## Facts

- Two husband-and-wife couples were partners in a California farming partnership using the cash method of accounting.
- The partnership entered into a 20-year farmland lease covering December 1, 1973 to November 30, 1993.
- The lease required annual rent of $27,000 for each lease year running December 1 to November 30, payable on December 20.
- On December 20, 1973, the partnership paid $27,000 for the lease year December 1, 1973 to November 30, 1974 and deducted the full amount on its 1973 return.
- The Commissioner disallowed $24,934 of the deduction as attributable to January 1 through November 30, 1974, requiring proration.
- The Tax Court sustained the deficiency, limiting the 1973 deduction to one-twelfth of the rent; the taxpayers appealed.

## Issues

1. Whether a cash-basis taxpayer may deduct in full, under I.R.C. § 162, an annual rent payment made in the taxable year when the rental benefit extends eleven months into the following taxable year.
2. Whether such a payment must instead be treated as a capital expenditure under I.R.C. § 263 and deducted ratably over the period benefited.

## Decision

- The Ninth Circuit reversed the Tax Court.
- The court held the entire $27,000 rent payment was deductible in 1973, the year paid.
- The court adopted a “one-year rule” for advance payments: capitalization is required only when the payment creates an asset or like advantage with a useful life exceeding one year.
- Because the payment secured the right to use land only eleven months beyond the end of 1973, it was not a capital expenditure requiring proration.

## Legal Principles

- Cash-basis taxpayers generally deduct ordinary and necessary business expenses when paid under I.R.C. § 162, including rent.
- Under I.R.C. § 263, an expenditure must be capitalized when it creates or enhances an asset or secures a comparable advantage extending substantially beyond the taxable year.
- Under the one-year rule, an advance payment is treated as a capital expenditure only if it creates a benefit with a useful life in excess of one year; otherwise it is currently deductible.
- Prior authority requiring proration of rent was not controlling where the taxpayer was on the cash method and the prepayment did not secure benefits extending beyond one year.

## Conclusion

The Ninth Circuit held that a cash-basis farming partnership could deduct a prepaid annual rent payment in full in the year of payment because the benefit extended less than one year beyond the close of that taxable year, making capitalization and proration unnecessary.


Zaninovich v. Commissioner, 616 F.2d 429 (9th Cir. 1980)