Opinion
Docket No. 27978.
1952-01-14
JOHN MANTELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Maurice Survis, Esq., for the petitioner. F. L. Van Haaften, Esq., for the respondent.
The sum received by petitioner-lessor upon execution of a lease, as security for the lessees' performance of the terms of the lease, was not taxable income upon receipt where lessor was under obligation to repay it unless in the meantime it should be appropriated to make good a default by the lessees. Maurice Survis, Esq., for the petitioner. F. L. Van Haaften, Esq., for the respondent.
The respondent has determined a deficiency of $13,771.62 in petitioner's income tax for the taxable year ended December 31, 1946. The entire deficiency results from the respondent's determination that the sum of $33,320 paid to the petitioner upon the execution of a lease in 1946 was paid in prepayment of rent rather than as a security deposit, and was taxable income in that year. An additional sum of $10,000 designated in the lease as security and paid in later years is not in issue.
FINDINGS OF FACT.
The petitioner is an individual who maintains his place of business in Miami Beach, Florida. His income tax return for the calendar year 1946 was filed with the collector of internal revenue at Jacksonville, Florida. His income was reported on the cash receipts and disbursements basis.
For approximately 30 years, the petitioner has been a hotel and real estate operator, and occasionally a builder, in Miami Beach. He was the owner of a hotel in Miami Beach which was built by him and known as Mantell Plaza Hotel. The structure and land cost approximately $250,000 and contained personalty which cost approximately $50,000.
On October 17, 1946, the petitioner leased the Mantell Plaza Hotel and the personalty contained therein. On April 30, 1947, the petitioner consented to an assignment of the entire interest of one of the original lessees, namely, Rose K. Rich, to Eli Katz, and Louis Katz, who in turn executed an agreement on the same date, assuming all the terms and conditions of the lease as if they had been parties to the lease agreement as lessees.
On or about November 15, 1948, the lessees filed a bill of complaint against the petitioner-lessor in the Circuit Court of the Eleventh Judicial Circuit in and for Dade County, Florida, alleging ‘that the said defendant has breached said lease and should therefore be declared by this Honorable Court to return to your plaintiffs the security moneys placed by your plaintiffs with the defendant in the sum of $43,320.00 for the faithful performance on their part of the terms of said lease.‘ The petitioner successfully defended this suit.
On August 9, 1949, the petitioner entered into an amended lease with the lessees whereby the term was reduced from 10 (seasonal) years to 5 (seasonal) years, and the dates of the rental installments and the return of the security deposit were changed, and the total rent reduced. Except for these changes, all of the covenants of the original lease remained in full force and effect.
The amended lease was entered into to settle disputes that had arisen between the petitioner-lessor and the lessees. The petitioner had disputes with the lessees over covenants in the lease during each of the four years that the lease was in effect.
On november 9, 1950, the original lease as amended was cancelled because of the lessees' inability to pay the rent.
The original lease provided for a term beginning November 1946, and ending June 1, 1956. The total rent for this term was $333,200. The rental installments from January 1, 1947, to September 1, 1948, were as follows:
+----------------------+ ¦Jan. 1, 1947 ¦$15,000¦ +--------------+-------¦ ¦Feb. 1, 1947 ¦10,000 ¦ +--------------+-------¦ ¦March 1, 1947 ¦8,320 ¦ +--------------+-------¦ ¦Sept. 1, 1947 ¦5,000 ¦ +--------------+-------¦ ¦Oct. 1, 1947 ¦5,000 ¦ +--------------+-------¦ ¦Nov. 1, 1947 ¦5,000 ¦ +--------------+-------¦ ¦Dec. 1, 1947 ¦5,000 ¦ +--------------+-------¦ ¦Jan. 1, 1948 ¦5,000 ¦ +--------------+-------¦ ¦Feb. 1, 1948 ¦8,320 ¦ +----------------------+
There were no rental installments due from February 1, 1948, to September 1, 1948. The rental installments from September 1, 1948, to the end of the term were due on the first day of the months of September, October, November, December, and on December 20 of the years 1948 through 1955. The payments due were to be $10,000, $5,000, $5,000, $5,000, and $8,320, respectively. The final installment was due on December 20, 1955.
