Sirbo Holdings, Inc. v. Comm'r of Internal Revenue

• Decision Date: 27 January 1972
• Docket Number: Docket No. 515-69.
• Citation: 57 T.C. 530
• Parties: SIRBO HOLDINGS, INC., PETITIONER V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

57 T.C. 530

SIRBO HOLDINGS, INC., PETITIONER V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 515-69.

United States Tax Court

Filed January 27, 1972.

Lester H. Salter, for the petitioner.

Marvin A. Batt and Marion L. Westen, for the respondent.

A lessee of property paid the lessor $125,000 for the modification of a lease upon the execution of which the lessee would continue to occupy the premises. Said modification called for the elimination of the obligation of the lessee to restore the premises to a prior condition. Held, the petitioner is not entitled to capital gain treatment for the payment by the lessee. QUEALY, Judge:

The respondent determined a deficiency in the Federal income tax of the petitioner in the amount of $53,573.30 for the taxable year ended June 30, 1964.

The issue presented for decision is whether the petitioner is entitled to capital gain treatment for a payment of $125,000 from its tenant or whether this amount is taxable to the petitioner as ordinary income.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are herein incorporated by this reference.

The petitioner, Sirbo Holdings, Inc. (hereinafter referred to as the petitioner), is a New York corporation with its principal office located in New York, N.Y. Petitioner filed a timely U.S. Corporation Income Tax Return for its taxable year ended June 30, 1964, with the district director of internal revenue for the district of Manhattan, New York.

At all times pertinent hereto, the petitioner maintained its books and records and filed its Federal income tax returns on the accrual method of accounting. Petitioner was incorporated on July 8, 1944. At all times pertinent hereto, the petitioner was engaged in the business or trade of renting real estate.

On or about July 8, 1944, the petitioner purchased commercial property located at 254 West 54th Street, 258 West 54th Street, and 229-237 West 53d Street, New York, N.Y., at a cost of $400,000. This property consisted of land and a building; the building is comprised of offices and a theater known as the New Yorker Theatre. The building was used in the petitioner's trade or business of renting real estate, and petitioner appointed Byron-Boyce Co., Inc., as agent with respect to the premises.

The New Yorker Theatre (hereinafter referred to as the theater) was built in the 1920's and was physically constructed to function as a legitimate theater. When the petitioner purchased the building in which the theater was located, it acquired the theater subject to a lease granted to the Columbia Broadcasting System, Inc. (hereinafter referred to as CBS), by the prior owner of the theater, the Bowery Savings Bank. The lease term had commenced on September 7, 1943, and was to terminate on September 12, 1948.

Under the terms of the 1943 lease, CBS, as the tenant, had the right to use the theater over the term of the lease ‘as a theatre, and for radio broadcasting and television purposes, and kindred purposes, and for the general purposes of its business.’ It was expressly understood that extensive structural as well as nonstructural changes would be made in the theater. With respect to such changes, the lease provided:

At the expiration or other termination of the term hereby granted, the TENANT shall and will leave the said premises and the theatre whole and in good order and condition and will remove therefrom every and all its equipment, goods and effects, and those of all persons claiming under it, and will deliver up the demised premises in as good order and conditions as reasonable wear and tear and damage by the elements will permit, * * * provided, however, that the TENANT shall restore the premises substantially to the condition in which they exist at the time of the making of this lease, reasonable wear and tear and damage by the elements excepted, all in accordance with the requirements of the LANDLORD, and the TENANT shall fully indemnify the LANDLORD for every and all costs and expenses of whatsoever name or nature that may be required for the purpose of reinstating the premises to said condition in which they now exist.

On November 14, 1947, the petitioner and CBS executed a new lease for the theater to commence September 13, 1948, for a period of 5 years terminating on September 12, 1953. The annual rental under the lease was $50,000 a year. Under the terms of this lease agreement, the tenant continued to have the right to use the theater as a theater and for radio-broadcasting and television purposes. Upon the expiration of this lease, the tenant was to restore the premises substantially to the condition in which they existed at the time of the making of the lease, reasonable wear and tear excepted, and in accordance with the requirements of the landlord. The tenant was also to indemnify the landlord for all costs and expenses which were required for reinstating the premises to the condition which existed prior to the tenant's occupancy.

