United States Supreme Court
HORT
v.
COMMISSIONER OF INTERNAL REVENUE

Docket No. 517
Date of Decision: March 31, 1941
Judge:  Murphy

Tax Analysts Citation: 1994 TNT 241-70
Parallel Citations: 25 AFTR 1207
Principal Code Reference: Section 61

Summary
Provided by Tax Analysts.  Copyright 2000 Tax Analysts.  All rights reserved.
CONSIDERATION FOR LEASE CANCELLATION IS ORDINARY INCOME.
Walter Hort acquired property from his father by devise in 1928.
In 1927, the father had leased a portion of the property to Irving Trust
Co. for fifteen years for $25,000 per year. In 1933, Hort and the company
agreed to cancel the lease in exchange for a payment to Hort of $140,000.
Hort did not report this as income but reported a loss of $21,495 on the
theory that the amount he received as consideration was $21,495 less than
the difference between the present value of the unmatured rental payments
and the rental value of the property leased for the unexpired term of the
lease. The IRS disallowed the loss and included the $140,00 in gross
income. The Board of Tax Appeals and the Second Circuit agreed with the IRS.
     The Supreme Court held that the $140,000 was gross income and
that the loss was not allowable. Justice Murphy noted that any proceeds of
a suit to recover damages if Irving Trust had breached the contract would
have been includable in income. The amount that Hort received, Justice
Murphy reasoned, was a substitute for the rent received in the lease just
as a suit to recover damages would have been. It was irrelevant, the Court
concluded, that Hort chose to accept an amount less than the strict present
value of the unmatured rental payments rather than engage in litigation.
The Court also ruled that the $140,000 was not a return of capital. The
$140,000, explained Justice Murphy, was essentially a substitute for rent
payments, which must be treated as ordinary income.

 US-SUP-CT, [41-1 USTC ¶9354], Walter M. Hort, Petitioner, v. Commissioner of Internal Revenue, Respondent, Lease cancellation: Income and loss.--, (Mar. 31, 1941)
[41-1 USTC ¶9354]Walter M. Hort, Petitioner, v. Commissioner of Internal Revenue, Respondent

Supreme Court of the United States, No. 517.  October Term, 1940, 313 US 28, 61 SCt 757, Decided March 31, 1941

On writ of certiorari to the United States Circuit Court of Appeals for the Second Circuit.

Lease cancellation: Income and loss.--The amount received as consideration for cancellation of a lease of realty was essentially a substitute for rental payments and not a return of capital.  It must be reported in full as gross income under Sec. 22(a), 1932 Act, without regard to the claimed disparity between that amount and the difference between the present value of the unmatured rental payments and the fair rental value of the property for the unexpired period of the lease.  The extent that cancellation of the lease reduced the value of the property would become a deductible loss only when fixed by a closed transaction.   Affirming Circuit Court of Appeals, Second Circuit, 40-1 ustc ¶9490, 112 Fed. (2d) 167, which aff’d 39 BTA 922, CCH Dec. 10,694.

Walter J. Rosston and Edwin Hort, 141 Broadway, New York, N. Y., for petitioner.  Francis Biddle, Solicitor General, Samuel O. Clark, Jr., Assistant Attorney General, and Sewall Key, Richard H. Demuth, and Morton K. Rothschild, Special Assistants to Attorney General, for respondent.

Mr. Justice Murphy delivered the opinion of the Court:

We must determine whether the amount petitioner received as consideration for cancellation of a lease of realty in New York City was ordinary gross income as defined in §22(a) of the Revenue Act of 1932 (47 Stat. 169, 178), and whether, in any event, petitioner sustained a loss through cancellation of the lease which is recognized in §23(e) of the same Act (47 Stat. 169, 180).

[The Facts]

Petitioner acquired the property, a lot and ten-story office building, by devise from his father in 1928.  At the time he became owner, the premises were leased to a firm which had subject the main floor of the Irving Trust Co. In 1927, five years before the head lease expired, the Irving Trust Co. and petitioner’s father executed a contract in which the latter agreed to lease the main floor and basement to the former for a term of fifteen years at an annual rental of $25,000, the term to commence at the expiration of the head lease.

In 1933, the Irving Trust Co. found it unprofitable to maintain a branch in petitioner’s building.  After some negotiations, petitioner and the Trust Co. agreed to cancel the lease in consideration of a payment to petitioner of $140,000.  Petitioner did not include this amount in gross income in his income tax return for 1933.  On the contrary, he reported a loss of $21,494.75 on the theory that the amount he received as consideration for the cancellation was $21,494.75 less than the difference between the present value of the unmatured rental payments and the fair rental value of the main floor and basement for the unexpired term of the lease.  He did not deduct this figure, however, because he reported other losses in excess of gross income.

[Contentions of the Parties]

The Commissioner included the entire $140,000 in gross income, disallowed the asserted loss, made certain other adjustments not material here, and assessed a deficient.  The Board of Tax Appeals affirmed.  9 B. T. A. 922 [CCH Dec. 10,694].  The Circuit Court of Appeals affirmed per curiam on the authority of Warren Service Corp. v. Helvering, 110 F. (2d) 723 [40-1 ustc ¶9333].  112 F. (2d) 167 [40-1 ustc ¶9490].  Because of conflict with Commissioner v. Langwell Real Estate Corp., 47 F. (2d) 841 [2 ustc ¶693], we granted certiorari limited to the question whether, “in computing net gain or loss for income tax purposes, a taxpayer [can] offset the value of the lease canceled against the consideration received by him for the cancellation.”  311 U. S. --.

