Annual Survey of Massachusetts Law Volume 1964 Article 6 1-1-1964 Chapter 3: Property and Conveyancing William Schwartz Follow this and additional works at: http://lawdigitalcommons.bc.edu/asml Part of the Property Law and Real Estate Commons Recommended Citation Schwartz, William (1964) "Chapter 3: Property and Conveyancing," Annual Survey of Massachusetts aL w: Vol. 1964, Article 6. Schwartz: Chapter 3: Property and Conveyancing CHAPTER 3 Property and Conveyancing WILLIAM SCHWARTZ §3.1. Federal taxation of real estate: The Revenue Act of 1964. Real estate plays a key role in our national economy because more than 60 percent of the total national wealth is represented by land resources and improvements.1 As a result, real estate has become an attractive and durable investment vehicle. To a considerable extent, the Federal Government, through its tax policies, has increased the financial opportunities afforded by real estate.2 In the 1964 SURVEY year there were a number of interesting developments pertaining to real estate taxation. The Internal Revenue Code grants the owner of real property used in a trade or business or held for the production of income an annual allowance for depreciation.s The availability of this deduc­ tion enables the real estate owner to amortize his mortgage indebted­ ness at the expense of the Federal Government. In addition, the realty owner can convert ordinary income into capital gain by utiliz­ ing a method of accelerated depreciation.' By deducting greater amounts annually (through accelerated depreciation), the realty owner reduces the amount of his ordinary income. Although the depreciation deduction reduces his basis and results in a greater capital gain upon a subsequent sale, this would appear to be. a small enough price to pay for the larger depreciation deductions taken in prior years against ordinary income.1I The Revenue Act of 1964 closes this loophole with respect to depreciable property held for less than ten years.4I If there is a sale, exchange, or other disposition of depreciable realty (called "Section 1250 property") held for less than ten years, a per­ centage of the gain resulting from the taking of additional deprecia­ tion is treated as ordinary income. One of the interesting problems posed in the area of depreciation is the question of who is entitled to the depreciation deduction. The WILLIAM SCHWARTZ is Professor of Law at Boston University Law School. He is the author of Future Interests and Estate Planning (1965). §5.l. 1 Benson. North. &: Ring. Real Estate Principles and Practices 16 (4th ed. 1954). 2 Casey and Lasser. Tax Sheltered Investments 80 (1951). S Int. Rev. Code of 1954. §167(a). 'Anderson. Tax Planning of Real Estate 47 (1957). lId. at 48. 41 Revenue Act of 1964, §251. adding Int. Rev. Code of 1954. §1250. Published by Digital Commons @ Boston College Law School, 1964 1 Annual Survey of Massachusetts Law, Vol. 1964 [1964], Art. 6 §3.1 PROPERTY AND CONVEYANCING 23 problem appears to be particularly poignant when there is a landlord­ tenant relationship and the landlord has contributed money for the acq~isition of improvements. Generally speaking, a contributor or credItor who transfers money to another for the acquisition of prop­ erty does not have a depreciable interest unless the contribution or loan was made on such terms as to give it an investment status in the property.7 Thus, in Commissioner of Internal Revenue v. Revere Land Co.,s a lessor which had contributed more than a million dollars to the cost of a building erected by its lessee was denied a depreciation allowance. The lessor was to receive by way of rental an annual fixed return of 6 percent of an amount equal to the cost of the land plus the contribution. This problem recurred in the recent case of Buzzell v. United States.9 In Buzzell, the lessor and lessee agreed that the lessee should erect an eleven story building, and that to accomplish that end the lessor would lend the lessee the necessary funds, which the lessee would repay at defined times. It was further agreed that the lessee could surrender the premises and be discharged from liability under the lease at any time after the building had been completed, provided he had been (until that time) in "full performance of all his convenants and agreements under said lease." At a time when the tenant was in default, a question arose as to whether the lessor or lessee had a depreciable interest. The court held that the tenant, and not the landlord, was entitled to the depreciation allowance. Since he was in default, the tenant could not surrender the premises and be discharged from liability. Hence, the tenant remained a debtor, and as such the "investor" in the building. The Revenue Act of 1964 has opened