Lessee herein named, such liability passing under the instrument of assignment or transfer to the assignee.
Mrs. Grigsby died on October 9, 1930, when title to the property covered by and subject to the lease vested in Lewis Eugene Grigsby as surviving joint tenant. No part of or interest in the property was included in Mrs. Grigsby's gross estate. Lewis Eugene Grigsby died on February 4, 1932, and his estate was administered in the Superior Court of the State of California in and for Los Angeles County. On May 14, 1934, a decree of distribution was entered, distributing the foregoing property and other properties to Stewart P. MacLennan and Walter M. Campbell, as trustees under the will of Lewis Eugene Grigsby, deceased. Campbell died on December 13, 1938, and Security-First National Bank of Los Angeles was appointed his successor as trustee on December 28, 1938.
The decree of distribution provided that the trustees should hold, protect, manage, and control the trust estate, and collect and received the rents, issues, income, and profits therefrom. They were empowered to rent the trust property or any part of it for a period of five years. However, they were not empowered to sell, mortgage, encumber, transfer, or dispose of the trust estate or any part of it, nor to lease the estate or any part of it for a longer period than five years, except with the written consent of four of a group of five beneficiaries, together with the written consent of 75 percent in interest of the remaining group of four beneficiaries.
Out of the gross income of the trust the trustees were to pay ‘all the necessary expenses of the trust, including taxes and insurance and the expenses of protecting and keeping in repair the trust property, and reasonable compensation to the Trustees, all as may be approved by the court,‘ or as might be approved jointly by two agents, one to be selected by the individual beneficiaries as a group and the other by the corporate beneficiaries as a group. After payment of the operating expenses of the trust, including compensation to the trustees, the income was distributable as follows: (1) Not to exceed $1,000 per month to be paid Walter M. Campbell out of the rentals from a specific property, not involved in the controversy herein, until he had received a total of $12,500, without interest; (2) $600 per month, payable at the end of the month, to Jessie MacDonald, beginning March 23, 1934, and thereafter during her life; and (3) one-eighth of the remaining income to each of four individual beneficiaries and each of four religious and charitable corporations, which it is stipulated are and at all times have been exempt from the Federal income tax. Twenty percent of the income distributable to the four religious and charitable corporations was to be paid to the First Presbyterian Church of Hollywood, California, until it should receive specified sums. The trust is to continue during the life of Jessie MacDonald and is to terminate upon her death. Upon termination of the trust the corpus thereof is to be distributed one-eighth to each of the above mentioned four individual beneficiaries and each of the four religious and charitable corporations, except that if the First Presbyterian Church of Hollywood, California, has not received in full the amounts it was to receive from the income distributable to the religious and charitable corporations, the trustees are to deduct the deficiency from the corpus distributable to those corporations. The interests in income and in corpus of the four individual beneficiaries and the four religious and charitable corporations are assignable. The decree provided for the termination of the trust prior to the death of Jessie MacDonald with her written consent and that of the individual and corporate beneficiaries.
The trust has never been terminated, but has continued in full force and effect. The $12,500 payable to Walter M. Campbell under the decree of distribution was paid in full prior to 1939. At all times the income of the trust has been greatly in excess of the $600 per month payable to Jessie MacDonald.
In accordance with the covenants of the lease executed to it on July 30, 1923, by Lewis Eugene and Mrs. Grigsby, the Owl Drug Co., during the latter part of 1928 and the first part of 1929, erected upon the leased premises a reinforced concrete building of two stories and basement, at a cost of approximately $97,000. The building was accepted by the lessors as a compliance with the terms of the lease. Thereafter, on May 10, 1929, the Owl Drug Co. assigned the leasehold estate to its wholly owned subsidiary, the Owl Realty Co., a Nevada corporation, and was thereby relieved of any further obligation under the lease.
