Docket No. 41543.
Albert B. Bernstein, Esq. , for the petitioner. Alben E. Carpens, Esq. , for the respondent.
Petitioner assigned and transferred for a lump sum all his right and interest in a master lease and certain subleases with respect to the erection and operation of a shopping center. The agreement of sale contained a covenant not to compete but no separate amount was fixed for such covenant. Held, the entire amount received was from the sale of capital assets and is subject to tax on the basis of a capital gain. Albert B. Bernstein, Esq., for the petitioner. Alben E. Carpens, Esq., for the respondent.
Respondent determined a deficiency in petitioner's income tax for 1948 in the amount of $4,810.01. By an amended petition petitioner claims an overpayment of $510.95 by reason of having included as gross income in his 1948 return an amount of $1,528 as prepaid rent. The sole contested issue is whether the sum of $22,000 received by petitioner pursuant to a purchase and sale agreement dated February 14, 1948, is taxable as ordinary income or capital gain.
FINDINGS OF FACT.
The stipulated facts are found accordingly.
Petitioner, a resident of Miami, Florida, filed his income tax return for 1948 with the collector of internal revenue for the district of Florida.
In 1946 the housing authority of the City of Los Angeles, California, was constructing a housing project for veterans known as Basilone Homes some 6 to 8 miles from Burbank, California, and some 2 1/2 miles from Roscoe, California, a city of a few hundred people. Roscoe had a main street with a department store, hardware store, and other shopping facilities. The housing project at that time contained no shopping facilities.
On September 1, 1946, a lease, hereinafter referred to as the master lease, was entered into between the housing authority of the City of Los Angeles, as lessor, and the petitioner, as lessee, covering certain land adjoining the properties on which the Basilone Homes project was being constructed. The land was to be used for the purpose of establishing and operating a community shopping center for the convenience of the tenants occupying the adjoining veterans' housing project. The basic term of the lease was for a period of 5 years, commencing December 1, 1946, and ending November 30, 1951. The lessee had the option to renew the lease for the duration of the temporary emergency housing project at an annual rental of $10,000.
Under the lease the petitioner was required to expend a minimum of $50,000 for the construction and furnishing of an adequate community shopping center upon the leased premises. It was further understood and agreed that the investment represented by such expenditure should be amortized over the 5-year term provided by the lease as rental for the premises.
The lease provided that all buildings and other equipment erected upon the leased premises by the lessee at his cost should remain his property with the right of removal upon the termination of the lease. The lessee was required to pay all charges for gas, water, electricity, garbage disposal, and other services, and to keep the premises, buildings, and sidewalks in good and sanitary order, condition, and repair.
Petitioner was required to pay the property and liability insurance upon the properties. In addition, he was to bear the cost and expense of extermination of vermin. Petitioner was not required to pay taxes because it was a State government housing project. Assignment of the lease required the prior written consent of the lessor.
Following the execution of the lease petitioner graded the property, poured concrete slabs, built sidewalks, brought in power lighting, black-topped the street and parking area, and erected 11 stores.
Petitioner then, as landlord, executed 11 subleases to various subtenants to operate the stores or places of business he constructed on the property. Ten of these subleases were for 5-year periods running concurrently with the master lease, and the eleventh lease, to a liquor store, was for 3 years.
In August 1947 petitioner traveled to Miami, Florida, to seek employment with an organization which owned and operated theaters in the Miami area. Being successful in his mission petitioner returned to California to sell his holdings in order to return to Miami, Florida, for his permanent employment.
While in California in the early part of February 1948 petitioner entered into an oral understanding with Harry Berger and Abraham Feldman to sell for the sum of $33,000, the buildings and improvements which petitioner had placed upon the leased premises and to sell his rights as tenant under the master lease and as landlord under the 11 subleases for the sum of $22,000. During the oral negotiations no mention was made of an agreement not to compete.
On February 14, 1948, petitioner entered into a purchase and sale agreement with Berger and Feldman which provided in pertinent part as follows:
WHEREAS, the Seller is desirous of transferring and assigning all his right, title and interest in and to the aforementioned master lease and sub-leases to the Purchasers and also is desirous of selling all his right, title and interest in and to all the buildings erected by him pursuant to the terms of the said master lease; and
WHEREAS, the Purchasers are desirous of purchasing from the Seller all his right, title and interest in the said master lease, sub-leases and buildings,
NOW, THEREFORE, it is agreed as follows:
1. The Seller does hereby agree, and does by these presents, sell, assign, transfer and set over unto the Purchasers all his right, title and interest of whatsoever nature in and to the following buildings:
* * * * * * *
for the purchase price of Thirty-three Thousand ($33,000.00) Dollars in cash; the Purchasers agree to purchase and by these presents purchase from the Seller the aforementioned buildings and agree to pay therefor the sum of Thirty-three Thousand ($33,000.00) Dollars in cash.