Under the amended lease of August 9, 1949, the rents for the period beginning September 1949 and ending June 1, 1951, the date the amended lease expired, totaled $85,960, which was $14,000 less than the total sum of payments due for this period under the original lease. This reduction in rent was part of the settlement of the disputes between the lessor and the lessees.
The amount of rent payable and the payment dates under the amended lease were:
+---------------------------------------------+ ¦ ¦1949 ¦ ¦1950 ¦ ¦1951 ¦ +-------+-------+-------+-------+------+------¦ ¦Sept. 1¦$14,000¦Aug. 15¦$10,000¦Jan. 1¦$3,864¦ +-------+-------+-------+-------+------+------¦ ¦Oct. 1 ¦3,700 ¦Sept. 1¦7,700 ¦Feb. 1¦3,864 ¦ +-------+-------+-------+-------+------+------¦ ¦Nov. 1 ¦7,700 ¦Oct. 1 ¦3,850 ¦Mar. 1¦3,864 ¦ +-------+-------+-------+-------+------+------¦ ¦Dec. 1 ¦3,700 ¦Nov. 1 ¦3,850 ¦Apr. 1¦3,864 ¦ +-------+-------+-------+-------+------+------¦ ¦Dec. 20¦4,220 ¦Dec. 1 ¦3,850 ¦May 1 ¦3,864 ¦ +-------+-------+-------+-------+------+------¦ ¦ ¦ ¦Dec. 20¦4,070 ¦ ¦ ¦ +---------------------------------------------+
Under the terms of the original lease, the lessees covenanted with the lessor to deposit the sum of $33,320 upon the execution of the lease and additional sums of $5,000 on April 1, 1947, and $5,000 on April 1, 1948, resulting in a total sum of $43,320, which was to be held by the lessor ‘as security for the performance by the Lessees of all terms, conditions, covenants and agreements in this lease contained by the Lessees to be kept and performed, as well as security for the return by the Lessees unto the Lessor of the real and personal property hereby demised in accordance with the terms of this agreement, and to indemnify the Lessor against any damage to the said premises, both real and personal, and for any damage sustained by the Lessor on account of any breach of or default in the lease by the Lessees.‘ In the leases executed by the petitioner-lessor and the lessees and in the bill of complaint filed by the lessees against the petitioner-lessor, the $43,320 security deposit was always designated as security and never as prepaid rent.
The security payments were paid to the petitioner-lessor when due. The lessor and the lessees at all times regarded the sum as a security deposit. There was an acknowledged liability on the part of the petitioner-lessor to hold himself accountable to the lessees for the full security fund and to return it at a future date to the lessees.
The original lease specifically provided that the security deposit was not to be applied as rent and that the lessor was not required to pay interest on the sums or keep them in a separate account.
In the original lease, it was agreed that if the lessees ‘shall not then be in default,‘ the lessor will return the security deposit to the lessees, partly in the tenth year of the term and partly after the expiration of the lease, in the following installments:
+-----------------------------------------------------------------------------+ ¦Sept. 3, 1955 ¦$10,000¦ +---------------------------------------------------------------------+-------¦ ¦Oct. 3, 1955 ¦5,000 ¦ +---------------------------------------------------------------------+-------¦ ¦Nov. 3, 1955 ¦5,000 ¦ +---------------------------------------------------------------------+-------¦ ¦Dec. 3, 1955 ¦5,000 ¦ +---------------------------------------------------------------------+-------¦ ¦Dec. 20, 1955 ¦8,320 ¦ +---------------------------------------------------------------------+-------¦ ¦Simultaneously with the return by lessees unto the Lessor of the ¦ ¦ ¦demised premises in accordance with the terms of the Lease respecting¦10,000 ¦ ¦such return ¦ ¦ +---------------------------------------------------------------------+-------¦ ¦Total ¦$43,320¦ +-----------------------------------------------------------------------------+
In the amended lease, the dates and amounts with respect to the return of the security deposit were modified. The modified amounts and dates with respect to the return of the security deposit were:
+----------------------+ ¦Sept. 5, 1949 ¦$14,000¦ +--------------+-------¦ ¦Aug. 20, 1950 ¦10,000 ¦ +--------------+-------¦ ¦Jan. 5, 1951 ¦3,864 ¦ +--------------+-------¦ ¦Feb. 5, 1951 ¦3,864 ¦ +--------------+-------¦ ¦March 5, 1951 ¦3,864 ¦ +--------------+-------¦ ¦April 5, 1951 ¦3,864 ¦ +--------------+-------¦ ¦May 5, 1951 ¦3,864 ¦ +----------------------+
The sum of $33,320 paid by the lessees to the lessor in 1946 was recovered by the lessees during the years 1949 and 1950. Fourteen thousand dollars was applied on September 9, 1949, to the defaulted rental installment due September 1, 1949; $10,000 was returned on August 20, 1950; and $9,320 was returned on November 9, 1950, upon the execution of the agreement cancelling the lease. In the agreement cancelling the lease the lessees acknowledged the recovery of the $33,320 sum.
