AINSWORTH, Circuit Judge:
This appeal by Herman H. Anderson and his wife
from the United States Tax Court’s decision presents the issue of when a cash basis taxpayer may deduct prepaid interest. After moving to California in June 1968, Anderson, a successful real estate builder and investor, was approached by Lytton Savings and Loan Association of Northern California (Lytton) about the possibility of purchasing Adobe Wells Motor Home Park. Several months of negotiations followed. On August 2, 1968, the parties signed a Letter of Intent for the purchase. According to that document, Lytton intended to sell the property for $2,700,000 financed by a twenty-year loan which required prepayment of approximately $500,000, representing interest for approximately thirty months. A more formal agreement was to be executed within twenty-five days during which time the property would not be sold to anyone else. Nonetheless, a contract for Anderson’s purchase of the property was not completed until December 27,1968. During this interim, a second potential buyer made a higher offer for the property and the cost of completing the trailer park also increased. As a result, the price finally agreed upon with Anderson increased from $2,700,000 to $2,995,000. The closing of the transaction and prepayment of interest finally occurred on December 30, 1968.
In 1968 Anderson had income of $652,-894.36. Anderson, a cash basis taxpayer, deducted the entire amount of prepaid interest in the Adobe Wells deal, the sum of $500,000, in that year. Along with other deductions, this resulted in his having a $28,491 net loss for tax purposes.
An IRS audit of Anderson’s return resulted in a disallowance of taxpayer’s deduction of the entire $500,000 of prepaid interest in 1968 and required Anderson to allocate the prepayment over the taxable years involved in the loan. The result was a tax deficiency for 1968. The IRS determination was in accordance with its Revenue Ruling 68-643, 1968-2 C.B. 76, issued on November 26, 1968. Taxpayer’s petition to the Tax Court resulted in an adverse decision and Anderson appealed to this Court.
Anderson is, of course, entitled to a deduction for the $500,000 interest paid on money borrowed to purchase the trailer park since “[t]here shall be allowed as a deduction all interest paid on accrued within the taxable year on indebtedness.” I.R.C. § 163(a). However, the dispute here involves the year or years in which the deduction may be taken. The solution depends on the accounting method used. A cash basis taxpayer would normally be able to deduct interest only in the year paid while an accrual basis taxpayer would be able to deduct interest only when he received the benefits of the prepayment.
See
I.R.C. § 461(a).
Usually a taxpayer may apply his regular accounting method for computing his taxable income and his allowable deductions.
See
I.R.C. §§ 446(a), 461(a). However, a different method may be compelled if his accounting method does not “clearly reflect income.”
See
I.R.C. § 446(b).
The Internal Revenue Service initially resisted efforts by cash basis taxpayers to deduct the entire prepayment of interest in the year of payment. However, after the decisions in
Fackler v. Commissioner,
39 B.T.C. 395 (1939),
a cq.
1939-1 C.B. 11,
acq. withdrawn
1968-3 C.B. 3, and
Court Holding Company v. Commissioner,
2 T.C. 531 (1943),
a cq.
1943 C.B. 5,
acq. withdrawn
1968-2 C.B. 3, the Commissioner accepted the position that for interest paid for less than five years in advance, a cash basis taxpayer would have an allowable deduction for the year in which the amount was paid. In 1968, however, the Commissioner changed his policy in this regard and issued a Revenue Ruling which required a cash basis taxpayer to deduct the interest over the period for which it was paid. By its terms the ruling was made effective for prepaid interest payments for a period not in excess of five years made on or after November 26, 1968.
We find the Commissioner’s position in Revenue Ruling 68-643 valid as applied to this transaction. This change can be justified on several grounds. Requiring the taxpayer to accrue the prepayment to interest is consistent with the treatment of other prepayments such as prepaid insurance or rent.
See
Asimow, Principle and Prepaid Interest, 16 U.C.L.A.L.Rev. 36, 74-84 (1968). In addition, prepaid interest, particularly in real estate transactions, was becoming a major form of tax avoidance.
See id.
at 37-38. Finally, while the earlier cases had been concerned about the fairness of requiring a taxpayer to change his accounting method with respect to a single item,
see, e. g., Fackler v. Commissioner, supra,
later versions of the Internal Revenue Code explicitly authorized hybrid methods of accounting.
See
I.R.C. § 446(c)(4). Other circuits which have considered the Commissioner’s current stance on the deductibility of prepaid interest by a cash basis taxpayer have approved singling out prepaid interest
for separate accounting treatment.
See Resnik v. Commissioner of Internal Revenue,
7 Cir., 1977, 555 F.2d 634;
Sandor v. Commissioner of Internal Revenue,
9 Cir., 1976, 536 F.2d 874;
Burck v. Commissioner of Internal Revenue, 2
Cir., 1976, 533 F.2d 768.
Further, we find that the validity of Revenue Ruling 68-643 is unimpaired by recent legislation requiring a cash basis taxpayer to treat any prepayment of interest as paid in the period to which the interest is allocable.
See
I.R.C. § 461(g).
While conflicting legislative history can be cited, most of the statements in the committee reports accompanying the legislation indicate that
no inference should be drawn concerning the deductibility of prepaid interest paid before the effective dates of the new rule. It is expected that deductions for such prepayments will be determined according to the criteria of present law.
