Frank Lyon Co

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FRANK LYON CO. v. UNITED STATES

SUPREME COURT OF THE UNITED STATES 435 U.S. 561 November 2, 1977, Argued April 18, 1978, Decided

PRIOR HISTORY: which the building was completed and the bank took CERTIORARI TO THE possession, petitioner ac- UNITED STATES COURT crued rent from the bank and OF APPEALS FOR THE claimed as deductions depre- EIGHTH CIRCUIT. ciation on the building, interest on its construction loan DISPOSITION: and mortgage, and other ex- 536 F.2d 746, reversed. penses related to the sale- and-leaseback transaction. LexisNexis(R) Headnotes The Commissioner of Internal Revenue disallowed the deductions on the ground that SYLLABUS: petitioner was not the owner of the building for tax purpos- A state bank, which was es but that the sale-and- a member of the Federal Re- leaseback arrangement was serve System, upon realizing a financing transaction in that it was not feasible, be- which petitioner loaned the cause of various state and bank $ 500,000 and acted as federal regulations, for it to fi- a conduit for the transmission nance by conventional mort- of principal and interest to gage and other financing a petitioner's mortgagee. This building under construction resulted in a deficiency in pe- for its headquarters and prin- titioner's income tax, which it cipal banking facility, entered paid. After its claim for a re- into sale-and-leaseback fund was denied, it brought agreements by which peti- suit in the District Court to re- tioner took title to the building cover the amount so paid. and leased it back to the That court held that the bank for long-term use, peti- claimed deductions were al- tioner obtaining both a con- lowable, but the Court of Ap- struction loan and permanent peals reversed, agreeing with mortgage financing. The the Commissioner. Held: Pe- bank is obligated to pay rent titioner is entitled to the equal to the principal and in- claimed deductions. Pp. terest payments on petition- 572-584. er's mortgage and has an option to repurchase the build- (a) Although the rent ing at various times at prices agreed to be paid by the equal to the then unpaid bal- bank equaled the amounts ance of petitioner's mortgage due from the petitioner to its and initial $ 500,000 invest- mortgagee, the sale-and- ment. On its federal income leaseback transaction is not tax return for the year in a simple sham by which peti-

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tioner was but a conduit used him on the briefs was J. Gas- to forward the mortgage pay- ton Williamson. ments made under the guise Stuart A. Smith argued of rent paid by the bank to the cause for the United petitioner, on to the mort- States. With him on the gagee, but the construction briefs were Solicitor General loan and mortgage note obli- McCree, Assistant Attorney gations on which petitioner General Ferguson, and John paid interest are its obliga- A. Dudeck, Jr. * tions alone, and, accordingly, it is entitled to claim deductions therefor under § 163 (a) of the Internal Revenue * George G. Gal- Code of 1954. Helvering v. lantz filed a brief for Lazarus & Co., 308 U.S. 252, the National Realty distinguished. Pp. 572-581. Committee as amicus curiae urging reversal. (b) While it is clear that none of the parties to the JUDGES: sale-and-leaseback agreements is the owner of the BLACKMUN, J., deliv- building in any simple sense, ered the opinion of the Court, it is equally clear that peti- in which BURGER, C. J., and tioner is the one whose capi- BRENNAN, STEWART, tal was invested in the build- MARSHALL, POWELL, and ing and is therefore the party REHNQUIST, JJ., joined. entitled to claim depreciation WHITE, J., filed a dissenting for the consumption of that statement, post, p. 584. capital under § 167 of the STEVENS, J., filed a dissent- Code. P. 581. ing opinion, post, p. 584. (c) Where, as here, there OPINIONBY: is a genuine multiple-party transaction with economic BLACKMUN substance that is compelled or encouraged by business OPINION: or regulatory realities, that is [*562] [***554] imbued with tax-independent [**1293] MR. JUSTICE considerations, and that is BLACKMUN delivered the not shaped solely by tax- opinion of the Court. avoidance features to which meaningless labels are at- [***LEdHR1A] [1A]This case tached, the Government concerns the federal income should honor the allocation of tax consequences of a sale- rights and duties effectuated and-leaseback in which peti- by the parties; so long as the tioner Frank Lyon Company lessor retains significant and (Lyon) took title to a building genuine attributes of the tra- under construction by ditional lessor status, the Worthen Bank & Trust Com- form of the transaction adopt- pany (Worthen) of Little ed by the parties governs for Rock, Ark., and simultane- tax purposes. Pp. 581-584. ously leased the building back to Worthen for longterm COUNSEL: use as its headquarters and Erwin N. Griswold argued principal banking facility. the cause for petitioner. With [*563] I

The underlying pertinent mortgage loan on the new facts are undisputed. They premises. Worthen's plan, are established by stipula- however, had to be aban- tions, App. 9, 14, the trial tes- doned for two significant rea- timony, and the documentary sons: evidence, and are reflected in 1. As a bank chartered the District Court's findings. under Arkansas law, Worthen A legally could not pay more interest on any debentures it Lyon is a closely held Ar- might issue than that then kansas corporation engaged specified by Arkansas law. in the distribution of home But the proposed obligations furnishings, primarily would not be marketable at Whirlpool and RCA electrical that rate. products. Worthen in 1965 was an Arkansas-chartered [*564] 2. Applicable bank and a member of the statutes or regulations of the Federal Reserve System. Arkansas State Bank Depart- Frank Lyon was Lyon's ma- ment and the Federal Re- jority shareholder and board serve System required chairman; he also served on Worthen, as a state bank Worthen's board. Worthen at subject to their supervision, that time began to plan the to obtain prior permission for construction of a multistory the investment in banking bank and office building to re- premises of any amount (in- place its existing facility in Lit- cluding that placed in a real tle Rock. About the same estate subsidiary) in excess time Worthen's competitor, of the bank's capital stock or Union National Bank of Little of 40% of [***555] its capital Rock, also began to plan a stock and surplus. n1 See new bank and office building. Ark. Stat. Ann. § 67-547.1 Adjacent sites on Capitol Av- (Supp. 1977); [**1294] 12 enue, separated only by U. S. C. § 371d (1976 ed.); Spring Street, were acquired 12 CFR § 265.2 (f)(7) by the two banks. It became (1977). Worthen, according- a matter of competition, for ly, was advised by staff em- both banking business and ployees of the Federal Re- tenants, and prestige as to serve System that they would which bank would start and not recommend approval of complete its building first. the plan by the System's Board of Governors. Worthen initially hoped to finance, to build, and to own the proposed facility at a total n1 Worthen, as of cost of $ 9 million for the site, June 30, 1967, had building, and adjoining park- capital stock of $ 4 ing deck. This was to be ac- million and surplus of complished by selling $ 4 mil- $ 5 million. During the lion in debentures and using period the building the proceeds in the acquisi- was under construction of the capital stock of a tion Worthen became wholly owned real estate a national bank sub- subsidiary. This subsidiary ject to the supervision would have formal title and and control of the would raise the remaining $ 5 Comptroller of the million by a conventional Currency.