Some time after November 14, 1947, CBS began to make changes in the physical arrangement of the theater in order to adapt the theater for use by CBS as a television studio. These changes included the removal of approximately 300 to 400 theater seats, the elimination of all carpeting, chandeliers, and stage curtains; the extension of the stage area into what was formerly the audience area, a change in the floor level and the elimination of the ‘loop’ in the former seating arrangement, the construction of walls and partitions and appropriate structural changes to accommodate control rooms, the alteration of bathrooms and the heating system, and the installation of thousands of feet of electrical wiring.

On August 14, 1953, the petitioner and CBS executed a new lease for a term of 5 years and 18 days commencing September 13, 1953. Pursuant to this lease, the tenant, upon the expiration of the lease term, was required to remove all of its equipment, goods and effects, and all scenery, stage hangings, properties, decorations and equipment, including radio and audio equipment installed and paid for by the t nant. The tenant was also required to restore the premises substantially to the condition in which they existed at the making of the lease, reasonable wear and tear and damage by the elements excepted. In addition, the tenant was to fully indemnify the landlord for all costs and expenses which were required for reinstating the premises to their prior condition. Finally, the tenant agreed to restore any and all seats which it had removed, to remove the control booths which it had installed, and to remove the extension of the stage apron which it had constructed. On July 17, 1958, the petitioner and CBS agreed to extend the term of this 1953 lease to December 31, 1958, upon the same terms and conditions.

On July 15, 1958, the petitioner and CBS entered into a new lease for the theater to commence January 1, 1959, for a period of 3 years. The termination or expiration clause of the lease was similar to the termination clause in the prior lease. The tenant was required to remove all of its equipment and to restore the premises to the condition in which they existed on November 14, 1947. The tenant was also required to fully indemnify the landlord for any expense required to reinstate the premises to the condition in which they existed on November 14, 1947. Furthermore, the tenant agreed to restore any and all seats which it had removed, to remove the control booths which it installed, and to remove the stage apron extension which it had constructed.

In a letter dated December 20, 1960, CBS notified the petitioner that it was exercising its option to extend the 1959 lease for 2 years. The period of the extension was to commence on January 1, 1962, and terminate December 31, 1963. The petitioner agreed to the extension on December 24, 1960.

Prior to December 31, 1963, CBS determined as a matter of corporate policy to eliminate restoration clauses from leases which it held on theaters in New York. In turn, CBS advised the petitioner that it wished to eliminate the restoration clause in the lease of the theater.

Before undertaking negotiations with respect to the restoration clause, the petitioner and CBS undertook to negotiate a new lease for the continued occupancy of the theater by CBS for the period from January 1, 1964, to December 31, 1968. As a result of these negotiations, CBS sent to the petitioner a letter, under date of December 24, 1963, to serve as a memorandum of understanding with respect to the provisions of a new lease to be entered into between the petitioner and CBS and to commence on January 1, 1964. Under the terms set forth therein, there was to be no obligation on the part of the tenant to restore the premises on the termination of the new lease, except as to conditions as they existed on January 1, 1964, i.e., the time of the commencement of the lease.

After the basic provisions of the new lease had been agreed upon by the petitioner and CBS in December 1963, the parties entered into negotiations with respect to the amount to be paid by CBS for ‘up-dating’ the restoration clause in the 1963 lease. As the result of these negotiations, the parties agreed that CBS would pay the petitioner $125,000. In negotiating the $125,000 amount, CBS considered the payment as part of the cost of occupying the theater. At no time during the period of negotiation and agreement did the parties intend or contemplate that the premises would be restored to their condition of November 14, 1947.

Under date of December 23, 1963, CBS sent to the petitioner a letter which referred to enclosed releases from the petitioner to CBS and from CBS to the petitioner which purported to release the parties from any obligations arising under the lease ending December 31, 1963. Both of the releases were to be held in escrow pending the execution of a new lease and a payment by CBS to ...