Petitioner apparently contends that the amount received for cancellation of the lease was capital rather than ordinary income and that it was therefore subject to §101, 111-113, and 117 (47 Stat. 169, 191, 195-202, 207), which govern capital gains and losses.  Further, he argues that even if that amount must be reported as ordinary gross income he sustained a loss which §23(c) authorizes him to deduct.  We cannot agree.

[Nature of Payment Received for Cancellation of Lease]

The amount received by petitioner for cancellation of the lease must be included in his gross income in its entirety.  Section 22(a), copied in the margin, 1 expressly defines gross income to include “gains, profits, and income derived from * * * rent, * * * or gains or profits and income from any source whatever.”  Plainly this definition reached the rent paid prior to cancellation just as it would have embraced subsequent payments if the lease had never been canceled.  It would have included a prepayment of the discounted value of unmatured rental payments whether received at the inception of the lease or at any time thereafter.  Similarly, it would have extended to the proceeds of a suit to recover damages had the Irving Trust Co. breached the lease instead of concluding a settlement.  Compare United States v. Safety Car Heating Co., 297 U. S. 88 [36-1 ustc ¶9042]; Burnet v. Sanford & Brook Co., 282 U. S. 359 [2 ustc ¶636].  That the amount petitioner received resulted from negotiations ending in cancellation of the lease rather than from a suit to enforce it cannot alter the fact that basically the payment was merely a substitute for the rent reserved in the lease.  So far as the application of §22(a) is concerned, it is immaterial that petitioner chose to accept an amount less than the strict present value of the unmatured rental payments rather than to engage in litigation, possibly uncertain and expensive.

The consideration received for cancellation of the lease was not a return of capital.  We assume that the lease was “property,” whatever that signifies abstractly.  Presumably the bond in Helvering v. Horst, 311 U. S. 112 [40-2 ustc ¶9787], and the lease in Helvering v. Bruun, 309 U. S. 461 [40-1 ustc ¶9337], were also “property,” but the interest coupon in Horst and the building in Bruun nevertheless were held to constitute items of gross income.  Simply because the lease was “property” the amount received for its cancellation was not a return of capital, quite apart from the fact that “property” and “capital” are not necessarily synonymous in the Revenue Act of 1932 or in common usage.  Where, as in this case, the disputed amount was essentially a substitute for rental payments which §22(a) expressly characterizes as gross income, it must be regarded as ordinary income, and it is immaterial that for some purposes the contract creating the right to such payments may be treated as “property” or “capital.”

For the same reasons, that amount was not a return of capital because petitioner acquired the lease as an incident of the realty devised to him by his father.  Theoretically, it might have been possible in such a case to value realty and lease separately and to label each a capital asset.  Compare Maass v. Higgins [41-1 ustc ¶10,032], No. 274, decided March 3, 1941; Appeal of Farmer, 1 B. T. A. 711 [CCH Dec. 265].  But that would not have converted into capital the amount petitioner received from the Trust Co. since §22(b)(3) 2 of the 1932 Act (47 Stat. 169, 178) would have required him to include in gross income the rent derived from the property, and that section, like §22(a), does not distinguish rental payments and a payment which is clearly a substitute for rental payments.

[Conclusions]

We conclude that petitioner must report as gross income the entire amount received for cancellation of the lease without regard to the claimed disparity between that amount and the difference between the present value of the unmatured rental payments and the fair rental value of the property for the unexpired period of the lease.  The cancellation of the lease involved nothing more than relinquishment of the right to future rental payments in return for a present substitute payment and possession of the leased premises.  Undoubtedly it diminished the amount of gross income petitioner expected to realize, but to that extent he was relieved of the duty to pay income tax.  Nothing in §23(e) 3 indicates that Congress intended to allow petitioner to reduce ordinary income actually received and reported by the amount of income he failed to realize.  See Warren Service Corp. v. Commissioner, supra; Josey v. Commissioner, 104 F. (2d) 453 [39-2 ustc ¶9548]; Tiscornia v. Commissioner, 95 F. (2d) 678 [38-1 ustc ¶9208]; Farrelly-Walsh Inc. v. Commissioner, 13 B. T. A. 923 [CCH Dec. 4444]; Goerke Co. v. Commissioner, 7 B. T. A. 860 [CCH Dec. 2648]; Merckens v. Commissioner, 7 B. T. A. 32 [CCH Dec. 2470].  Compare, United States v. Safety Car Heating Co., supra; Voliva v. Commissioner, 36 F. (2d) 212 [1 ustc ¶448]; Appeal of Denholm & McKay Co., 2 B. T. A. 444 [CCH Dec. 690].  We may assume that petitioner was injured in so far as the cancellation of the lease affected the value of the realty.  But that would become a deductible loss only when its extent had been fixed by a closed transaction.  Regulations No. 77, Art. 171, p. 46; United States v. White Dental Mfg. Co., 274 U. S. 398 [1 ustc ¶235].

The judgment of the Circuit Court of Appeals is affirmed.

 
(3)  The value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income).

(1)  if incurred in trade or business; or

(2)  if incurred in any transaction entered into for profit, though not connected with the trade or business; or

(3)  of property not connected with the trade or business, if the loss arises from fires, storms, shipwreck, or other casualty, or from theft.  No loss shall be allowed as a deduction under this paragraph if at the time of the filing of the return such loss has been claimed as a deduction for estate tax purposes in the estate tax return.