Hort v. Commissioner
61 S. Ct. 757, 1941 U.S. LEXIS 1283, 313 U.S. 28 (1941)
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Rule of Law:
A payment received by a lessor in consideration for the cancellation of a lease constitutes a substitute for future rental payments and is therefore taxable as ordinary gross income, not as a return of capital.
Facts:
- In 1928, Hort inherited an office building from his father.
- At the time of inheritance, the property was subject to a long-term lease with the Irving Trust Co., which had been executed by Hort's father.
- The lease was for a fifteen-year term at an annual rental of $25,000.
- In 1933, Irving Trust Co. determined it was unprofitable to continue occupying the space.
- Hort and Irving Trust Co. negotiated an agreement to cancel the remainder of the lease.
- In consideration for the cancellation, Irving Trust Co. paid Hort a lump sum of $140,000.
Procedural Posture:
- Hort filed his 1933 income tax return, did not include the $140,000 payment as gross income, and instead reported a loss on the transaction.
- The Commissioner of Internal Revenue included the entire $140,000 in Hort's gross income, disallowed the loss, and assessed a tax deficiency.
- Hort challenged the deficiency in the Board of Tax Appeals (the trial court for tax cases), which affirmed the Commissioner's determination.
- Hort, as appellant, appealed to the United States Circuit Court of Appeals, which affirmed the Board's decision.
- Hort, as petitioner, was granted a writ of certiorari by the United States Supreme Court.
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Issue:
Does a lump-sum payment received by a landlord from a tenant for the cancellation of a lease agreement constitute ordinary income for tax purposes?
Opinions:
Majority - Mr. Justice Murphy
Yes, a lump-sum payment for the cancellation of a lease is ordinary income. The payment is merely a substitute for the rent reserved in the lease. Section 22(a) of the Revenue Act of 1932 expressly defines gross income to include rent, and a payment that is a substitute for rent falls within this definition. The fact that the lease itself may be considered 'property' does not convert the payment into a return of capital; it is a payment for the relinquishment of the right to receive future rental payments, which would have been ordinary income. Therefore, the entire $140,000 must be included in gross income and cannot be offset by a claimed loss representing the difference between the payment and the present value of the unmatured rental payments.
Analysis:
This case establishes the foundational 'substitute for ordinary income' doctrine in tax law. It prevents taxpayers from converting what would otherwise be ordinary income into capital gains, which are often taxed at a lower rate, by altering the form of the payment. The Court's reasoning emphasizes substance over form, focusing on the nature of the income that the payment replaces. This principle has been broadly applied to other contexts, such as payments for the cancellation of employment or service contracts, ensuring that lump-sum settlements for rights to future ordinary income are taxed as ordinary income.
