Friendly, Chief Judge, Mansfield and Timbers, Circuit Judges.
The issue is whether a tenant's payment to its landlord of $125,000 in satisfaction of the tenant's obligation to restore leased premises to their pre-lease condition is entitled, in whole or in part, to long-term capital gains treatment under § 1231 of the Internal Revenue Code of 1954.*fn1 The Commissioner determined the payment, which was received by petitioner, Sirbo Holdings, Inc. ("Sirbo") from its tenant, to be taxable as ordinary income, and accordingly found a deficiency in petitioner's income tax for the taxable year ending June 30, 1964, which was upheld by the Tax Court. Petitioner then sought review pursuant to 26 U. S. C. § 7482.
The essential facts are undisputed: At all relevant times Sirbo was engaged in the trade or business of renting real estate. In 1944 it purchased premises at 254-6 West 54th Street, New York, N. Y., which consisted of a building with offices and a theatre called The New Yorker Theatre, subject to an existing lease of the theatre to the Columbia Broadcasting System, Inc. ("CBS"), which used it for radio broadcasting purposes. In July, 1944, Sirbo notified CBS that it had purchased the entire building and would assume all the terms and obligations of the theatre lease. In anticipation of the expiration of the existing lease term in 1948, Sirbo in November, 1947, negotiated a new lease of the theatre to CBS. Thereafter Sirbo continuously rented the theatre to CBS under several successive leases until at least December 31, 1968. Each lease gave CBS the "right to use the premises as a theatre, and for radio broadcasting and television purposes of its business." Until 1964 each lease provided that at the expiration of the lease term CBS "shall restore the premises substantially to the condition in which they existed on November 14, 1947, reasonable wear and tear and damage by the elements excepted, and . . . shall fully indemnify for every and all costs and expenses of whatsoever name or nature that may be required for the purposes of reinstating the premises to said condition."*fn2
Prior to December 31, 1963, according to findings of the Tax Court,*fn3 CBS, becoming concerned over rising construction costs which made it difficult to predict its ultimate cost of fulfilling its obligations to restore premises leased by it, determined as a matter of corporate policy to eliminate or update restoration clauses from leases it held for theatres in New York and so advised Sirbo. The parties negotiated the terms of the 1964 lease, including an "updated" restoration clause which limited CBS' terminal obligation to restore the theatre to removal of alterations or additions made after January 1, 1964, and repair of any damage caused thereby. Thereupon they entered into separate negotiations for settlement of CBS' obligation under the former lease to restore the theatre to its 1947 condition. Each party caused appraisals of the cost of restoration to be made. Estimates of $70,000 and $200,000 were made by representatives of CBS and Sirbo, respectively, and the sum of $125,000 was agreed upon as a compromise figure. The sizable cost estimates reflected the changes CBS had made after 1947 to adapt the former legitimate theatre for use as a television studio. As found by the Tax Court, these "changes included the removal of approximately 300 to 400 theatre seats, . . . all carpeting, chandeliers, and stage curtains; the extension of the stage 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." The restoration clauses contained in the leases covering the period from 1953-1964 implicitly recognized the alterations made by CBS by providing for the eventual replacement of the removed seats, the removal of the control booths, and the removal of the extension of the stage apron.*fn4
In a settlement signed on January 31, 1964 but backdated to December 31, 1963, CBS paid Sirbo the $125,000 sum for the release of any claims, injury or damage Sirbo might have as a result of the provisions of the restoration clause contained in the lease dated July 15, 1958. The release stated that Sirbo had claimed at the expiration of the lease term that CBS had partially destroyed the premises and Sirbo therefore requested indemnification for the cost of reinstating the premises to their condition in 1947; CBS acknowledged its obligation so to indemnify Sirbo.*fn5 No portion of the payment was used to restore the structure to its former use as a legitimate theatre, however, since CBS continued in occupancy. Indeed, the Tax Court found that, after entering into the 1964 lease, CBS made further modifications in the theatre to adapt it for use as a color television studio.
On its corporate tax return for its taxable year ending June 30, 1964, Sirbo reported as long-term capital gain resulting from "involuntary conversion as a result of partial destruction of property used in trade or business," the amount by which the $125,000 received from CBS exceeded Sirbo's adjusted basis in the entire property, $93,333.51 (including the leased theatre as a part), i.e., $31,666.49.*fn6 The Commissioner determined that the $125,000 payment from CBS was taxable as ordinary income rather than as long-term capital gain and accordingly noted a deficiency in Sirbo's tax liability for the taxable year in question. Sirbo's ordinary income was increased by that amount and capital gain was decreased by $31,666.49, resulting in a net deficiency in income tax of $53,573.30. Sirbo was allowed additional depreciation for the year in issue in the amount of $4,444.44, however, which had not been taken because the taxpayer had claimed an involuntary conversion of the property.
