67 T.C. 71">*78 2. Option Consideration. As consideration for this Option Agreement, the OPTIONEE 1976 U.S. Tax Ct. LEXIS 37">*52 agrees to pay to the OPTIONOR quarter-annually, beginning on the date hereof, the sum of Nine Thousand Six Hundred and no/100 Dollars ($ 9,600.00). Such payments may be paid in cash or by check of the OPTIONEE made payable to the OPTIONOR and mailed or delivered to: * * * Upon default of OPTIONEE in making any of said quarter-annual payments for a period of ten (10) days after notice of default is served upon OPTIONEE by Registered or Certified Mail, this Option Agreement shall automatically terminate and the parties hereto shall thereupon be released and relieved from all further obligations hereunder. Payment in the manner set forth above within said ten (10) day period shall relieve the default.

Option money paid to keep the option in effect shall not be applied on the purchase price if the option is exercised.

* * *

5. Payment of Purchase Price. OPTIONEE shall pay twenty-nine percent (29%) of the purchase price in cash or by valid check at the time of closing of the sale and the balance shall be evidenced by a promissory note of the OPTIONEE, secured by a purchase money mortgage on the property covered hereby, payable in three (3) equal annual installments, plus interest1976 U.S. Tax Ct. LEXIS 37">*53 at the rate of six percent (6%) per annum payable annually on the unpaid balance of principal from time to time until the purchase price is paid in full. The first annual payment of principal and interest shall be payable one (1) year after the date of closing of the sale. The note and mortgage shall give full prepayment privileges to the mortgagor, without penalty, at any time after the first year following the date of closing.

On September 17, 1971, petitioner entered into an agreement with Sunlife which made reference to the agreement of June 30, 1969, as amended by agreements dated September 30, 1969, and December 16, 1969, and to the following separate agreements entered into on December 17, 1969, and then recited that the present agreement was independent of all the other agreements. This agreement provided in part as follows:

1. SELLER hereby grants unto PURCHASER the right and option to purchase the following described lands all upon the terms and conditions hereinafter set forth: * * * The purchase price of the above described land is Five Thousand Dollars ($ 5,000.00) per acre. Subject to the final number of acres that will be certified by boundary survey, the price 1976 U.S. Tax Ct. LEXIS 37">*54 is 90 x $ 5,000 = $ 450,000.00, and this land shall only be purchased as a whole.

2. As respects the lands which are the subject of this option agreement, same are hereby excluded from the option portion of the above referred to agreement of June 30, 1969, and amendments thereto.

3. This option shall continue from the date hereof for a period ending December 17, 1974. As consideration for this option, the PURCHASER agrees to pay to SELLER Three Thousand Three Hundred Seventy-five 67 T.C. 71">*79 Dollars ($ 3,375.00) on October 30, 1971, and agrees to pay the sum of Six Thousand Seven Hundred Fifty Dollars ($ 6,750.00) in quarter-annual payments commencing October 30, 1971 and continuing thereafter until this option is exercised or terminates as above provided. Therefore, the amount of the payment due October 30, 1971 shall be a total of Ten Thousand One Hundred Twenty-five Dollars ($ 10,125.00) and the quarter-annual payments thereafter shall be Six Thousand Seven Hundred Fifty Dollars ($ 6,750.00). Such payments shall be paid on or before the due dates to the SELLER'S attorneys, CARLTON, FIELDS, WARD, EMMANUEL, SMITH & CUTLER, P.A., at Tampa, Florida.

4. All terms, conditions and provisions1976 U.S. Tax Ct. LEXIS 37">*55 of the aforementioned agreement of June 30, 1969 and amendments thereto which previously applied to the lands which are the subject of this agreement are expressly incorporated herein by reference except as same are expressly modified or changed by this agreement.

* * *

6. Said contract of June 30, 1969, and as amended on September 30, 1969 and December 16, 1969, and thereafter and as further modified and amended by this agreement, is hereby ratified and confirmed by the parties hereto and the same shall inure to the benefit of and be binding upon said parties, their heirs, legal representatives and assigns respectively.

On April 20, 1972, Sunlife assigned its interest with respect to 1,000 lots covered by the agreement of June 30, 1969, to Fred C. Howard.