Lyon as the investor. After further negotiations, resulting Worthen therefore was in the elimination of that rent forced to seek an alternative reduction (offset, however, by solution that would provide it higher interest Lyon was to with the use of the building, pay Worthen on a subse- satisfy the state and federal quent unrelated loan), Lyon regulators, and attract the in November 1967 was ap- necessary capital. In Sep- proved as an acceptable bor- tember 1967 it proposed a rower by First National City sale-and-leaseback arrange- Bank for the construction fi- ment. The State Bank De- nancing, and by New York partment and the Federal Re- Life, as the permanent serve System approved this lender. In April 1968 the ap- approach, but the Depart- provals of the state and fed- ment required that Worthen eral regulators were re- possess an option to pur- ceived. chase the leased property at the end of the 15th year of In the meantime, on Sep- the lease at a set price, and tember 15, before Lyon was the federal regulator required selected, Worthen itself be- that the building be owned by gan construction. an independent third party. B Detailed negotiations en- In May 1968 Worthen, sued with investors that had Lyon, City Bank, and New indicated interest, namely, York Life executed comple- Goldman, Sachs & Compa- mentary and interlocking ny; White, Weld & Co.; East- agreements under which the man Dillon, Union Securities building was sold by Worthen & Company; and Stephens, to Lyon as it was construct- Inc. Certain of these firms ed, and Worthen leased the made specific proposals. completed building back from Worthen then obtained a Lyon. commitment from New York 1. Agreements between Life Insurance Company to Worthen and Lyon. Worthen provide $ 7,140,000 in per- and Lyon executed a ground manent mortgage financing lease, a sales agreement, on the building, conditioned and a building lease. upon its approval of the title- holder. At this point Lyon en- Under the ground lease tered the negotiations and it, dated May 1, 1968, App. 366, too, made a proposal. Worthen leased the site to Lyon for 76 years and 7 [*565] Worthen submit- months through November ted a counterproposal that in- 30, 2044. The first 19 corporated the best features, months were the [***556] from its point of view, of the estimated construction peri- several offers. Lyon accept- od. The ground rents ed the counterproposal, sug- payable by Lyon to Worthen gesting, by way of further in- were $ 50 for the first 26 ducement, a $ 21,000 reduc- years and 7 months and tion in the annual rent for the thereafter in quarterly pay- first five years of the building ments: lease. Worthen selected

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12/1/94 through 11/30/99 (5 years) $ 100,000 annually 12/1/99 through 11/30/04 (5 years) $ 150,000 annually 12/1/04 through 11/30/09 (5 years) $ 200,000 annually 12/1/09 through 11/30/34 (25 years) $ 250,000 annually 12/1/34 through 11/30/44 (10 years) $ 10,000 annually. ______

[*566] Under the sales During the period between the agreement dated May 19, expiration of the building lease 1968, id., at 508, Worthen (at the latest, November 30, agreed to sell the building to 2034, if fully extended) and the Lyon, and Lyon agreed to buy end of the ground lease on No- it, piece by piece as it was vember 30, 2044, full owner- constructed, for a total price ship, use, and control of the not to exceed $ 7,640,000, in building were Lyon's, unless, reimbursements to Worthen for of course, the building had its expenditures for the con- been repurchased by Worthen. struction of the building. n2 Id., at 369. Worthen was not obligated to pay rent under the building lease until completion n2 This arrange- of the building. For the first 11 ment appeared advis- years of the lease, that is, until able and was made be- November 30, 1980, the stated cause purchases of ma- quarterly rent was $ terials by Worthen 145,581.03 ($ 582,324.12 for (which then had be- the year). For the next 14 come a national bank) years, the quarterly rent was $ were not subject to Ar- 153,289.32 ($ 613,157.28 for kansas sales tax. See the year), and for the option Ark. Stat. Ann. § 84- periods the rent was $ 300,000 1904 (l) (1960); First a year, payable quarterly. Id., Agricultural Nat. Bank v. at 378-379. The total rent for Tax Comm'n, 392 U.S. the building over the 25-year 339 (1968). Sales of the primary term of the lease thus building elements to was $ 14,989,767.24. That Lyon also were not sub- rent equaled the principal and ject to state sales tax, interest payments that would since they were sales of amortize the $ 7,140,000 New real estate. See Ark. York Life mortgage loan over Stat. Ann. § 84-1902 the same period. When the (c) (Supp. 1977). mortgage was paid off at the end of the primary term, the annual building rent, if [**1295] Under the build- Worthen extended the lease, ing lease dated May 1, 1968, came down to the stated $ id., at 376, Lyon leased the 300,000. Lyon's [*567] net building back to Worthen for a rentals from the building would primary term of 25 years from be further reduced by the in- December 1, 1969, with op- crease in ground rent Worthen tions in Worthen to extend the would receive from Lyon dur- lease for eight additional 5- ing the extension. n3 year terms, a total of 65 years.

Lyon during the building lease's extended terms, n3 This, of course, if all are claimed, would is on the assumption approximate the amount that Worthen exercises required to repay Lyon's its option to extend the $ 500,000 investment at building lease. If it does 6% compound interest. not, Lyon remains liable Brief for United States for the substantial rents 14. prescribed by the

ground lease. This possibility brings into sharp The [***557] building focus the fact that Lyon, lease was a "net lease," under in a very practical which Worthen was responsi- sense, is at least the ul- ble for all expenses usually as- timate owner of the sociated with the maintenance building. If Worthen of an office building, including does not extend, the repairs, taxes, utility charges, building lease expires and insurance, and was to and Lyon may do with keep the premises in good the building as it choos- condition, excluding, however, es. reasonable wear and tear. The Government Finally, under the lease, would point out, howev- Worthen had the option to re- er, that the net amounts purchase the building at the payable by Worthen to following times and prices:

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11/30/80 (after 11 years) $ 6,325,169.85 11/30/84 (after 15 years) $ 5,432,607.32 11/30/89 (after 20 years) $ 4,187,328.04 11/30/94 (after 25 years) $ 2,145,935.00 ______