The original lease provided that if the property was totally destroyed by fire or windstorm either the lessees or the lessor had the right to cancel the lease and that if the property was partially damaged and could not be repaired within 6 months, the lessees had the right to cancel the lease. If the right of cancellation was exercised by either party, the lessor was obliged to return the security deposit to the lessees, together with any unused or prepaid rent.
The original lease provided that the lessor was to retain the security deposit in the amount of $43,320 in the event the lease was cancelled by the lessor for default of the lessees of any of the terms, conditions, covenants, and agreements to be performed by the lessees. The lease provided that ‘Upon such cancellation for default, the Lessor may either retain the security fund as liquidated and agreed upon damages sustained by him at the hands of the Lessees without in any way, however, affecting the right of the Lessor to have such action against the Lessees by reason of such default as the law permits.‘
Among the specific covenants, agreements, terms, and conditions to be performed by the lessees for which the security deposit was to stand as security were the following: To return the property in good condition at the end of the term; to pay the additional security on April 1, 1947, and April 1, 1948; to pay the current rentals; to replace all broken, damaged, and missing personal property included in the inventory attached to the original lease; to subordinate the lease to any mortgage which the lessor may subsequently place upon the property, and to execute such other or further formal instruments of subordination as may be required by the lessor or the mortgagee; to pay all charges for utility services; to operate the hotel under the name of Mantell Plaza and not to use such name in the operation of any other hotel or apartment house, or acquire any property interest in any hotel or apartment house with such a name; to operate the hotel so that it would not be used for illegal or immoral purposes; to keep in good condition the interior of the premises and all other portions of the building excepting the exterior walls and the roof; to make no structural alterations without the written consent of the lessor and if any alterations were made, not to permit any bills for such alterations to remain unpaid so that any lien could be asserted against the premises; to permit the lessor to enter and examine the premises and make repairs to prevent waste; not to place any signs on the outside of the premises without the consent of the lessor; to take all risk of damage to the property occasioned by leakage of water or gas unless the damage was caused by the failure of the lessor to keep the exterior walls and roof in good repair after having been notified of the need for repairs; to indemnify the lessor against any claim of any kind that may be brought against the lessor out of or in connection with the lessees' operation of the hotel; to carry public liability and boiler insurance; to pay any license or operating taxes required by the city, state, or county; to assign to the lessor and pledge as additional security for the payment of the rent all personalty brought into the leased premises; and not to assign the lease without written consent of the lessor. There were at least 25 explicit covenants to be performed by the lessees.
The sum of $33,320 received by the petitioner upon the execution of the lease in 1946 was intended to be and was in fact a security deposit. It was not paid as prepaid rent and was not taxable income when received.
OPINION.
ARUNDELL, Judge:
The issue before us is whether the sum of $33,320 received on the execution of the lease in 1946 should be included in petitioner's gross income for that year. The legal principles by which the issue is to be resolved are not in dispute. If the sum is received under a present claim of full ownership, subject to the lessor's unfettered control, and is to be applied to the rent for the last year of the term, it is income in the year of receipt even though under certain circumstances a refund may be required. Hirsch Improvement Co. v. Commissioner, 143 F.2d 912, certiorari denied 323 U.S. 750; Astor Holding Co. v. Commissioner, 135 F.2d 47; Renwick v. United States, 87 F.2d 123; Commissioner v. Lyon, 97 F.2d 70.
