Hoopengarner v. Comm'r of Internal Revenue , Docket No. 14462-79.

• Court: United States Tax Court
• Writing for the Court: STERRETT
• Citation: 80 T.C. 538
• Parties: HERSCHEL H. HOOPENGARNER and ROBERTA S. HOOPENGARNER, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Docket Number: Docket No. 14462-79.
• Decision Date: 21 March 1983

80 T.C. 538

HERSCHEL H. HOOPENGARNER and ROBERTA S. HOOPENGARNER, PETITIONERS
v.
COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 14462-79.

United States Tax Court

Filed March 21, 1983.

In April of 1976, petitioner acquired a leasehold interest in a parcel of undeveloped land. The lease, which ran for 521;2 years at the time of acquisition, required petitioner to construct and operate an office building on the leased premises. During 1976, petitioner made rental payments pursuant to the lease. Construction of the building was completed in September of 1977. Held, the 1976 rental payments are not deductible pursuant to sec. 162, I.R.C. 1954, since petitioner was not carrying on a trade or business at the time they were made. Held, further, part of the rental payments are deductible under sec. 212(2) since they were ordinary and necessary expenses paid or incurred for the management, conservation, or maintenance of property held for the production of income. Held, further, the accrued rent attributable to the period prior to the time that petitioner acquired the leasehold is not currently deductible.

[80 T.C. 538]

Warren Sikora, for the petitioners.

Rosa Berman, for the respondent.

OPINION STERRETT , Judge:

By statutory notice dated July 6, 1979, respondent determined a deficiency of $8,379 in petitioners' Federal income tax for their 1976 taxable year. After concessions, the sole issue for decision is whether certain lease payments made by petitioners in 1976 are deductible under section 162(a), I.R.C. 1954, or alternatively, under section 212.

The facts have been fully stipulated pursuant to Rule 122, Tax Court Rules of Practice and Procedure. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.

Petitioners Herschel H. Hoopengarner and his wife, Roberta S. Hoopengarner, resided in San Clemente, Calif., at the time of filing the petition herein. They timely filed their 1976 joint Federal income tax return with the Internal Revenue Service Center, Fresno, Calif. Roberta Hoopengarner is a party to this proceeding solely by reason of having filed a joint return with Herschel H. Hoopengarner (hereinafter petitioner).

During the year in issue, petitioner was employed by Penn Mutual Life Insurance Co. In April of 1976, he acquired by

[80 T.C. 539]

assignment a leasehold interest in a parcel of undeveloped land in Irvine, Calif., from Troy Associates, Ltd., for $67,500. No part of this payment was deducted on petitioner's 1976 return. The lease originally was entered into by the Irvine Co., as lessor, and Troy Associates, Ltd., as lessee, for a period of 55 years, commencing November 1, 1973. Thus, petitioner's term was for approximately 52 1/2 years.

Under the terms of the lease, rent for the entire year was due in advance on November 1 of each year. On April 27, 1976, petitioner paid $9,270.56 into an escrow account for the rent attributable to the period from October 15, 1975, to October 31, 1976. Of this amount, $4,524.03 was attributable to the period from April 27, 1976, to October 31, 1976. On December 1, 1976, petitioner paid $8,974.10 to the Irvine Co. to cover the rental period from November 1, 1976, to October 31, 1977. The foregoing payments were ordinary and necessary expenses.

The lease provided that the lessee was to construct and operate an office building on the leased premises, both of which would ultimately revert to the lessor. Construction of the building began in February of 1977 and was completed by September of 1977. Petitioner, as lessor of the office building, entered into a lease agreement in December 1976 with his employer Penn Mutual Life Insurance Co. However, Penn Mutual did not move into the building until November of 1977. Petitioner received no rent in 1976. Another tenant, Red Jacket, took possession in September of 1977.

On a schedule entitled “Rental and Royalty Income” attached to his 1976 return, petitioner claimed a deduction from gross income for rental payments made to Irvine Co. in the amount of $10,767.¹ In his notice of deficiency, respondent denied this deduction on the ground that the lease payments were “pre-opening expenses.”

Petitioner contends that the lease payments made by him are deductible under section 162(a)(3), or, in the alternative, under section 212. Section 162(a) allows a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Such expenses can include rental payments. Sec. 162(a)(3).