Worthen as well as by Lyon, and an assignment by Lyon of These repurchase option its interests in the building prices were the sum of the un- lease and in the ground lease. paid balance of the New York 3. Permanent financing Life mortgage, Lyon's $ agreement. By Note Purchase 500,000 investment, and 6% [*568] Agreement dated May interest compounded on that 1, 1968, id., at 443, New York investment. Life agreed to purchase Lyon's 2. Construction financing $ 7,140,000 6 3/4% 25-year agreement. By agreement secured note to be issued dated May 14, 1968, id., at upon completion of the build- 462, City Bank agreed to lend ing. Under this agreement Lyon $ 7,000,000 for the con- Lyon warranted that it would struction of the building. This lease the building to Worthen loan was secured by a mort- for a noncancelable term of at gage on the building and the least 25 years under a net parking deck, executed by lease at a rent at least equal to

the mortgage payments on the He also added $ 2,298.15 to note. Lyon agreed to make Lyon's 1969 income as "ac- quarterly payments of principal crued interest income." This and interest equal to the was the computed 1969 por- rentals payable by Worthen tion of a gain, considered the during the corresponding pri- equivalent of interest income, mary term of the lease. Id., at [*569] the realization of which 523. The security for the note was based on the assumption was a first deed of trust and that Worthen would exercise Lyon's assignment of its inter- its option to buy the building ests in the building lease and after 11 years, on November in the ground lease. Id., at 527, 30, 1980, at the price stated in 571. Worthen [**1296] joined the lease, and on the addition- in the deed of trust as the own- al determination that Lyon had er of the fee and the parking "loaned" $ 500,000 to deck. Worthen. In other words, the Commissioner determined that In December 1969 the the sale-and-leaseback ar- building was completed and rangement was a financing Worthen took possession. At transaction in which Lyon that time Lyon received the loaned Worthen $ 500,000 and permanent loan from New acted as a conduit for the York Life, and it discharged the transmission of principal and interim loan from City Bank. interest from Worthen to New The actual cost of constructing York Life. the office building and parking complex (excluding the cost of All this resulted in a total the land) exceeded $ increase of $ 497,219.18 over 10,000,000. Lyon's reported income for 1969, and a deficiency in Ly- C on's federal income tax for that Lyon filed its federal in- year in the amount of $ come tax returns on the accru- 236,596.36. The Commission- al and calendar year basis. er assessed that amount, to- On its 1969 return, Lyon ac- gether with interest of $ crued rent from Worthen for 43,790.84, for a total of $ December. It asserted as de- 280,387.20. n4 ductions one month's interest to New York Life; one month's depreciation on the building; n4 These figures do interest on the construction not include uncontested loan from City Bank; and sums adjustments not in- for legal and other expenses volved in this litigation. incurred in connection with the transaction. Lyon paid the assessment On audit of Lyon's 1969 re- and filed a timely claim for its turn, [***558] the Commis- refund. The claim was denied, sioner of Internal Revenue de- and this suit, to recover the termined that Lyon was "not amount so paid, was instituted the owner for tax purposes of in the United States District any portion of the Worthen Court for the Eastern District of Building," and ruled that "the Arkansas within the time al- income and expenses related lowed by 26 U. S. C. § 6532 to this building are not allow- (a)(1). able . . . for Federal income tax purposes." App. 304-305, 299.

After trial without a jury, that the Commissioner correct- the District Court, in a memo- ly determined that Lyon was randum letter-opinion setting not the true owner of the build- forth findings and conclusions, ing and therefore was not enti- ruled in Lyon's favor and held tled to the claimed deductions. that its claimed deductions It likened ownership for tax were allowable. 75-2 USTC purposes to a "bundle of para. 9545 (1975), 36 AFTR sticks" and undertook its own 2d para. 75-5059 (1975); App. evaluation of the facts. It con- 296-311. It concluded that the cluded, in agreement with the legal intent of the parties had Government's contention, that been to create a bona fide Lyon "totes an empty bundle" sale-and-leaseback in accor- of ownership sticks. Id., at dance with the form and lan- 751. It stressed the following: guage of the documents evi- (a) The lease agreements cir- dencing the transactions. It re- cumscribed Lyon's right to jected the argument that profit from its investment in the Worthen was acquiring an eq- building by giving Worthen the uity in the building through its option to purchase for an rental payments. It found that amount equal to Lyon's $ the rents were unchallenged 500,000 equity plus 6% com- and were reasonable through- pound interest and the as- out the period of the lease, and sumption of the unpaid bal- that the option prices, negotiat- ance of the New York Life ed at arm's length between the mortgage. n5 (b) The option parties, represented fair esti- prices did not take into account mates of market value on the possible appreciation of the applicable dates. It rejected value of the building or infla- any negative [*570] inference tion. n6 (c) Any award realized from the fact that the rentals, as a [*571] result of destruc- combined with the options, tion or condemnation of the were sufficient to amortize the building in excess of the mort- New York Life loan and to pay gage balance and the $ Lyon a 6% return on its equity 500,000 would be paid to investment. It found that Worthen and not Lyon. n7 (d) Worthen would acquire an eq- The building rental payments uity in the building only if it ex- during the primary term were ercised one of its options to exactly equal to the mortgage purchase, and that it was high- payments. n8 (e) Worthen re- ly unlikely, as a practical mat- tained control over the ultimate ter, that any purchase option disposition of the building would ever be exercised. It re- through its various options to jected any inference to be repurchase and to renew the drawn from the fact that the lease plus its ownership of the lease was a "net lease." It site. n9 (f) Worthen enjoyed all found that Lyon had mixed mo- benefits and bore all burdens tivations for entering into the incident to the operation and transaction, including the need ownership of the building so to diversify as well as the de- that, in the Court of Appeals' sire to have the benefits of a view, the only economic ad- "tax shelter." App. 296, 299. vantages accruing to Lyon, in the event it were considered to [***559] [**1297] The be the true owner of the prop- United States Court of Appeals erty, were income tax savings for the Eighth Circuit reversed. of approximately $ 1.5 million 536 F.2d 746 (1976). It held during the first 11 [*572]

years of the arrangement. n10 dates and to be reason- [***560] Id., at 752-753. n11 able. App. 303, 299. The court concluded, id., at n7 Lyon asserts that 753, that [**1298] the trans- this statement is true action was "closely akin" to only with respect to the that in Helvering v. Lazarus & total destruction or tak- Co., 308 U.S. 252 (1939). "In ing of the building on or sum, the benefits, risks, and after December 1, 1980. burdens which [Lyon] has in- Lyon asserts that it, not curred with respect to the Worthen, would receive Worthen building are simply the excess above the too insubstantial to establish a mortgage balance in the claim to the status of owner for event of total destruc- tax purposes. . . . The vice of tion or taking before De- the present lease is that all of cember 1, 1980, or in [its] features have been em- the event of partial dam- ployed in the same transaction age or taking at any with the cumulative effect of time. Id., at 408-410, depriving [Lyon] of any signifi- 411. cant ownership interest." 536 F.2d, at 754.

