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lent to cash, and the profit indicated by the entire consideration is taxable income for the year in which the initial payment was made and the obligations assumed. If the buyer defaults and the seller regains title to the land by agreement or process of law, retaining payments previously made, he may deduct from his gross income as a loss such proportion of the defaulted payments as was previously returned as income, provided that so much of the selling price previously received as has not been reported as income is accounted for in the inventory of the property by deduction from the original cost.29

29 Reg. 45, Art. 43.

CHAPTER 21

INCOME FROM RENT

Rent is returnable as income in the year in which it is received, and not necessarily in the year in which it becomes due. Thus, where a tenant pays part of his rent for the preceding year on the second day of January of the following year, the amount so paid is income to the landlord for the year in which it is received, and not the year which it covers. This rule, however, is not absolute, as the landlord may, if he keeps his books accordingly, report the rent for the year in which the income accrues and charge against it the deductions for the same period.

Value of Improvements Made by Tenant. Where, under the terms of a rental or lease contract, a tenant agrees to erect a building or to expend during the rental period a certain fixed sum in making improvements upon the freehold of the lessor, it is held for income tax purposes that the building or permanent improvement becomes a part of the realty unless otherwise agreed between the contracting parties; and, as such, must be accounted for as gain or profit to the lessor at the time the lease is terminated, whether terminated by expiration or otherwise. The amount of the gain or profit to the lessor at the termination of the lease is the difference between the cost of the building or improvement so made by the tenant and a reasonable allowance for depreciation during the period of its life under the lease.3

1 Letter from Treasury Department dated February 26, 1915; I. T. S. 1918, 1353.

2 Letter from Treasury Department dated February 9, 1915; I. T. S., 1918, 97 15% and 354. 3 Reg. 33 Rev., Art. 4; Reg. 45, Art. 45; T. D. 2442. It necessarily Lessor Corporations. Where a corporation leases all of its property to another and specifies that the consideration therefor shall be paid direct to its stockholders and bondholders or creditors the lessor corporation is, nevertheless, held to be the proper recipient of the income and must report, as rent, the amount so paid to its stockholders, bondholders or creditors by the lessee.

Payments by Tenant on Behalf of Landlord. Where under the terms of a lease a tenant pays taxes, repairs or interest, or makes any other payments for and on behalf of the landlord, the amount of such payments constitutes income to the landlord and should be reported by him as such. The theory covering these transactions is that the tenant is acting merely as agent for the landlord in making such payments. The expenses are the landlord's, which he may deduct from his net income, and the amounts used to defray such expenses must be included by the landlord as his net income. Such payments may be deducted by the tenant as rent in the year in which they are paid.

Receipt of Rent in Kind. Where rent is received in the form of produce, as for instance, a share of the crops of a farm, the amount realized on the sale of such share must be included as income in the year in which the share is disposed of or reduced to money or its equivalent. Where board or lodging is given as the equivalent of rent, the value of such board or lodging is required to be included.?

follows that the tenant may consider the cost of the building as a part of his rental payments and may deduct such amount as an expense, pro-rating the original cost over the number of years constituting the term of the lease.

4 For a further discussion of this subject see sub-heading entitled Lessor and Lessee Corporations in Chapter 12 on Corporations.

6 Reg. 33 Rev., Art. 4.
6 Reg. 33 Rev., Art. 8.
7 See Chapter 16, p. 312.

CHAPTER 22

INCOME FROM INTEREST

Income derived in the form of interest is taxable in the hands of citizens and residents and domestic corporations whether received from debtors in this country or debtors in foreign countries. Interest is taxable in the hands of non-resident aliens and foreign corporations when it is paid on bonds, notes or other interest-bearing obligations of residents, corporate or otherwise. 1

Interest Exempt from Tax, The Revenue Act of 1918 expressly provides that interest upon the obligations of a state, territory or possession of the United States, and any political subdivision thereof, or the District of Columbia, or securities issued under provisions of the Federal Farm Loan Act of July 17, 1916, or interest upon the obligations of the United States issued prior to September 1, 1917, (and to a limited extent the interest on obligations issued after that date) and bonds issued by the War Finance Corporation, to the extent noted below, shall not be included in gross income, and shall be exempt from income tax.?

Interest on Obligations of the United States. terest received on obligations of the United States, issued on or before September 1, 1917, is not to be included in gross income and is exempt. In the case of obligations issued after that date the interest is exempt only if and to the extent provided in the respective acts, authorizing the issue thereof as amended and supplemented and is

In

1 Revenue Act 1918, 88 213 (c) and 233 (b). 2 Revenue Act of 1918, $ 213 (b) 4.

excluded from gross income only if and to the extent it is wholly exempt from taxation to the taxpayer both from income (normal and surtax) and profits taxes. Interest credited to postal savings accounts upon moneys deposited in postal savings banks on or before September 1, 1917, is exempt from income tax, while interest credited upon deposits made subsequently to September 1, 1917, is liable to tax. Interest on the bonds of the first liberty loan is entirely exempt from tax, but that absolute exemption is lost if the bonds are converted into bonds of later issues. 4

Liberty Bond Exemption from Normal Tax, The Sec. ond Liberty Bond Act of September 24, 1917, as amended by the Third Liberty Bond Act of April 4, 1918, and by the Fourth Liberty Bond Act of July 9, 1918, provides:

Sec. 7. That none of the bonds authorized by section one, nor of the certificates authorized by section five, or by section six, of this Act, shall bear the circulation privilege. All such bonds and certificates shall be exempt, both as to principal and interest from all taxation now or hereafter imposed by the United States, any State, or any of the possessions of the United States, or by any local taxing authority, except (a) estate or inheritance taxes, and (b) graduated additional income taxes, commonly known as surtaxes, and excess-profits and war-profits taxes now or hereafter imposed by the United States, upon the income or profits of individuals, partnerships, associations, or corporations. The interest on an amount

3 Revenue Act of 1918, $$ 213 (b) 4 and 233. Under earlier income tax laws, interest upon the obligations of the United States was expressly included as taxable income (see Act of March 2, 1867). Under the 1909 Law the Attorney General held that interest on national bonds should be included as income of corporations, since the tax was not on property, but a tax on the privilege of carrying on business (28 Op. Atty. Gen. 138).

4 Reg. 45, Art. 76.

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