The following schedule shows the total payments received by petitioner under the contracts heretofore in part set forth during the years 1970 and 1971 broken down with respect to specific properties:

1976 U.S. Tax Ct. LEXIS 37">*56 The options covering parcels 5, 6, 7, and 8A, 8B, 9, 10A, 10B, 10D, and the 110 acres of Tarpon Springs Point were 67 T.C. 71">*80 exercised by Sunlife during 1972 and the option covering parcel 1 was exercised by Imperial during 1972. The option covering parcel 16 lapsed in 1970, and the option covering parcel 10C lapsed in 1971. The options on the 1,000 lots at Tarpon Springs and the 90 acres of Tarpon Springs property were either exercised or allowed to lapse sometime after 1972.

Petitioners on their Federal income tax returns for the calendar years 1970 and 1971, did not include in income payments received under the agreements with respect to petitioners' land, including the amounts received with respect to parcel 16 on which the option lapsed in 1970 and parcel 10C on which it lapsed in 1971.

Respondent in his notice of deficiency increased petitioners' income as reported by the amounts of $ 191,283.75 in 1970 and $ 400,550 in 1971, which he referred to as "contract payments." He explained the adjustment as follows:

It has been determined that taxable income should be increased for the tax years 1970 and 1971 in the amounts of $ 191,283.75 and $ 400,550.00, respectively, because such1976 U.S. Tax Ct. LEXIS 37">*57 amounts pertain to non-refundable cash payments received by you which constituted compensatory consideration or interest income with respect to certain contracts negotiated by you which granted the other party the right to purchase certain parcels of vacant land in the state of Florida. The payments received did not constitute part of the agreed selling price of the property in question because they were computed on the basis of three to six percent of the agreed selling price. Taxable income is increased accordingly.

OPINION

Respondent at the trial took three positions in support of the adjustment he made in petitioners' taxable income. He first contended that the payments referred to in the agreements were not in fact option payments and were in fact interest payments. Secondly, he contended that even if the payments were option payments, they were for options extending for only 3 months and, therefore, were includable in petitioners' income in the year in which paid because one option lapsed and another was begun with each quarterly payment. Thirdly, he argued that even if the payments were strictly option payments for 5- or 3-year options the amounts of such payments were1976 U.S. Tax Ct. LEXIS 37">*58 includable in petitioners' income in the year received since the amounts of the option payments 67 T.C. 71">*81 were not to be used to reduce the otherwise agreed-to purchase price of the land.

At the trial respondent stated that his Revenue Ruling 58-234, 1958-1 C.B. 279, ¹ was distinguishable and was not applicable to the present case since that revenue ruling dealt with "put" and "call" stock options and not real estate 67 T.C. 71">*82 options. The third argument made by respondent at the trial is not mentioned in respondent's brief. Revenue Ruling 58-234, supra, is not mentioned by respondent in either his original or reply brief, although petitioner relied on this ruling at the trial and in his opening brief. After further contending that the payments are interest payments rather than for an option, respondent, in his reply brief, summarizes his only other contention on brief as follows:

It is respondent's position under Virginia Iron Coal & Coke Co. and Treas. Reg. 1.1234-1(b) (as set out on pages 21 - 23 of its opening brief) that since the options terminated every three months, the payments received1976 U.S. Tax Ct. LEXIS 37">*59 in 1971 [sic] and 1972 [sic] attributable to lapsed options are taxable in those years as ordinary income.

1976 U.S. Tax Ct. LEXIS 37">*60 Respondent, in his first argument, contends that because the payments provided for in the agreement are stated in terms of a percentage of the total purchase price and "because this percentage was at least partially intended to be interest," the payments are in reality interest and taxable in the year of their receipt under section 61(a)(4). ²

We have quoted in some detail the agreements involved in this case. These agreements are clearly option agreements. As we have pointed out in a number of cases, the clear distinction between an option and a contract of sale is that an option gives a person a right to purchase at a fixed price within a limited period of time but imposes no obligation on the person to do so, whereas a contract of sale contains mutual and reciprocal obligations, the seller being obligated to sell and the purchaser being obligated to buy. W. A. Drake, Inc., 3 T.C. 33">3 T.C. 33, 3 T.C. 33">37 (1944),1976 U.S. Tax Ct. LEXIS 37">*61 affd. 145 F.2d 365">145 F.2d 365 (10th Cir. 1944); Geo. S. Carter, 36 T.C. 128">36 T.C. 128, 36 T.C. 128">130 (1961). As we stated in Estate of Charles T. Franklin, 64 T.C. 752">64 T.C. 752, 64 T.C. 752">763 (1975):

If an option is not exercised, the optionor becomes entitled to keep only the amount paid as consideration for granting the option (the tax consequences being controlled by section 1234) and has no enforceable right of action against the optionee for damages. United States Freight Co. v. United States, 190 Ct. Cl. at 739-740; 422 F.2d at 895.