n8 Lyon concedes n5 Lyon here chal- the accuracy of this lenges this assertion on statement, but asserts the grounds that it had that it does not justify the right and opportuni- the conclusion that Lyon ties to sell the building served merely as a con- at a greater profit at any duit by which mortgage time; the return to Lyon payments would be was not insubstantial transmitted to New York and was attractive to a Life. It asserts that true investor in real es- Lyon was the sole oblig- tate; the 6% return was or on the New York Life the minimum Lyon note and would remain would realize if Worthen liable in the event of de- exercised one of its op- fault by Worthen. It also tions, an event the Dis- asserts that the fact the trict Court found highly rent was sufficient to unlikely; and Lyon amortize the loan during would own the building the primary term of the and realize a greater re- lease was a require- turn than 6% if Worthen ment imposed by New did not exercise an op- York Life, and is a usual tion to purchase. requirement in most

long-term loans secured n6 Lyon challenges by a long-term lease. this observation by pointing out that the n9 As to this state- District Court found the ment, Lyon asserts that option prices to be the the Court of Appeals ig- negotiated estimate of nored Lyon's right to sell the parties of the fair the building to another market value of the at any time; the District building on the option Court's finding that the

options to purchase We granted certiorari, 429 were not likely to be ex- U.S. 1089 (1977), because of ercised; the uncertainty an indicated conflict with that Worthen would re- American Realty Trust v. Unit- new the lease for 40 ed States, 498 F.2d 1194 years; Lyon's right to (CA4 1974). lease to anyone at any II price during the last 10

years of the ground [***LEdHR2] [2]This Court, al- lease; and Lyon's con- most 50 years ago, observed tinuing ownership of the that "taxation is not so much building after the expira- concerned with the refine- tion of the ground lease. ments of title as it is with actual n10 In response to command over the property this, Lyon asserts that taxed -- the actual benefit for the District Court found which the tax is paid." Corliss that the benefits of oc- v. Bowers, 281 U.S. 376, 378 cupancy Worthen will (1930). In a number of cases, enjoy are common in the Court has refused to permit most long-term real es- the transfer of formal legal title tate leases, and that the to shift the incidence of taxa- District Court found that tion attributable to ownership Lyon had motives other of property where the transfer- than tax savings in en- or continues to retain signifi- tering into the transac- cant control [*573] over the tion. It also asserts that property transferred. E. g., the net cash after-tax Commissioner v. Sunnen, 333 benefit would be $ U.S. 591 (1948); Helvering v. 312,220, not $ 1.5 mil- Clifford, 309 U.S. 331 (1940). lion. In applying this doctrine of substance over form, the Court has looked to the objective

economic realities of a trans- n11 Other factors action rather than to the partic- relied on by the Court of ular form the parties employed. Appeals, 536 F.2d, at The Court has never regarded 752, were the allocation "the simple expedient of draw- of the investment credit ing up papers," Commissioner to Worthen, and a claim v. Tower, 327 U.S. 280, 291 that Lyon's ability to sell (1946), as controlling for tax the building to a third purposes when the objective party was "carefully cir- economic realities are to the cumscribed" by the contrary. "In the field of taxa- lease agreements. The tion, administrators of the laws, investment credit by and the courts, are concerned statute is freely alloca- with substance and realities, ble between the parties, and formal written documents § 48 (d) of the 1954 are not rigidly binding." Helver- Code, 26 U. S. C. § 48 ing v. Lazarus & Co., 308 U.S., (d), and the Govern- at 255. See also Commission- ment has not pressed er v. P. G. Lake, Inc., 356 U.S. either of these factors 260, 266-267 (1958); Commis- before this Court. sioner v. Court Holding Co., 324 U.S. 331, 334 (1945). Nor is the parties' desire to achieve

a particular tax result neces- able option and lease renewal sarily relevant. Commissioner terms made it highly unlikely v. Duberstein, 363 U.S. 278, that Worthen would abandon 286 (1960). the building after it in effect had "paid off" the mortgage. In the light of these gener- [**1299] The Government im- al and established principles, plies that the arrangement was the Government [***561] one of convenience which, if takes the position that the accepted on its face, would en- Worthen-Lyon transaction in its able Worthen to deduct its entirety should be regarded as payments to Lyon as rent and a sham. The agreement as a would allow Lyon to claim a whole, it is said, was only an deduction for depreciation, elaborate financing scheme based on the cost of construc- designed to provide economic tion ultimately borne by benefits to Worthen and a Worthen, which Lyon could off- guaranteed return to Lyon. set against other income, and The latter was but a conduit to deduct mortgage interest used to forward the mortgage that roughly would offset the payments, made under the inclusion of Worthen's rental guise of rent paid by Worthen payments in Lyon's income. If, to Lyon, on to New York Life however, the Government ar- as mortgagee. This, the Gov- gues, the arrangement was ernment claims, is the true only a financing transaction substance of the transaction under which Worthen was the as viewed under the micro- owner of the building, scope of the tax laws. Al- Worthen's payments would be though the arrangement was deductible only to the extent case in sale-and-leaseback that they represented mort- form, in substance it was only gage interest, and Worthen a financing transaction, and would be entitled to claim de- the terms of the repurchase preciation; Lyon would not be options and lease renewals so entitled to deductions for either indicate. It is said that mortgage interest or deprecia- Worthen could reacquire the tion and it would not have to building simply by satisfying include Worthen's "rent" pay- the mortgage debt and paying ments in its income because Lyon its $ 500,000 advance its function with respect to plus interest, regardless of the those payments was that of a fair market value of the build- conduit between Worthen and ing at the time; similarly, when New York Life. the mortgage was paid off, Worthen could extend the The Government places lease at [*574] drastically re- great reliance on Helvering v. duced bargain rentals that like- Lazarus & Co., supra, and wise bore no relation to fair claims it to be precedent that rental value but were simply controls this case. The tax- calculated to pay Lyon its $ payer there was a department 500,000 plus interest over the store. The legal title of its extended term. Lyon's return three buildings was in a bank on the arrangement in no as trustee for land-trust certifi- event could exceed 6% com- cate holders. When the trans- pound interest (although the fer to the trustee was made, Government conceded it might the trustee at the same time well be less, Tr. of Oral Arg. leased the buildings back to 32). Furthermore, the favor- the taxpayer for 99 years, with

