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Applying the foregoing to the instant case, we conclude that
(1) petitioners’ expenditures dealt with in this issue are
capital expenditures and (2) (unless some other provision or rule
leads to a different result) petitioners’ deductions on account
of these expenditures are determined under sections 167 and 168,
and not under section 162(a)(3).
There is a nonstatutory exception to the foregoing that
applies to the instant case. Where a lessee makes a capital
expenditure in lieu of some rent, then the expenditure will be
treated as rent and not as a capital expenditure by the lessee.
This exception’s rationale is explained, and its application is
illustrated, in Your Health Club, Inc. v. Commissioner, 4 T.C.
385, 389-390 (1944), as follows:
The second question relates to the deductibility of
rent in the amount of $4,250 in the fiscal year ended March
31, 1940. The facts show that petitioner had obligated
itself to pay rental for that year in the amount of $4,250,
but that a clause in the lease provided that petitioner
might make certain improvements to the premises, the cost of
which to the extent of $1,500 might be applied to the
contractual rental. Petitioner expended $1,374.96 in making
such improvements, applying this amount as a credit against
the total rent due, and paid the lessor the difference,
$2,875.04. The Commissioner determined that only the latter
amount was deductible as rent and disallowed the deduction
of the amount of $1,374.96, adding it to capital and making
proper adjustment for amortization. Petitioner contends
that the disallowed item was properly deductible as rent.
Petitioner does not question the general rule that the
cost borne by a lessee in making permanent improvements upon
leased property is a capital expenditure, but contends that
the outlay in this instance was no more than an indirect
payment of a part of the stipulated rental, inasmuch as it
was agreed that the cost of the improvements should be
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