A contract of sale, in contrast, carries mutual obligations on the part of the seller to sell and the buyer to buy. See W. A. Drake, Inc. v. Commissioner, * * *; Lawler v. Commissioner, 78 F.2d 567">78 F.2d 567, 78 F.2d 567">568 (9th Cir. 67 T.C. 71">*83 1935). It "is a contract 'to pass rights of property for money, -- which the buyer pays or promises to pay to the seller.'" Commissioner v. Brown, 380 U.S. 563">380 U.S. 563, 380 U.S. 563">571 (1965). The purchaser in such a bilateral contract is liable for full contract damages if he fails to1976 U.S. Tax Ct. LEXIS 37">*62 perform. United States Freight Co. v. United States, * * *. Accordingly, a contract of sale imposes an enforceable obligation to pay the purchase price, which will support interest deductions and give the purchaser a cost basis in the property on which depreciation is allowable.

The agreements here bound petitioner to sell the property to Sunlife during a period of 5 years if the option was kept in force, but did not bind Sunlife to purchase any of the property. Sunlife was privileged to exercise the right to purchase in accordance with the agreement, provided the necessary payments had been made to keep the agreement in full force and effect, but could let any one of the options lapse at any time without exercising the right granted and had no further obligation to petitioner.

Under these facts it is clear that there was no indebtedness of Sunlife to petitioner in the ordinary sense of the word. An indebtedness has many times been held by us to be an "existing, unconditional, and legally enforceable obligation for the payment of a principal sum." Sterling G. Howlett, 56 T.C. 951">56 T.C. 951, 56 T.C. 951">960 (1971). Ordinarily, interest is an amount paid by a person1976 U.S. Tax Ct. LEXIS 37">*63 on an indebtedness for the use of, or forbearance to require immediate payment of, a stated sum.

It is true, as respondent points out, that there have been cases in which we have found that, although a contract did not specifically call for interest payments, the terms of the contract as a whole were such that some part of the payments to be made was properly to be considered, for purposes of Federal taxation, as interest payments.

One such case typical of this general type of case is Judson Mills, 11 T.C. 25">11 T.C. 25 (1948), cited by respondent. That case involved certain agreements denominated as leases requiring monthly payments which were denominated as rentals of machinery. Under the agreement, at the end of a 5-year period, the lessee was entitled to acquire the machinery for a small additional payment. We concluded in that case that the payments were not rental payments but were payments made by the taxpayer to acquire title to the machinery and that by these payments the taxpayer was acquiring substantial equity ownership of the machinery. We then concluded, based on the 67 T.C. 71">*84 fact that the evidence showed that the parties had arrived at the amount1976 U.S. Tax Ct. LEXIS 37">*64 of monthly payment on the basis of a principal amount as the cost of the machinery with an increase for amounts computed to represent interest, that in substance the agreements called for interest payments and that the taxpayer should be sustained in his alternative contention that a portion of the amount was deductible as interest. It is apparent that the factual situation in the Judson Mills case is completely different from that in the instant case. Where we have concluded that in substance the payments under an agreement were either for rental or for an option to purchase property we have held that the payments were to be so treated. See Kitchin v. Commissioner, 353 F.2d 13">353 F.2d 13 (4th Cir. 1965), affg. a Memorandum Opinion of this Court; 56 T.C. 951">Sterling G. Howlett, supra; and Dill Co., 33 T.C. 196">33 T.C. 196 (1959), affd. 294 F.2d 291">294 F.2d 291 (3d Cir. 1961).

The case of Jones v. Commissioner, 330 F.2d 302">330 F.2d 302 (3d Cir. 1964), remanding 40 T.C. 249">40 T.C. 249 (1963), involved a totally different situation from that involved in the instant case. 1976 U.S. Tax Ct. LEXIS 37">*65 That case involved an individual who purchased remainder interests, which were contingent on the owners surviving the life tenants, that were sold at a discount by the taxpayer after the death of the life tenants. In our view, that case has no bearing on the problem involved in the instant case.