option to renew and purchase. volves three parties, Worthen, The Commissioner, in stark Lyon, and the finance agency. contrast to his posture in the The usual simple two-party ar- present case, took the position rangement was legally unavail- that the [*575] statutory right able to Worthen. Independent to depreciation followed legal investors were interested in title. The Board of Tax Ap- participating in the alternative peals, however, concluded that available to Worthen, and Lyon the transaction between the itself (also independent from taxpayer and the bank in reali- Worthen) won the privilege. ty was a mortgage loan and al- Despite Frank Lyon's presence lowed the taxpayer deprecia- on Worthen's board of direc- tion on the buildings. This tors, the transaction, as it ulti- Court, as had the Court of Ap- mately developed, was not a peals, [***562] agreed with familial one arranged by that conclusion and affirmed. Worthen, but one compelled It regarded the "rent" stipulated by the realities of the restric- in the leaseback as a promise tions imposed upon the bank. to pay interest on the loan, and Had Lyon not appeared, an- a "depreciation fund" required other interested investor would by the lease as an amortiza- have been selected. [*576] tion fund designed to pay off The ultimate solution would the loan in the stated period. have been essentially the Thus, said the Court, the same. Thus, the presence of Board justifiably concluded the third party, in our view, sig- that the transaction, although nificantly distinguishes this in written form a transfer of case from Lazarus and re- ownership with a leaseback, moves the latter as controlling was actually a loan secured by authority. the property involved. III The Lazarus case, we feel, is to be distinguished from the [***LEdHR3] [3]It is true, of present one and is not control- course, that the transaction ling here. Its transaction was took shape according to one involving only two (and not Worthen's needs. As the Gov- multiple) parties, the taxpayer- ernment points out, Worthen department store and the throughout the negotiations re- trustee-bank. The Court garded the respective propos- looked closely at the sub- als of the independent stance of the agreement be- [**1300] investors in terms of tween those two parties and its own cost of funds. E. g., rightly concluded that depreci- App. 355. It is also true that ation was deductible by the both Worthen and the prospec- taxpayer despite the nomen- tive investors compared the clature of the instrument of various proposals in terms of conveyance and the lease- the return anticipated on the back. See also Sun Oil Co. v. investor's equity. But all this is Commissioner, 562 F.2d 258 natural for parties contemplat- (CA3 1977) (a two-party case ing entering into a transaction with the added feature that the of this kind. Worthen needed second party was a tax-ex- a building for its banking oper- empt pension trust). ations and other purposes and necessarily had to know what [***LEdHR1B] [1B] The its cost would be. The in- present case, in contrast, investors were in business to

employ their funds in the most nancial statements peri- remunerative way possible. odically. See Note Pur- And, as the Court has said in chase Agreement, App. the past, a transaction must be 453-454, 458-459. given its effect in accord with n13 It may well be what actually occurred and not that the remedies avail- in accord with what might have able to New York Life occurred. Commissioner v. against Lyon would be National Alfalfa Dehydrating & far greater than any Milling Co., 417 U.S. 134, 148- remedy available to it 149 (1974); Central Tablet against Worthen, which, Mfg. Co. v. United States, 417 as lessee, is liable to U.S. 673, 690 (1974). New York Life only

through Lyon's assign- [***LEdHR1C] [1C]There is ment of its interest as no simple device available to lessor. peel away the form of this

transaction and to reveal its substance. The effects of the The effect of this liability transaction on all the parties on Lyon is not just the abstract were obviously [***563] differ- possibility that something will ent from those that would have go wrong and that Worthen will resulted had Worthen been not be able to make its payable simply to make a mort- ments. Lyon has disclosed gage agreement with New this liability on its balance York Life and to receive a $ sheet for all the world to see. 500,000 loan from Lyon. Then Its financial position was af- Lazarus would apply. Here, fected substantially by the however, and most significant- presence of this long-term ly, it was Lyon alone, and not debt, despite the offsetting Worthen, who was liable on presence of the building as an the notes, first to City Bank, asset. To the extent that Lyon and then to New York Life. has used its capital in this Despite the facts that Worthen transaction, it is less able to had agreed to pay rent and obtain financing for other busi- that this rent equaled the ness needs. amounts due from Lyon to New York Life, should anything [***LEdHR4] [4]In concluding go awry in the later years of that there is this distinct ele- the lease, Lyon [*577] was ment of economic reality in Ly- primarily liable. n12 No matter on's assumption of liability, we how the transaction could have are mindful that the characteri- been devised otherwise, it re- zation of a transaction for fi- mains a fact that as the agree- nancial accounting purposes, ments were placed in final on the one hand, and for tax form, the obligation on the purposes, on the other, need notes fell squarely on Lyon. not necessarily be the same. n13 Lyon, an ongoing enter- Commissioner v. Lincoln Sav- prise, exposed its very busi- ings & Loan Assn., 403 U.S. ness well-being to this real and 345, 355 (1971); Old Colony substantial risk. R. Co. v. Commissioner, 284 U.S. 552, 562 (1932). Account- ing methods or descriptions, n12 New York Life without more, do not lend sub- required Lyon, not stance to that which has no Worthen, to submit fi- substance. But in this case

accepted accounting methods, ments in accord with as understood by the several FASB Standard No. 13. parties to the respective agree- Standard No. 13, how- ments and as applied to the ever, by its terms, transaction by others, gave the states, para. 78, that transaction a meaningful char- there are many in- acter consonant with the form stances where tax and it was given. n14 Worthen financial accounting [*578] was not [**1301] al- treatments diverge. lowed to [***564] enter into Further, Standard No. the type of transaction which 13 is nonapplicable with the Government now urges to respect to a lease exe- be the true substance of the cuted prior to January 1, arrangement. Lyon and 1977 (as was the Lyon- Worthen cannot be said to Worthen lease), until have entered [*579] into the January 1, 1981. Obvi- transaction intending that the ously, Banking Circular interests involved were allocat- No. 95 was not in effect ed in a way other than that as- in 1968 when the Lyon- sociated with a sale-and-lease- Worthen lease was exe- back. cuted. Then-existing pro- n14 We are aware nouncements of the In- that accounting stan- ternal Revenue Service dards have changed gave Lyon very little significantly since 1968 against which to mea- and that the propriety of sure the transaction. Worthen's and Lyon's The most complete methods of disclosing statement on the gener- the transaction in ques- al question of character- tion may be a matter for ization of leases as debate under these new sales, Rev. Rul. 55-540, standards. Compare 1955-2 Cum. Bull. 39, Accounting Principles by its terms dealt only Bd. Opinion No. 5, Re- with equipment leases. porting of Leases in Fi- In that ruling it was stat- nancial Statements of ed that the Service will Lessee (1964), and Ac- look at the intent of the counting Principles Bd. parties at the time the Opinion No. 7, Account- agreement was execut- ing for Leases in Finan- ed to determine the cial Statements of proper characterization Lessors (1966), with Fi- of the transaction. Gen- nancial Accounting erally, an intent to enter Standards Board, State- into a conditional sales ment of Financial Ac- agreement will be found counting Standards No. to be present if (a) por- 13, Accounting for tions of the rental pay- Leases (1976). See ments are made specifi- also Comptroller of the cally applicable to an Currency, Banking Cir- equity acquired by the cular No. 95 (Nov. 11, lessee, (b) the lessee 1977), instructing that will acquire a title auto- national banks revise matically after certain their financial state- payments have been