On July 24, 1934, and after the entry of the decree of distribution of the estate of Lewis Eugene Grigsby, by which the above mentioned leased premises were distributed to them as trustees, MacLennan and Campbell filed with the court a ‘Petition for Leave to Compromise Rentals and to Permit Assignment of Lease.‘ In the petition they recited that, as executors of the will of Grigsby, they had, on March 1, 1933, with the approval of the court, consented to a reduction of rental for the period September 1, 1932, through December 31, 1933, from $2,500 a month to $1,000 a month, with the Owl Realty Co. agreeing to pay the second installment of city and county taxes against the property for the year 1932-1933 and the first installment of such taxes for 1933-1934. They further recited that the Owl Realty Co. had complied with the terms of that compromise agreement, except that it refused to pay the first installment of the taxes for 1933-1934, amounting to $4,232.16. They also stated that prior to December 31, 1933, the Owl Realty Co. notified the executors that it would not thereafter comply with the terms of the lease. It offered to release and quitclaim or assign its leasehold interest in the property in consideration of a release by the executors of all claims and demands arising in their favor under the lease, and agreed to pay the $4,232.16 of taxes with interest, together with all rents collected by it after January 1, 1934. They informed the court that, subject to its approval, they had agreed to such compromise and assignment and that from the information they had the Owl Realty Co. was financially unable to comply with the terms of the lease and an attempt to enforce compliance would probably force it into bankruptcy. They further informed the court that they were negotiating for the acceptance of the lease by a third party, and requested the court to approve the compromise offer and authorize them to permit the assignment of the leasehold interest of the Owl Realty Co. to any person or corporation acceptable to them. On August 10, 1934, the court entered an order authorizing MacLennan and Campbell to accept the compromise offer ‘and to permit the assignment of be leasehold interest of said The Owl Realty Company, a corporation, to any person or corporation acceptable to petitioners.‘
On August 13, 1934, the trustees caused to be formed a California corporation known as Long Beach Properties, Inc., whose articles of incorporation set forth the usual purposes of a business corporation, including ownership and operation of real estate, and provided for the issuance of 2,500 shares of stock of no par value. On August 17, 1934, the Corporation Commissioner of the State of California issued a permit for the issuance of 1,000 shares of stock by Long Beach Properties, Inc. Under date of August 22, 1934, a certificate for 998 shares of stock was issued to R. Wilcox, and certificates of 1 share each were issued to H. K. Wilcox and W. Fleming. R. Wilcox was engaged in the business of furnishing incorporating service. H. K. Wilcox was his wife and W. Fleming was a stenographer in his office. None of the foregoing parties had any beneficial interest in the said share of stock, and the certificates therefor were endorsed in blank by the respective parties to whom issued and were delivered to the trustees, in whose possession they continued to remain. No money was paid to the newly formed corporation for the stock, either by the parties to whom it was issued or by anyone else, but the consideration for its issuance was the assignment and transfer to it of the interest of the Owl Realty Co. under the lease. Due to delay in obtaining the consent of the beneficiaries of the trust, such assignment and transfer was not made immediately, but was effected by an instrument executed by Apex Realty Co. (formerly the Owl Realty Co.) on November 27, 1934. The assignment and transfer was to be effective as of the close of May 31, 1934. R. Wilcox never at any time had any beneficial ownership of the leasehold.
At or about the time of the foregoing assignment and transfer, the trustees entered into an agreement with Long Beach Properties, Inc., for a reduction of rental from $2,500 a month, as provided in the lease, to $1,000 a month for the period June 1, 1934, through May 31, 1936. This reduction was made with the proviso that if, after the exercise of reasonable diligence in keeping the property rented at reasonable rentals, the corporation should be unable to pay the expenses required to be borne by it under the lease and the rental of $1,000 a month, the trustees would accept the amount of the rentals actually received by the corporation less the amount of the required expenses, and would not forfeit the rights of the corporation as lessee because of its failure to pay the full amount of $1,000 a month rental.
In June 1939, with the consent of the trustees, who constituted the only shareholders, Long Beach Properties, Inc., was dissolved. It was completely liquidated in September 1939 by its execution to the trustees of a quitclaim deed and assignment with respect to its interest in the leased property and the lease, and the execution to the trustees of an instrument entitled ‘Transfer of Assets.‘ The only assets distributed consisted of the transfer of whatever interest Long Beach Properties, Inc., had under and by virtue of the leasehold, and cash in the amount of $9,209.69. The cash was delivered to the trustees as and was treated by them as in payment of the corporation's liability in an equal amount for rent owing by the corporation.
Throughout its existence, Long Beach Properties, Inc., turned over all its net income to the trustees as rent under the arrangement entered into between it and the trustees at or about the time the lease was assigned to it. It did not have at any time any assets other than those acquired under and pursuant to the assignment of the leasehold and such sums as were owing to it from time to time as rentals from sublessees, which, when collected were paid over to the trustees as rent. It did not carry on or engage in any business other than the holding and operation of the leasehold. Although the property was under lease to Long Beach Properties, Inc., the trustees had full supervision of the leasing of the property and of the collection and application of the rentals therefrom. For the years 1934 through 1939 neither Long Beach Properties, Inc., nor the trust was allowed any deduction for depreciation of the improvements on the property.
In the Federal estate tax return filed for the estate of Lewis Eugene Grigsby, deceased, the leased property was listed as improved with a two-story and basement reinforced concrete building, and was reported as having a value of $350,000 at the date of death. There was no segregation of the amount as between land and improvements, nor anything else to indicate what portion, if any, of the reported value was attributable to the improvements. The respondent determined that the value to be $400,000, but in making such determination he did not indicate what portion, if any, of such value represented the value of the improvements. On the date of the death of Lewis Eugene Grigsby, February 4, 1932, the property was subject to the lease, and the value determined by the respondent was in part determined by consideration of a capitalization of present (February 4, 1932) and probable future earnings under the lease. The Owl Drug Co., which owned all the stock of the Owl Realty Co., filed a voluntary petition in bankruptcy in the United States District Court for the District of Nevada in October 1932, and, as stated above, the rentals under the lease were reduced to $1,000 a month, commencing September 1, 1932.