If, on the other hand, the sum was deposited to secure the lessee's performance under the lease, it is not taxable income even though the fund is deposited with the lessor instead of in escrow and the lessor has temporary use of the money. Warren Service Corporation v. Commissioner, 110 F.2d 723, affirming on this point and reversing on another, 39 B.T.A. 856; Clinton Hotel Realty Corporation v. Commissioner, 128 F.2d 968; Estate of George E. Barker, 13 B.T.A. 562. See Virginia Iron Coal & Coke Co., 37 B.T.A. 195, affd. 99 F.2d 919, certiorari denied 307 U.S. 630.
In some instances the deposit serves as security for the lessee's performance and, in addition, if any or all of it remains during the final period of the lease, it is to be applied to rent. It then becomes necessary to determine whether the deposit was primarily a security payment or a prepayment of rent. Gilken Corporation, 10 T.C. 445, affd. 176 F.2d 141. This question of fact is resolved by reference to the intention and acts of the parties ascertained from the lease agreement and the circumstances incident thereto. Astor Holding Co. v. Commissioner, supra; Hirsch Improvement Co. v. Commissioner, supra. See C.J.S., vol. 52, Landlord and Tenant, section 472.
It is clear that the deposit in the instant case served as a security payment. The respondent attempts to offset the significance of this factor by contending that it was also to serve as prepaid rent. This contention contradicts the clause in the lease expressly providing that the deposit was not to be applied as rent, and also contradicts the clause providing for the return of the deposit to the lessees.
We are, of course, aware of the relationship in time and amount between the deposit repayment installments and the rent installments for the final period. However, we cannot conclude therefrom as does the respondent that the provision for the repayment of the security deposit to the lessees lacked substance and was in fact a provision for the prepayment of rent. Such an express provision cannot easily be disregarded when, as here, the legal rights of the parties, and of third parties also, may be substantially different depending on whether the clause provides that the deposit is to be returned to the lessees or applied to the rent of the final period. See C.J.S., sections 472, 473 and 545, particularly section 473, pp. 223, 224, wherein it is explained that the latter is a covenant that runs with the land, whereas the former is merely a personal obligation of the lessor. See also Walker v. 18th Street Holding Corporation, 267 App.Div. 141, 44 N.Y.S.2d 866, and Casino Amusement Co. v. Ocean Beach Amusement Co., 101 Fla. 59, 133 So. 559.
We are satisfied from our examination of the lease agreement and the conduct of the parties thereto that they intended the deposit to serve as a security payment and gave effect to that intent. It is clear from a reading of the lease agreement that the petitioner-lessor resolved to provide himself with the maximum security, including a security deposit which is commonly used in leases. See C.J.S., supra; In re Frey, 26 F.2d 472. The deposit was distinctly described and treated as a security payment in the original lease agreement. There were at least 25 explicit covenants to be performed by the lessees, many of an unusual character. This cautious policy, born of past experience, was justified by the quarrels and lawsuits that ensued.
The conduct of the parties subsequent to the execution of the original lease agreement was in harmony with the purpose of the deposit as expressed in their agreement. In a bill of complaint filed by the lessees in an attempt to recover the deposit, it was referred to as a security payment. In the amended lease it was again distinctly described and treated as a security payment. Finally, in the agreement canceling the lease it was treated as a security payment and that portion still retained by the lessor was in fact returned to the lessees.
Under these circumstances, we find no reason to conclude that the deposit was anything other than what the parties have expressly declared it to be. In our opinion, the deposit was a security payment and as such it did not constitute taxable income when received in 1946. Warren Service Corporation v. Commissioner, supra; Clinton Hotel Realty Corporation v. Commissioner, supra; Estate of George E. Barker, supra, and Virginia Iron, Coal & Coke Co., supra.
Decision will be entered for the petitioner.