made, (c) the rental than the benefits re- payments are a dispro- ceived solely from the portionately large tax treatment. These amount in relation to the guidelines are not in- sum necessary to com- tended to be definitive, plete the sale, (d) the and it is not clear that rental payments are they provide much guid- above fair rental value, ance in assessing real (e) title can be acquired estate transactions. at a nominal option See Rosenberg & Wein- price, or (f) some por- stein, Sale-leasebacks: tion of the rental pay- An analysis of these ments are identifiable transactions after the as interest. See also Lyon decision, 45 J. Rev. Rul. 60-122, 1960- Tax. 146, 147 n. 1 1 Cum. Bull. 56; Rev. (1976). Rul. 72-543, 1972-2 Cum. Bull. 87. Other factors also reveal The Service an- that the transaction cannot be nounced more specific viewed as anything more than guidelines, indicating a mortgage agreement be- under what circum- tween Worthen and New York stances it would answer Life and a loan from Lyon to requests for rulings on Worthen. There is no legal leverage leasing trans- obligation between Lyon and actions, in Rev. Proc. Worthen representing the $ 75-21, 1975-1 Cum. 500,000 "loan" extended under Bull. 715. In general, the Government's theory. And "[unless] other facts and the assumed 6% return on this circumstances indicate putative loan -- required by the a contrary intent," the audit to be recognized in the Service will not rule that taxable year in question -- will a lessor in a leveraged be realized only when and if lease transaction is to Worthen exercises its options. be treated as the owner The Court of Appeals ac- of the property in ques- knowledged that the rents tion unless (a) the alone, due after the primary lessor has incurred and term of the lease and after the maintains a minimal in- mortgage has been paid, do vestment equal to 20% not provide the simple 6% re- of the cost of the prop- turn which, the Government erty, (b) the lessee has urges, Lyon is guaranteed, no right to purchase ex- 536 F.2d, at 752. Thus, if cept at fair market val- Worthen chooses not to exer- ue, (c) no part of the cise its options, Lyon is gam- cost of the property is bling that the rental value of furnished by the lessee, the building during the last 10 (d) the lessee has not years of the ground lease, dur- lent to the lessor or ing which the ground rent is guaranteed any indebt- minimal, will be sufficient to re- edness of the lessor, coup its investment before it and (e) the lessor must must negotiate again with demonstrate that it ex- Worthen regarding the ground pects to receive a profit lease. There are simply too on the transaction other many contingencies, including

variations in the value of real n15 Indeed, it is not estate, in the cost of money, inevitable that the trans- and in the capital structure of action, as treated by Worthen, to permit the conclu- Lyon and Worthen, will sion that the parties intended not result in more rev- to enter into the transaction as enues to the Govern- [*580] structured in the audit ment rather than less. and according to which the Lyon is gambling that in Government now urges they the first 11 years of the be taxed. lease it will have income that will be sheltered by [***565] It is not inappro- the depreciation deduc- priate to note that the Govern- tions, and that it will be ment is likely to lose little rev- able to make sufficiently enue, if any, as a result of the good use of the tax dol- shape given the transaction by lars preserved thereby the parties. No deduction to make up for the in- [**1302] was created that is come it will recognize not either matched by an item and pay taxes on during of income or that would not the last 14 years of the have been available to one of initial term of the lease the parties if the transaction and against which it will had been arranged differently. enjoy no sheltering de- While it is true that Worthen duction. paid Lyon less to induce it to

enter into the transaction because Lyon anticipated the benefit of the depreciation deductions it would have as the [***LEdHR1D] [1D]The con- owner of the building, those clusion that the transaction is deductions would have been not a simple sham to be ig- equally available to Worthen nored does not, of course, au- had it retained title to the build- tomatically compel the further ing. The Government so con- conclusion that Lyon is entitled cedes. Tr. of Oral Arg. 22-23. to the items claimed as deduc- The fact that favorable tax con- tions. Nevertheless, on the sequences were taken into ac- facts, this readily follows. As count by Lyon on entering into has been noted, the obliga- the transaction is no reason for tions on which Lyon paid inter- disallowing those conse- est [*581] were its obligations quences. n15 We cannot ig- alone, and it is entitled to claim nore the reality that the tax deductions therefor under § laws affect the shape of nearly 163 (a) of the 1954 Code, 26 every business transaction. U. S. C. § 163 (a). See Commissioner v. Brown, 380 U.S. 563, 579-580 (1965) [***LEdHR5A] [5A]As is clear (Harlan, J., concurring). Lyon from the facts, none of the par- is not a corporation with no ties to this sale-and-leaseback purpose other than to hold title was the owner of the building to the bank building. It was not in any simple sense. But it is created by Worthen or even fi- equally clear that the facts fo- nanced to any degree by cus upon Lyon as the one Worthen. whose capital was committed to the building and as the party, therefore, that was entitled to claim depreciation for the