In the fiduciary return of income filed by the trustees for 1934, no income or gain was reported on account of termination of the lease. In an audit of the return, the respondent did not include any amount as arising from such source. In the fiduciary return of income filed by the trustees for 1939, no income or gain was reported on account of termination of the lease, but attached to the amended return filed for that year was a statement setting forth the default of the Owl Realty Co. under the lease in 1934, the compromise agreement between it and the trustees, the formation by the latter of Long Beach Properties, Inc., to take an assignment of the lease and ownership of all of that corporation's stock, and the dissolution in 1939 of the corporation with the distribution to the trustees of such rights as the corporation had under the lease. In determining the deficiency in controversy, the respondent determined that the trust received income in the amount of $70,000 in 1939, upon the termination of the lease, through its acquisition of the improvements which the original lessee at its own cost had constructed thereon. The said $70,000 represented the amount determined by the respondent as the excess of the value, in September 1939, of the real estate with the improvements thereon over the value, at that date, of the real estate without the improvements.
OPINION.
TURNER, Judge:
The primary contentions of the petitioner are (1) that the improvements on the leased premises were included by the respondent in the gross estate of Lewis Eugene Grigsby in determining the estate tax liability and, therefore, could never be income to his estate or to the instant trust, which was created under his will; (2) that if any income was realized by the trust upon termination of the lease and its acquisition of the improvements, such income was realized not in 1939, but in 1934, when Long Beach Properties, Inc., was organized and acquired the lease; and (3) that if any income was realized either in 1934 or in 1939, it was taxable to the beneficiaries of the trust as income currently distributable to them and therefore deductible by the trust in computing the net income of the trust.
That a transaction whereby a lessor, through the surrender of a lease, acquires improvements which have been erected on the leased property by the lessee at its own cost is a gain-realizing transaction, is no longer open to question. Helvering v. Bruun, 309 U.S. 461. In the instant case, the building in question was constructed by the lessee, the Owl Drug Co., but upon completion of the building the lease was assigned to the Owl Realty Co., which succeeded to all of the rights and liabilities of the Owl Drug Co. When the lease was made the property was owned jointly by Lewis Eugene Grigsby and his wife, and in 1930 Grigsby became the sole owner as the surviving joint tenant. Grigsby died in 1932, and sometime in 1933 the Owl Realty Co. notified his executors that it would not thereafter comply with the terms of the lease. It offered to release and quitclaim or assign its leasehold interest in the property, and to pay certain unpaid taxes thereon and all rents collected by it therefrom after January 1, 1934, if the executors would release it from all claims and demands against it under the lease. In May of 1934 the property, subject to the lease, was distributed to the trust herein pursuant to the terms of the Grigsby will. In July of 1934 the trustees brought their problem with respect to the said property to the attention of the court and in August of that year obtained the court's permission to accept the offer of the Owl Realty Co. and to permit the assignment of the leasehold interest to any person or corporation acceptable to the trustees. The trustees thereupon caused Long Beach Properties, Inc., to be organized, and they became its only stockholders. On November 27, 1934, the Apex Realty Co., formerly the Owl Realty Co., assigned and transferred its interest under the lease to Long Beach Properties, Inc. The assignment of the leasehold interest was the consideration to Long Beach Properties, Inc., for the issuance of its stock. It received no money or other property therefor. From the time of its creation until its dissolution in 1939, Long Beach Properties, Inc., never engaged in any business except the holding and operating of the leasehold. At no time did it ever have any assets other than the leasehold and such rights and interests as were acquired thereunder. The rents owing by sublessees on the leased property, when collected, were turned over to the trustees. The trustees in fact supervised the leasing of the property and the collection and application of the rents received from the tenants.
From the facts, it is apparent, we think, that for the purposes of applying Helvering v. Bruun, supra, the lease was surrendered in 1934, and any gain resulting from the acquisition of the improvements through such surrender was realized in that year. Long Beach Properties, Inc., was petitioner's nominee. It issued its stock to petitioner, receiving the lease therefor. The fact that the petitioner did not see fit to cancel the lease and make a new one, but decided to continue operation of the properties under the former lease, is of no consequence. Income subject to one's unfettered command and that he is free to receive as his own is income to him, whether he sees fit to receive it or not. Corliss v. Bowers, 281 U.S. 376. In 1939, when the lease was formally canceled and Long Beach Properties, Inc., was dissolved, the petitioner here was, in so far as the above improvements were concerned, receiving back only that which it had formerly acquired in 1934, and any gain realized through acquisition of the said improvements was realized in 1934, not in 1939.
By reason of the conclusion reached, it becomes unnecessary for us to consider the remaining contentions of the petitioner, and the respondent is free to consider with respect to the gain, if any, realized by the trust in 1934, the applicability of section 3801 of the Internal Revenue Code.
Decision will be entered for the petitioner.