## Facts

- A taxpayer (through a subsidiary) owned improved real property used as a motion picture theater and leased it in 1930 for a ten-year term beginning upon completion of specified improvements.
- The lease required the lessor, at its own cost, to make certain alterations and improvements under agreed plans.
- The lease required the lessee to install theater equipment and fixtures necessary to operate a modern theater; those installations would become the lessor’s property at lease expiration or earlier termination.
- Total improvement costs were $114,468.77: the lessor paid $73,794.47 and the lessee paid $40,674.30.
- For federal income tax purposes, the Commissioner treated lessee-paid improvements as income to the lessor based on an “estimated depreciated value” of those improvements at the end of the ten-year term.
- The Commissioner increased the lessor’s income for the first taxable year by including one-tenth of the projected end-of-term depreciated value of the lessee-funded improvements under § 22(a) of the Revenue Act of 1932.
- The Court of Claims sustained the deficiency assessment and dismissed the taxpayer’s refund suit, relying on findings that described the lease terms, improvement costs, and the Commissioner’s estimates, but did not identify what the Commissioner’s figures represented as “value.”

## Issues

1. Whether, under § 22(a) of the Revenue Act of 1932, the lessor realized taxable income in the first year of a lease based on one-tenth of the estimated depreciated end-of-term value of improvements paid for by the lessee that would become the lessor’s property at lease termination.
2. Whether the record supported treating the lessee’s improvement expenditures as “rent” or otherwise as realized income to the lessor during the first year of the lease.

## Decision

- The Supreme Court reversed the Court of Claims.
- The Court held that, on this record and under this lease, one-tenth of the estimated depreciated end-of-term value of lessee-funded improvements was not taxable income to the lessor in the first year.
- The Court found no factual basis to treat the lessee’s improvement costs as rent or as realized gain to the lessor in the tax year assessed.
- The Court rejected the Commissioner’s valuation approach as insufficiently defined and too speculative to establish taxable income in the first year.

## Legal Principles

- Special findings of fact by the Court of Claims control and are not altered by statements or reasoning in that court’s opinion.
- Rent is a fixed sum, or property amounting to a fixed sum; it does not include lessee payments for improvements that are uncertain in amount and time.
- Lessee-made improvements, even if required by a lease and even if they ultimately become the lessor’s property, are not treated as rent unless the lease plainly discloses that intent.
- A deficiency based on prorating a speculative end-of-term “estimated depreciated value” of improvements into current income lacks a defined valuation basis and does not establish the time of realization of taxable gain.

## Conclusion

The Court held that the lessor did not realize taxable income in the first lease year merely because the lessee paid for improvements that would later vest in the lessor, where the lease did not clearly treat such expenditures as rent and the asserted “value” was undefined and speculative.


M.E. Blatt Co. v. United States, 305 U.S. 267 (1938)