consumption of that capital. ence on the Worthen board of The Government has based its directors; Lyon's departure contention that Worthen from its principal corporate ac- should be treated as the owner tivity into this unusual venture; on the assumption that the parallel between the pay- throughout the term of the ments under the building lease lease Worthen was acquiring and the amounts due from an equity in the property. In Lyon on the New York Life order to establish the presence mortgage; the provisions relat- of that growing equity, howev- ing to condemnation or de- er, the Government is forced to struction of the [*582] proper- speculate that one of the op- ty; the nature and presence of tions will be exercised and the several options available to that, if it is not, this is only be- Worthen; and the tax benefits, cause the rentals for the ex- such as the use of double de- tended term are a bargain. clining balance [**1303] de- We cannot indulge in such preciation, that accrue to Lyon speculation in view of the Dis- during the initial years of the trict Court's clear finding to the arrangement, form the basis of contrary. n16 We therefore an argument that Worthen conclude that it is Lyon's capi- should be regarded as the tal that is invested in the build- owner of the building and as ing according to the agreement the recipient of nothing more of [***566] the parties, and it from Lyon than a $ 500,000 is Lyon that is entitled to de- loan. preciation deductions, under § We, however, as did the 167 of the 1954 Code, 26 U. District Court, find this theoriz- S. C. § 167. Cf. United States ing incompatible with the sub- v. Chicago B. & Q. R. Co., 412 stance and economic realities U.S. 401 (1973). of the transaction: the competi- tive situation as it existed be- n16 tween Worthen and Union Na- tional Bank in 1965 and the [***LEdHR5B] [5B]The years immediately following; general characterization Worthen's undercapitalization; of a transaction for tax Worthen's consequent inability, purposes is a question as a matter of legal restraint, to of law subject to review. carry its building plans into ef- The particular facts from fect by a conventional mort- which the characteriza- gage and other borrowing; the tion is to be made are additional barriers imposed by not so subject. See the state and federal regula- American Realty Trust tors; the suggestion, forthcom- v. United States, 498 ing from the state regulator, F.2d 1194, 1198 (CA4 that Worthen possess an op- 1974). tion to purchase; the requirement, from the federal regulator, that the building be owned IV by an independent third party; We recognize that the the presence of several fi- Government's position, and nance organizations seriously that taken by the Court of Ap- interested in participating in peals, is not without superficial the transaction and in the reso- appeal. One, indeed, may the- lution of Worthen's problem; orize that Frank Lyon's pres- the submission of formal pro-

posals by several of those or- n17 Lyon's consoli- ganizations; the bargaining dated balance sheet on process and period that en- December 31, 1968, sued; the competitiveness of showed assets of $ the bidding; the bona fide char- 12,225,612, and total acter of the negotiations; the stockholders' equity of $ three-party aspect of the trans- 3,818,671. Of the as- action; Lyon's substantiality sets, the sum of $ n17 and its independence from 2,674,290 represented Worthen; the fact that diversifi- its then investment in cation was Lyon's principal the Worthen building. motivation; Lyon's being liable App. 587-588. alone on the successive notes n18 Thus, the facts to City Bank and New York of this case stand in Life; the reasonableness, as contrast to many others the District Court found, of the in which the form of the rentals and of the option transaction actually cre- prices; the substantiality of the ated tax advantages purchase prices; [*583] Ly- that, for one reason or on's not being engaged gener- another, could not have ally in the business of financ- been enjoyed had the ing; the presence of all building transaction taken anoth- depreciation risks on Lyon; the er form. See, e. g., Sun risk, borne by Lyon, that Oil Co. v. Commission- Worthen might default or fail, er, 562 F.2d 258 (CA3 as other banks have failed; the 1977) (sale-and-lease- facts that Worthen could "walk back of land between away" from the relationship at taxpayer and tax-ex- the end of the 25-year primary empt trust enabled the term, and probably would do taxpayer to amortize, so if the option price were through its rental deduc- more than the then-current tions, the cost of acquir- worth of the building to ing land not otherwise Worthen; the inescapable fact depreciable). Indeed, that if the building lease were the arrangements in this not extended, Lyon [***567] case can hardly be la- would be the full owner of the beled as tax-avoidance building, free to do with it as it techniques in light of the chose; Lyon's liability for the other arrangments be- substantial ground rent if ing promoted at the Worthen decides not to exer- time. See, e. g., Zeitlin, cise any of its options to ex- Tax Planning in Equip- tend; the absence of any un- ment-Leasing Shelters, derstanding between Lyon and 1969 So. Cal. Tax Inst. Worthen that Worthen would 621; Marcus, Real Es- exercise any of the purchase tate Purchase-Lease- options; the nonfamily and backs as Secured nonprivate nature of the entire Loans, 2 Real Estate L. transaction; and the absence J. 664 (1974). of any differential in tax rates

and of special tax circumstances for one of the parties In so concluding, we em- -- all convince us that Lyon has phasize that we are not con- far the better of the case. n18 doning manipulation by a taxpayer through arbitrary labels and dealings that have no eco-

nomic significance. Such, States, 541 F.2d 829 however, has not happened in (CA9 1976). this case.

The judgment of the Court [***LEdHR1E] [1E] of Appeals, accordingly, is re- [***LEdHR6] [6] [***LEdHR7] versed. [7]In short, we hold that where, as here, there is a genuine It is so ordered. multiple-party transaction with economic substance which is MR. JUSTICE WHITE dis- compelled or encouraged by sents and would affirm the business or regulatory reali- judgment substantially for the ties, is [*584] imbued with reasons stated in the opinion tax-independent considera- in the Court of Appeals for the tions, and is not shaped solely Eighth Circuit. 536 F.2d 746 by tax-avoidance features that (1976). have meaningless labels at- tached, the Government DISSENTBY: [**1304] should honor the allo- STEVENS cation of rights and duties effectuated by the parties. Ex- DISSENT: pressed another way, so long as the lessor retains significant MR. JUSTICE STEVENS, and genuine attributes of the dissenting. traditional lessor status, the In my judgment the con- form of the transaction adopt- trolling issue in this case is the ed by the parties governs for economic relationship between tax purposes. What those at- Worthen and petitioner, and tributes are in any particular matters such as the number of case will necessarily depend parties, their reasons for struc- upon its facts. It suffices to turing the transaction in a par- say that, as here, a sale-and- ticular way, and the tax bene- leaseback, in and of itself, fits [***568] which may result, does not necessarily operate are largely irrelevant. The to deny a taxpayer's claim for question whether a leasehold deductions. n19 has been created should be answered by examining the n19 See generally character and value of the pur- Commissioner v. ported lessor's reversionary Danielson, 378 F.2d estate. 771 (CA3), cert. denied, For a 25-year period 389 U.S. 858 (1967), on Worthen has the power to ac- remand, 50 T. C. 782 quire full ownership of the (1968); Levinson v. bank building by simply repay- Commissioner, 45 T. C. ing the [*585] amounts, plus 380 (1966); World Pub- interest, advanced by the New lishing Co. v. Commis- York Life Insurance Company sioner, 299 F.2d 614 and petitioner. During that pe- (CA8 1962); Northwest riod, the economic relationship Acceptance Corp. v. among the parties parallels ex- Commissioner, 58 T. C. actly the normal relationship 836 (1972), aff'd, 500 between an owner and two F.2d 1222 (CA9 1974); lenders, one secured by a first Cubic Corp. v. United mortgage and the other by a second mortgage. n1 If