up a new vista in the real estate field.10 An individual who is sixty-five years or older may .exclude from his gross income any capital gain attributable to the first $20,000 of the sale price of his personal residence, provided it has been owned and used by the taxpayer as his principal residence for at least five years during the eight-year period preceding the sale. This exclusion may induce older homeowners to sell their present residences which are now too large for their needs. If they are then interested in acquiring housing that combines apartment living with many of the advantages of individual home ownership, they may ac­ quire an interest in a condominium.11 Furthermore, by re-investing the proceeds of the sale of the old residence in a condominium unit, the tax bite is further soothed by the fact that gain will be recognized only to the extent that the taxpayer's adjusted sales price exceeds the cost of purchasing the condominium unit.12 7 Mertens, Law of Federal Income Taxation §23.06 (1960). 8169 F.2d 469 (3rd Cir. 1948), cert. denied, 335 U.S. 853 (1948). 9326 F.2d 825 (1st Cir. 1964). 10 Revenue Act of 1964, §206, adding Int. Rev. Code of 1954, §121. 11 See 1965 Ann. Surv. Mass. Law §1.5. 12 Int. Rev. Code of 1954, §1034. http://lawdigitalcommons.bc.edu/asml/vol1964/iss1/6 2 Schwartz: Chapter 3: Property and Conveyancing 24 1964 ANNUAL SURVEY OF MASSACHUSETTS LAW §3.2 The Revenue Act of 1964 has an important impact on other phases of real estate planning and counseling. The use of multiple corpo­ rations to own realty (as well as other assets) is discouraged.1s In addition, rental income may be personal holding company income even when it represents 50 percent or more of adjusted gross income, if other personal holding company income represents more than 10 percent of the company's ordinary gross income.14 §3.2. Percentage leases: Implied covenant to continue operations. The percentage lease has manifold advantages.l Its obvious and most fundamental purpose is to gear the landlord's return, and conversely the tenant's rent, to the productivity of the leased premises.2 In order to attain these ends adequately, it is imperative that the lease be prudently drafted.s In Stop 6- Shop, Inc. v. Ganem,4 decided during the 1964 SURVEY year, the Supreme Judicial Court was concerned with a percentage lease that failed to deal explicitly with the question of whether the lessee had an obligation to continue operations. The question posed for the Court's consideration was whether there was an implied covenant to continue operations. In concluding that there was no such implied covenant, the Court relied upon the fact that there was an apparently substantial minimum rent provided for and an absence of a showing of disparity between the fixed rent and the fair rental value. IS The Court further held that the burden of showing a dis­ parity between fixed rent and fair rental value was on the lessor.6 The approach adopted by the Court parallels that followed else­ where. Thus, when no guaranteed minimum rental is provided for in the lease, the courts have generally found an obligation on the part of the tenant to occupy and use the leased premises.7 A similar result has been reached when the guaranteed minimum rental was inadequate to meet the landlord's overhead costs.s Conversely, the existence of an implied covenant to continue operations has been denied when the guaranteed D,linimum was obviously more than was IS Revenue Act of 1964, §235, adding Int. Rev. Code of 1954, §§1561-1563. 14 Revenue Act of 1964, §225(d), amending Int. Rev. Code of 1954, §543(a) and (b). §3.2. 1 McMichael & O'Keefe, Leases, Percentage, Short and Long Term 36 (5th ed. 1959). 2 Note, 44 Com. L.Q. 251, 254 (1959). S See Landis, Problems in Drafting Percentage Leases, 36 B.V.L. Rev. 190 (1956); Van Doren, Some Suggestions for the Drafting of Long Term and Percentage Leases, 51 Co1um. L. Rev. 186 (1951); Note, 61 Harv. L. Rev. 317 (1948); Annota­ tion, 38 A.L.R.2d 1113 (1954). 41964 Mass. Adv. Sh. 1049, 200 N.E.2d 248. IS Id. at 1052, 200 N.E.2d at 251. 6 Ibid. 7 See Note, 44 Com. L.Q. 251, 256 (1959). See also cases cited in 1 American Law of Property §3.66, nn.9-11 (Casner ed. 1952); Schwartz, Lease Drafting in Massachusetts §6.11, n.5 (1961). 8 Schwartz, supra note 7. Published by Digital Commons @ Boston College Law School, 1964 3 Annual Survey of Massachusetts Law, Vol. 1964 [1964], Art. 6 §3.3 PROPERTY AND CONVEYANCING 25 required to pay the fixed charges.9 This method of handling the problem is consistent with the function that the parties intended the guaranteed minimum to serve.10 In the case being reviewed, the minimum rent in the lease appeared to be substantial in comparison to the lessor's fixed charges.