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While we have already found as a fact that the rental payments were ordinary and necessary, we cannot find as a fact, in the circumstances here present, that the petitioner made those payments “for the purposes of the trade or business” as required by section 162(a)(3). The acquisition of the leasehold interest and the securing of a tenant during 1976 were not events of sufficient magnitude to put petitioner in the office building rental trade or business. Simply put, his rental business had not started to function in the year before us and he was, in fact, in the act during that year of incurring what has been termed “preopening expenses.” See Richmond Television Corp. v. United States, 345 F.2d 901 (4th Cir. 1965), vacated and remanded on other issues 382 U.S. 68 (1965); Bennett Paper Corp. v. Commissioner, 78 T.C. 458 (1982), affd. 699 F.2d 450 (8th Cir. 1983, 83-1 USTC par. 9208); Goodwin v. Commissioner, 75 T.C. 424, 433 (1980), affd. without published opinion 691 F.2d 490 (3d Cir. 1982). Accordingly, we must sustain respondent's determination that section 162 does not permit the deduction of the expenses under consideration.²

However, all is not lost for petitioner because the disqualifying fact, just discussed in terms of section 162, is irrelevant when we turn to a consideration of the applicability of section 212. There is no requirement in that latter section that the taxpayer be in a trade or business, and, indeed, the perceived need for the omission of such requirement is the raison d'etre for its enactment. United States v. Gilmore, 372 U.S. 39 (1963).

Section 212(2) allows a deduction all ordinary and necessary expenses paid or incurred for the management, conservation, or maintenance of property held for the production of income. Again, we note our finding that the rental payments were ordinary and necessary. Thus, the question remains whether such payments were incurred for the management, conservation,

[80 T.C. 541]

or maintenance of property held for the production of income.

The property that was held in this case was not the land or the building, it was the leasehold interest, upon which annual payments were due.³ This interest was acquired by petitioner with but a single objective in mind: to generate recurring income in the near future. No profound leap of legal logic is necessary for us to conclude that the lease was purchased and subsequently held for the production of income.

During 1976, petitioner received no income from his leasehold acquisition. However, this does not preclude deductibility. Section 1.212-1(b), Income Tax Regs., provides that “income” as used in section 212 includes income which the taxpayer “may realize in subsequent taxable years; and is not confined to recurring income but applies as well to gains from the disposition of property.” See H. Rept. 2333, 77th Cong., 1st Sess. (1942), 1942-2 C.B. 372, 430. Thus, expenses incurred with respect to property held for the production of future recurring income, as well as for future appreciation, may be deductible under section 212(2). Horrmann v. Commissioner, 17 T.C. 903, 908 (1951); Robinson v. Commissioner, 2 T.C. 305, 308-309 (1943). We find that petitioner held the lease for the production of future income for purposes of section 212(2).

We are conscious that there is a requirement under section 212 that the taxpayer have a proprietary or possessory interest in the income-producing property. See Walet v. Commissioner, 31 T.C. 461, 472 n. 1 (1958), affd. 272 F.2d 694 (5th Cir. 1959); Frank v. Commissioner, 20 T.C. 511, 514 (1953); Beck v. Commissioner, 15 T.C. 642, 670 (1950), affd. 194 F.2d 537 (2d Cir. 1952); Weinstein v. United States, 190 Ct. Cl. 437, 420 F.2d 700, 702 (1970). We have found that petitioner met this requirement by virtue of his ownership of the lease. We are unable to find authority for an additional requirement that such property be currently capable of producing income. This is clearly not the rule in the case of property that is held for investment. However, section 1.212-1(b), Income Tax Regs., is not limited to this latter situation but embraces both the holding of property for future recurring income and the

[80 T.C. 542]

holding of property for investment within its confines. To hold that current deductions are not allowable with respect to property held for the production of income would require us to ignore the plain language of this regulation.⁴ Accordingly, we find that the conditions for the deductibility of the expenses in dispute have been met under section 212(2).

We are also cognizant of the fact that an expenditure that is otherwise deductible under section 212 cannot be deducted if it is capital in nature. Sec. 1.212-1(n), Income Tax Regs.; sec. 1.263(a)-1, Income Tax Regs. An expenditure resulting in the acquisition of an asset or benefit having an economically useful life of more than 1 year is normally considered to be a capital expenditure. Sec. 1.263(a)-2(a), Income Tax Regs.; Colorado Springs National Bank v. United States, 505 F.2d 1185, 1191-1192 (10th Cir. 1974); W. H. Tompkins Co. v. Commissioner, 47 B.T.A. 292, 295 (1942). Here, the rent paid during 1976 did not produce any equity that survived a year beyond the time that the payment was made. The possessory right received by petitioner in return for the rent attributable to 1976 was, of course, wholly consumed during that year and did not...