Worthen repays both loans, it 564, did contemplate will have unencumbered own- that Worthen would pay ership of the property. What a price above the fi- the character of this relation- nancing costs for acqui- ship suggests is confirmed by sition of the leasehold the economic value that the interest. For instance, parties themselves have Goldman, Sachs & placed on the reversionary in- Company proposed terest. that, at the end of the lease's primary term, Worthen would have the n1 "[Where] a fixed option to repurchase the price, as in Frank Lyon property for either its Company, is designed fair market value or merely to provide the 20% of its original cost, lessor with a predeter- whichever was the mined fixed return, the greater. See Brief for substantive bargain is United States 8 n. 7. A more akin to the rela- repurchase option tionship between a based on fair market debtor and creditor than value, since it acknowl- between a lessor and edges the lessor's equi- lessee." Rosenberg & ty interest in the proper- Weinstein, Sale-lease- ty, is consistent with a backs: An analysis of lessor-lessee relation- these transactions after ship. See Breece Ve- the Lyon decision, 45 J. neer & Panel Co. v. Tax. 146, 149 (1976). Commissioner, 232 F.2d 319 (CA7 1956); LTV Corp. v. Commis- All rental payments made sioner, 63 T. C. 39, 50 during the original 25-year (1974); see generally term are credited against the Comment, Sale and option repurchase price, which Leaseback Transac- is exactly equal to the unamor- tions, 52 N. Y. U. L. tized cost of the financing. The Rev. 672, 688-689, n. value of the repurchase option 117 (1977). is thus limited to the cost of the financing, and Worthen's power to exercise the option is cost free. Conversely, petitioner, n3 The situation in the nominal owner of the re- this case is thus analo- versionary estate, is not enti- gous to that in Corliss v. tled to receive any value for Bowers, 281 U.S. 376, the surrender of its supposed where the Court held rights of ownership. n2 Nor that the grantor of a does [*586] it have any power trust who retains an un- to control Worthen's exercise restricted cost-free pow- of the option. n3 er of revocation remains the owner of the trust assets for tax purposes. n2 It is worth noting Worthen's power to ex- that the proposals sub- ercise its repurchase mitted by two other po- option is similar; the tential investors in the only restraints upon it building, see ante, at are those normally as-

sociated with the repay- possible or only at the ment of a loan, such as end of 25 years. limitations on the timing Worthen, on the other of repayment and the hand, does bear the risk amount due at the stat- of depreciation, since its ed intervals. opportunity to make a profit from the exercise of its repurchase option [**1305] "It is fundamen- hinges on the value of tal that 'depreciation is not the building at the time. predicated upon ownership of property but rather upon an in- n5 After the 11th vestment in property.' No such year of the lease, there investment exists when pay- are three ways that the ments of the purchase price in lease might be terminat- accordance with the design of ed. The property might the parties yield no equity to be condemned, the the purchaser." Estate of building might be de- Franklin v. Commissioner, 544 stroyed by act of God, F.2d 1045, 1049 (CA9 1976) or Worthen might exer- (citations omitted; emphasis in cise its option to pur- original). Here, the petitioner chase. In any such has, in effect, been guaranteed event, if the property that it will receive its original $ had increased in value, 500,000 plus accrued interest. the entire benefit would [***569] But that is all. It in- be received by Worthen curs neither the risk of depreci- and petitioner would re- ation, n4 nor the benefit of ceive only its $ 500,000 possible appreciation. Under plus interest. See Reply the terms of the sale-lease- Brief for Petitioner 8-9, back, it will stand in no better n. 2. or worse position after the 11th year of the lease -- when [*587] Petitioner has as- Worthen can first exercise its sumed only two significant option to repurchase -- risks. First, like any other whether the property has ap- lender, it assumed the risk of preciated or depreciated. n5 Worthen's insolvency. Sec- And this remains true through- ond, it assumed the risk that out the rest of the 25-year peri- Worthen might not exercise its od. option to purchase at or before the end of the original 25-year term. n6 If Worthen should ex- n4 Petitioner argues ercise that right not to repay, that it bears the risk of perhaps it would then be ap- depreciation during the propriate to characterize peti- primary term of the tioner as the owner and lease, because the op- Worthen as the lessee. But tion price decreases speculation as to what might over time. Brief for Peti- happen in 25 years cannot jus- tioner 29-30. This is tify the present characteriza- clearly incorrect. Peti- tion of petitioner as the owner tioner will receive $ of the building. Until Worthen 500,000 plus interest, has made a commitment either and no more or less, to exercise or not to exercise whether the option is its option, n7 I think the Gov- exercised as soon as ernment is correct in its view

that petitioner is not the owner as long as it retains its of the building for tax purpos- unrestricted cost-free es. At present, since Worthen power to do so, it must has [*588] the unrestricted be considered the own- right to control the residual val- er of the building. See ue of the property for a price Sun Oil Co. v. Commis- which does not exceed the sioner, 562 F.2d 258, cost of its unamortized financ- 267 (CA3 1977) (repur- ing, I [**1306] would hold, as chase option enabling a matter of law, that it is the lessee to acquire leased owner. premises by repaying financing costs indicative of lessee's equity inter- n6 The possibility est in those premises). that Worthen might not In effect, Worthen exercise its option is a has an option to "put" risk for petitioner be- the building to petitioner cause in that event peti- if it drops in value below tioner's advance would $ 500,000 plus interest. be amortized during the Even if the "put" ap- ensuing renewal lease pears likely because of terms, totaling 40 years. bargain lease rates after Yet there is a possibility the primary terms, that that Worthen would would not justify the choose not to renew for present characterization the full 40 years or that of petitioner as the own- the burdens of owning a er of the building. building and paying a

ground rental of $ 10,000 during the years I therefore respectfully dis- 2034 through 2044 sent. would exceed the benefits of ownership. Ante, at 579.

n7 In this case, the lessee is not "economi- cally compelled" to exercise its option. See American Realty Trust v. United States, 498 F.2d 1194 (CA4 1974). Indeed, it may be more advantageous for Worthen to let its option lapse since the present value of the renewal leases is somewhat less than the price of the option to repurchase. See Brief for United States 40 n. 26. But whether or not Worthen is likely to exercise the option,