2. The Seller agrees to transfer and assign and does by these presents transfer and assign to the Purchasers, all his right, title and interest of whatsoever nature in and to a certain lease dated September 1st, 1946, wherein the Seller is the lessee and the Housing Authority of the City of Los Angeles is lessor covering the following property:
* * * * * * *
and all his right, title and interest of whatsoever nature in and to the following sub-leases wherein the Seller is the lessor and the tenants therein mentioned are the sub-tenants:
* * * * * * *
3. The Seller does hereby covenant and agree that he shall not engage in a business competitive with that being transferred and sold under the terms of this agreement for a period of three (3) years hereafter within a radius of three (3) miles of Basilone Homes.
4. For and in consideration of the transfer and assignment of the master lease and sub-leases hereinabove mentioned and the restrictive covenant not to engage in a competitive business, the Purchasers agree to pay to the Seller the sum of Twenty-two Thousand ($22,000.00) Dollars in cash.
Under the agreement petitioner agreed to turn over to the purchasers, Berger and Feldman, certain deposits received by him as security from subtenants in the aggregate amount of $12,300, and the purchasers agreed to deposit the same in a trust fund for the benefit of the sublessees to be returned at the expiration of each sublease provided each had been performed faithfully. The sum of $4,038.45 received by the petitioner as advance rental from certain sublessees was to be credited against the purchase price.
There were a great number of vacant parcels of land within 3 miles of Basilone Homes on which other store buildings or commercial projects could have been built. At the time petitioner sold his interest in February 1948 a third party had begun construction of several stores diagonally across the street from the shopping center of Basilone Homes.
Petitioner left California in the latter part of 1948 and has not returned to that State nor had business interests there since March of 1948.
Petitioner's only experience in building and renting stores was the one project, Basilone Homes, which lasted approximately 1 1/2 years.
The amount of $22,000 realized by the petitioner in the taxable year 1948 from the sale of his interest in the master lease and the 11 subleases was capital gain and not ordinary income.
The question presented involves the correctness of the respondent's determination that the sum of $22,000 received by the petitioner pursuant to a purchase and sale agreement was the consideration for a covenant not to compete and is taxable as ordinary income. The petitioner contends that the payment was for the sale of capital assets and is taxable as capital gain.
Pursuant to a contract dated February 14, 1948, petitioner assigned and transferred all of his right, title, and interest in a shopping center in connection with the Basilone Homes housing project. The total consideration to be paid was $55,000, consisting of two parts. The amount applicable to the buildings and equipment was $33,000 and no question with respect to that amount is in controversy. The remaining $22,000, which is here in question, was stated to be in consideration of the assignment and transfer of the master lease owned by petitioner, certain subleases, and a covenant not to compete. The respondent argues that as the master lease and the subleases were without value the total consideration of $22,000 was, therefore, paid for the restrictive covenant. We do not agree with this premise.
It appears well established that the question of whether any portion of the sale price should be attributed to a restrictive covenant as opposed to other items in the transaction depends upon whether the parties treated the covenant as a separate and distinct item in their negotiations and whether the purchasers actually paid anything for the covenant as a separate item in the deal. Clarence Clark Hamlin Trust, 19 T. C. 718, affd. 209 F. 2d 761; Gazette Telegraph Co., 19 T. C. 692, affd. 209 F. 2d 926; and Rodney B. Horton, 13 T. C. 143.
Petitioner testified that in the oral negotiations leading to the written agreement of February 14, 1948, mention had not been made at any time of a covenant not to compete. Petitioner further testified that the consideration was fixed in the oral understanding without reference to such a covenant; that he did not regard any part of the fixed consideration as having been received for the agreement not to compete because of his plans to take up permanent employment in Florida, and therefore agreed to the incorporation of the restrictive covenant in the final written agreement. See Harold J. Burke, 18 T. C. 77.
We think the agreement of February 14, 1948, and the other evidence clearly indicate that the restrictive covenant was not treated as a separate item nor was any separate part of the consideration paid for such covenant. Cf. Clarence Clark Hamlin Trust, supra.
After giving due consideration to all of the facts and circumstances disclosed by this record, we have found as a fact that the amount of $22,000 received by the petitioner pursuant to the purchase and sale agreement for the assignment of his interest in the master lease and subleases was capital gain.
We hold, therefore, that the respondent erred in taxing the $22,000 as ordinary income of the petitioner in the taxable year 1948. Effect will be given to the stipulated fact that the petitioner erroneously included the sum of $1,528 in gross income in his return filed for 1948.
Decision will be entered under Rule 50.