We do not share respondent's view that because the payments were expressed as a percentage of the purchase price, they should be considered as interest payments. In fact the Imperial Land Co. option was in terms of a fixed amount, but otherwise the same as the other agreements. In our view, the use of a percentage figure for the option payments was merely for convenience since the original agreement provided for exercise of the privilege in part. We conclude that the payments petitioner received under the agreements were in return for the continuing right of the optionee to purchase the property and so were payments for options.

Our concluding that the payments were for the granting of the options does not dispose of this case. Most of the cases dealing with option payments involved contracts which specifically provided for the option payments being used to reduce the stated purchase1976 U.S. Tax Ct. LEXIS 37">*66 price if the option were exercised. Under these circumstances, the option price would have no 67 T.C. 71">*85 element of compensation in the nature of interest unless the purchase price itself included such an element. Certainly it is not unrealistic to assume, in case of a long-term option with a stated purchase price, that the purchase price might be fixed to include some element of interest. However, the fact that the payments here were not to reduce the stated purchase price if the option were exercised does not cause them not to be as specifically stated in the agreements, payments for keeping the options effective.

Respondent, in support of his argument that the agreements provided for a series of options each expiring at the end of a 3-month period, relies on Koplin v. Bennett, 155 So. 2d 568 (Fla. Ct. App. 1963); Ratner v. Coral Television Corp., 139 So. 2d 437 (Fla. Ct. App. 1962); and Melvin v. West, 107 So. 2d 156 (Fla. Ct. App. 1958). None of these cases support respondent's contention. Both Koplin v. Bennett, supra, and Melvin v. West, supra,1976 U.S. Tax Ct. LEXIS 37">*67 hold merely that there must be consideration for an option contract and a mere offer to sell without consideration being paid by the person to whom the offer is made is revocable at any time prior to the acceptance of the offer. Ratner v. Coral Television Corp., supra, holds that failure to exercise an option may be waived or the option may be extended by a new contract. None of these cases deals with a situation of an option for a stated period of time with the option lapsing unless periodical payments are made.

In our view, the options here were clearly options for periods of 5 and 3 years and were not a series of 3-month options. The case of Virginia Iron Coal & Coke Co., 37 B.T.A. 195">37 B.T.A. 195 (1938), affd. 99 F.2d 919">99 F.2d 919 (4th Cir. 1938), involved an option agreement that could be retained for a period of 5 years by a payment of $ 300,000 on August 1 of the first year and $ 125,000 on the first day of August in each succeeding year for the 5-year period. In that case, after the first payment of $ 125,000 the holder of the option permitted it to expire. Thereafter, the holder of the option notified1976 U.S. Tax Ct. LEXIS 37">*68 the grantor of the option that the option would not be exercised. We held that the two payments which kept the option in effect were includable in the taxpayer's income in the year in which the option was surrendered.

Even though respondent does not argue on brief that the option payments are includable in petitioner's income in the 67 T.C. 71">*86 year these payments were received because these payments were not to be used to reduce the stated purchase price of the property, he has not specifically waived this contention. We therefore consider this issue to still remain in the case.

In the Virginia Iron Coal & Coke Co. case, we stressed that it was impossible to tell when the payments were received whether they would ultimately represent income to the taxpayer or a return of capital. We pointed out that the payments were to be applied against the purchase price in case of the exercise of the option and that, therefore, only upon termination of the option would it be apparent whether the payments represented clear gain to the taxpayer rather than a return of capital. We also stressed the fact that even though the payments were received in the earlier years without any obligations1976 U.S. Tax Ct. LEXIS 37">*69 to return them, there was the condition attached to their receipt that they had to be applied against the purchase price in case the option was exercised. We then stated (37 B.T.A. 195">37 B.T.A. at 199):

That one condition is the determining factor in this case. Until it was removed in 1933, the question of the liability of the recipient for income tax upon the payments had to be held in abeyance. Similar cases of forfeiture arise under contracts of sale and are treated the same way. * * *

Insofar as we have been able to determine in other cases involving the treatment of option payments, either the contract has clearly provided that the payment would be offset against the purchase price of the property which was the subject of the option or we have concluded from the contract as a whole that in fact the payment was at least partially a part of the purchase price if the options were exercised.