The government does not dispute that the property to which the release of the obligation to restore related was "property used in trade or business" within the meaning of § 1231. It denies, however, that the $125,000 payment constituted either gain on its compulsory or involuntary conversion, or from its sale or exchange. Insofar as petitioner rested its claim to capital gains treatment on the involuntary conversion clause of § 1231, we agree with the Tax Court that it failed. The New Yorker Theatre was voluntarily leased to CBS with the understanding that it might be converted for use as a television studio. When CBS sought to be released from its obligations to restore the theatre to its 1947 condition and to indemnify Sirbo for the cost of doing so, Sirbo voluntarily agreed to accept a cash payment rather than enforce these obligations. This was understandable from Sirbo's vantage point, since CBS wanted to continue to occupy the converted theatre and use it as a television studio at a substantial rental. But the decision to accept the $125,000 rather than hold CBS to its obligation to restore was not "compulsory or involuntary." It is not claimed that it resulted from duress or some external force over which Sirbo had no control, such as occurs when property is destroyed by natural causes, is stolen or seized, or is transferred under power or threat of eminent domain.
The cases relied upon by petitioner on this point are distinguishable. In Guy L. Waggoner, 15 T. C. 496 (1950), the taxpayers leased property to the United States under threat of condemnation. The lease gave the government a qualified right to alter the premises, but provided for restoration at the taxpayers' request. When the taxpayers subsequently requested restoration, the United States decided to pay the cost of repair for damage it had caused while in possession rather than itself restore the premises. Thus, as the Tax Court held, the property altered or destroyed was involuntarily converted into money within the meaning of the predecessor to § 1231, and the taxpayers' acceptance of compensation for the property in lieu of actual restoration "did not alter the character of the lease agreement." 15 T. C. at 503. See also C. I. R. v. Gillette Motor Transport, Inc., 364 U.S. 130, 135-36, 4 L. Ed. 2d 1617, 80 S. Ct. 1497 (1960). Sirbo, however, was neither forced to lease the premises to CBS nor compelled to accept the payment instead of requiring renovation. The settlement it reached with its tenant did not arise from an occupancy imposed upon it pursuant to law, but from an occupancy it sought as part of its normal business operations. Unlike the taxpayers in Guy L. Waggoner, supra, it could choose whether it would lease its premises, the identity of the person to whom it might lease them, and the conditions of occupancy.
Similarly, in Walter A. Henshaw, 23 T. C. 176 (1954), and United States v. Pate, 254 F.2d 480 (10 Cir. 1958), the property of the taxpayer used in the trade or business (oil in place in Henshaw, a building in Pate) was physically damaged under circumstances beyond the taxpayer's control, namely through the negligence of others. In both cases the taxpayer recovered monetary damages as a result of litigation, and the sums were taxed as long-term capital gains from the compulsory or involuntary conversion of the damaged property. Here the structural modifications needed to convert the theatre to a television studio were contemplated as a distinct possibility under the lease agreement and were essentially made with Sirbo's consent, subject to the obligation to restore.
Relying on Grant Oil Tool Co. v. United States, 180 Ct. Cl. 620, 381 F.2d 389 (1967), Sirbo urges that prior contemplation of alterations in the leased structure does not deprive the lessee's conversion of its involuntary character, even when the lease agreement provides for restoration or compensation to the lessor. We disagree. Grant Oil Tool Co. differs in a crucial respect. There the taxpayer could not have had restoration of the destroyed property, whereas Sirbo could. In that case a manufacturer leased oil well drilling tools to drillers for use in their business, subject to loss in the drill hole, misplacement, or damage beyond repair due to the driller's negligence in use. The decision to abandon or try to retrieve the tools lost in the drill hole was found to be exclusively that of the driller-lessee, who was obligated in either event to reimburse the lessor at the sale price of new equipment. These payments were held to be entitled to capital gains treatment pursuant to § 1231(a) as a " compulsory or involuntary conversion," for the reason that the "complete and unwanted destruction of [the] taxpayer's tool bodies" which brought it "within the definition of 'involuntary conversion' as set forth in § 1231(a)," id. at 395-96, was beyond the taxpayer's control once its property was leased. As far as the lessor was concerned the property destroyed in the lessee's operations was irretrievably lost without opportunity of restoration or recovery. See also Philadelphia Quartz Co. v. United States, 179 Ct. Cl. 191, 374 F.2d 512 (1967). In contrast, not only did Sirbo have the power to fashion the lease agreement to prevent CBS from making the extensive alterations which were the subject of the payment, but it had the right to pursue the possible avenue of requiring CBS to restore the property to its former condition and voluntarily chose not to do so.
While involuntary conversion was the ground most strongly argued by Sirbo, it contended in the alternative that the transaction constituted the sale or exchange of property used in the trade or business. Judge Quealy rejected that contention, largely on the basis of extensive dicta in this court's decision in Billy Rose's Diamond Horseshoe, Inc. v. United States, 448 F.2d 549, 551-52 (2 Cir.), aff'g 322 F. Supp. 76 (S. D. N. Y. 1971). In their holding that a landlord receiving a series of notes in satisfaction of an obligation to restore was not entitled to the benefits of the installment sales provision of I. R. C. § 453(a), the court noted that the landlord's relinquishment of its rights to have the property restored caused these rights to have come "to an end and vanished" and thus could not constitute a "sale or other disposition of real property" under § 453(b)(1)(A). At least as applied to the question of capital gains treatment under § 1231, this seems to be taking somewhat of a keyhole view. Sirbo's claim for capital gains treatment does not rest entirely on the release of the covenant to restore, which clearly was not "property used in the trade or business," but it is based at least in part on CBS' payment for removal or destruction of "property" such as the theatre seats, carpeting, chandeliers, stage curtains and various structural features of the theatre. Realistically CBS was paying Sirbo for what it had done to this property over the years. Under our decision in C. I. R. v. Ferrer, 304 F.2d 125, 131 (2 Cir. 1962), see Eustice, Contract Rights, Capital Gain and Assessment of Income -- the Ferrer Case, 20 Tax L. Rev. 1, 7-34 (1964), it would not be fatal that this property did not "pass" to CBS. If the lease, in lieu of an obligation to restore, had obligated CBS from the outset to pay for the property to be removed or damaged by it, there could be little question but that the payment would be viewed as a sale or exchange of property used in the trade or business, see Hamilton & Main Inc., 25 T. C. 878 (1956); Washington Fireproof Building Co., 31 B. T. A. 824 (1934), since the government does not contend that such a payment would represent "collapsed income." See e.g., Hort v. C. I. R., 313 U.S. 28, 85 L. Ed. 1168, 61 S. Ct. 757 (1941); Holt v. C. I. R., 303 F.2d 687 (9 Cir. 1962); W. Lawrence Oliver, 1965 T.C. Memo 83, 24 T. C. M. 438 (1965). From a practical standpoint it is hard to see why the transaction here at issue should be treated differently. Classification of CBS's payment as ordinary income merely because of the parties' failure to cast the transaction at least partly in the form of a sale of the removed or damaged property would appear to exalt form over substance.
What makes a hard case even harder is the following: Two months after the decision here, Judge Raum of the Tax Court accorded capital gains treatment to a payment almost identical in nature. Boston Fish Market Corp., 57 T. C. 884 (1972). Sirbo immediately moved for reconsideration, but its motion was denied without a word of explanation. The government does not assert any pertinent distinction between the facts of the two cases; rather, it seeks to explain the disparate results on the ground that the taxpayer's contention in Boston Fish Market was that the lessee's payment was not income at all in the light of the provision of I. R. C. § 109 excluding from gross income the value of a lessee's improvements to which the lessor falls heir on the termination of a lease and, once that point was decided against the taxpayer, the Commissioner abandoned his challenge to the propriety of capital gains treatment, see 57 T. C. at 887 n. 2. The attempted explanation does not explain, for two reasons.
The first is that the Commissioner has a duty of consistency toward similarly situated taxpayers; he cannot properly concede capital gains treatment in one case and, without adequate explanation, dispute it in another having seemingly identical facts which is pending at the same time. Compare Moog Industries, Inc. v. FTC, 355 U.S. 411, 414, 2 L. Ed. 2d 370, 78 S. Ct. 377 (1958), with FTC v. Universal-Rundle Corp., 387 U.S. 244, 250-52, 18 L. Ed. 2d 749, 87 S. Ct. 1622 (1967); K. C. Davis, Discretionary Justice: A Preliminary Inquiry, Ch. VII (1969); L. Jaffe, Judicial Control of Administrative Action 700 (1965). That the Commissioner's seeming inconsistency may have arisen from the right hand's ignorance of the posture of the left is little ...