33 T.C. 196">Dill Co., supra, involved a contract whereby the taxpayer granted a license to a corporation to manufacture a product owned by it under a trademark for a stipulated royalty. The license was granted for a period of 5 years with the option to 1976 U.S. Tax Ct. LEXIS 37">*70 the licensee to purchase the trademark at the end of the 5-year period upon payment of $ 350,000, or upon payment of $ 50,000 obtain a 5-year extension of the license agreement with the right at the close of any calendar year during the additional 5-year period to purchase the taxpayer's interest in the trademark for $ 300,000. In that case we stated (33 T.C. 196">33 T.C. 199):

67 T.C. 71">*87 On the one hand it appears the $ 50,000 was paid in consideration for a 5-year extension of the license agreement; and yet, on the other, it seems clear that the payment was also intended to reduce or be applied against the agreed purchase price in the event the option to purchase was exercised.

There was no specific statement in the contract in the Dill case that the $ 50,000 was to be credited on the purchase price of the trademark. In fact, such an inference could be drawn only from the fact that during the second 5-year period the agreed purchase price was reduced by $ 50,000. We concluded (33 T.C. 196">33 T.C. 200) that "the $ 50,000 payment was intended to serve both as consideration for the extension of the agreement, and as a payment on account of1976 U.S. Tax Ct. LEXIS 37">*71 the purchase price should the option to purchase be exercised." We therefore held that the character of the $ 50,000 payment could not be determined until either the option to purchase was exercised or lapsed, relying on 37 B.T.A. 195">Virginia Iron Coal & Coke Co., supra.In the Dill case we distinguished cases such as Gilken Corp., 10 T.C. 445">10 T.C. 445 (1948), affd. 176 F.2d 141">176 F.2d 141 (6th Cir. 1949), on the ground that such cases involved whether a contract was one of sale or of rental, making it necessary to determine whether a lump sum payment was an initial rental payment or a part of the sales price. See also 353 F.2d 13">Kitchin v. Commissioner, supra.

In the instant case we have little to turn to other than the provisions of the contracts themselves to determine whether the negotiated purchase price was in fact less than it would have been had the option payments been used as a reduction of that price. If the purchase prices were less than they would have been had the option payments been used to reduce those prices if the option were exercised, then, in effect, the option payments did serve1976 U.S. Tax Ct. LEXIS 37">*72 as a reduction of purchase price. Certainly, when an option is granted fixing a purchase price for property for a period of years, it is reasonable that a payment be required to compensate the grantor of the option for the normally to be expected increase in the price of the property under option, since he is obligated to deliver the property at the stated price but the person to whom the option is given is not obligated to purchase the property. ³

1976 U.S. Tax Ct. LEXIS 37">*73 67 T.C. 71">*88 Since the grantor of the option has use of the property until the option is exercised, under some circumstances returns from the use of the property while it is under option would serve the function that interest might serve had a sale been made of the property and the property delivered to the purchaser. However, under other circumstances where the property is not income-producing, as apparently was the case here, the only return from the land while held by petitioner was the anticipated increase in its value.

There is no indication in the record in this case that petitioner's land was returning any income. However, presumably some use might have been made of the land while it was still owned by and in possession of petitioner, even though under option. Certainly it might be that the option payments contained some element of compensation for petitioner's being unable to immediately obtain money from the sale of property because of the property being under option. If this is assumed, then the option payments would be for the dual purpose of this form of compensation and for increment in value of the property. This latter purpose would effectively be the same as if the1976 U.S. Tax Ct. LEXIS 37">*74 purchase price of property had been fixed to account for such expected increment and the option payments used to reduce that purchase price. Under such circumstances we held in the Dill case that the character of payment could not be determined until either the option to purchase was exercised or lapsed.

67 T.C. 71">*89 It might be pointed out that respondent's Revenue Ruling 58-234, supra (see n. 1), reaches the conclusion with respect to option payments which are not to be used in reduction of the purchase price that the effect is no different than a higher price for the property reduced by the option payments if the option is exercised.

Of course petitioner incorrectly failed to report the option payments received with respect to those properties where the options expired in the years here in issue. Other than with respect to these option payments, we hold that petitioner was correct in not reporting the option payments in the years here in issue.

Decision will be entered under Rule 155.