S.Rep.No.94-938, 94th Cong., 2d Sess. 105 (1976), U.S.Code Cong. & Admin.News 1976, p. 3541. Moreover, the taxpayer is incorrect in his contention that the amendment would be unnecessary if Revenue Ruling 68-643 properly interpreted the then existing law. While this legislation controls transactions within the scope of that Ruling, the amended legislation also requires accrual of the interest deductions in situations not covered by Revenue Ruling 68-643. That Revenue Ruling treated prepayments for less than twelve months in advance on a case by case basis.
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AINSWORTH, Circuit Judge:
This appeal by Herman H. Anderson and his wife
from the United States Tax Court’s decision presents the issue of when a cash basis taxpayer may deduct prepaid interest. After moving to California in June 1968, Anderson, a successful real estate builder and investor, was approached by Lytton Savings and Loan Association of Northern California (Lytton) about the possibility of purchasing Adobe Wells Motor Home Park. Several months of negotiations followed. On August 2, 1968, the parties signed a Letter of Intent for the purchase. According to that document, Lytton intended to sell the property for $2,700,000 financed by a twenty-year loan which required prepayment of approximately $500,000, representing interest for approximately thirty months. A more formal agreement was to be executed within twenty-five days during which time the property would not be sold to anyone else. Nonetheless, a contract for Anderson’s purchase of the property was not completed until December 27,1968. During this interim, a second potential buyer made a higher offer for the property and the cost of completing the trailer park also increased. As a result, the price finally agreed upon with Anderson increased from $2,700,000 to $2,995,000. The closing of the transaction and prepayment of interest finally occurred on December 30, 1968.
In 1968 Anderson had income of $652,-894.36. Anderson, a cash basis taxpayer, deducted the entire amount of prepaid interest in the Adobe Wells deal, the sum of $500,000, in that year. Along with other deductions, this resulted in his having a $28,491 net loss for tax purposes.
An IRS audit of Anderson’s return resulted in a disallowance of taxpayer’s deduction of the entire $500,000 of prepaid interest in 1968 and required Anderson to allocate the prepayment over the taxable years involved in the loan. The result was a tax deficiency for 1968. The IRS determination was in accordance with its Revenue Ruling 68-643, 1968-2 C.B. 76, issued on November 26, 1968. Taxpayer’s petition to the Tax Court resulted in an adverse decision and Anderson appealed to this Court.
Anderson is, of course, entitled to a deduction for the $500,000 interest paid on money borrowed to purchase the trailer park since “[t]here shall be allowed as a deduction all interest paid on accrued within the taxable year on indebtedness.” I.R.C. § 163(a). However, the dispute here involves the year or years in which the deduction may be taken. The solution depends on the accounting method used. A cash basis taxpayer would normally be able to deduct interest only in the year paid while an accrual basis taxpayer would be able to deduct interest only when he received the benefits of the prepayment.
See
I.R.C. § 461(a).
Usually a taxpayer may apply his regular accounting method for computing his taxable income and his allowable deductions.
See
I.R.C. §§ 446(a), 461(a). However, a different method may be compelled if his accounting method does not “clearly reflect income.”
See
I.R.C. § 446(b).
The Internal Revenue Service initially resisted efforts by cash basis taxpayers to deduct the entire prepayment of interest in the year of payment. However, after the decisions in
Fackler v. Commissioner,
39 B.T.C. 395 (1939),
a cq.
1939-1 C.B. 11,
acq. withdrawn
1968-3 C.B. 3, and
Court Holding Company v. Commissioner,
2 T.C. 531 (1943),
a cq.
1943 C.B. 5,
acq. withdrawn
1968-2 C.B. 3, the Commissioner accepted the position that for interest paid for less than five years in advance, a cash basis taxpayer would have an allowable deduction for the year in which the amount was paid. In 1968, however, the Commissioner changed his policy in this regard and issued a Revenue Ruling which required a cash basis taxpayer to deduct the interest over the period for which it was paid. By its terms the ruling was made effective for prepaid interest payments for a period not in excess of five years made on or after November 26, 1968.
We find the Commissioner’s position in Revenue Ruling 68-643 valid as applied to this transaction. This change can be justified on several grounds. Requiring the taxpayer to accrue the prepayment to interest is consistent with the treatment of other prepayments such as prepaid insurance or rent.
See
Asimow, Principle and Prepaid Interest, 16 U.C.L.A.L.Rev. 36, 74-84 (1968). In addition, prepaid interest, particularly in real estate transactions, was becoming a major form of tax avoidance.
See id.
at 37-38. Finally, while the earlier cases had been concerned about the fairness of requiring a taxpayer to change his accounting method with respect to a single item,
see, e. g., Fackler v. Commissioner, supra,
later versions of the Internal Revenue Code explicitly authorized hybrid methods of accounting.
See
I.R.C. § 446(c)(4). Other circuits which have considered the Commissioner’s current stance on the deductibility of prepaid interest by a cash basis taxpayer have approved singling out prepaid interest
for separate accounting treatment.
See Resnik v. Commissioner of Internal Revenue,
7 Cir., 1977, 555 F.2d 634;
Sandor v. Commissioner of Internal Revenue,
9 Cir., 1976, 536 F.2d 874;
Burck v. Commissioner of Internal Revenue, 2
Cir., 1976, 533 F.2d 768.
Further, we find that the validity of Revenue Ruling 68-643 is unimpaired by recent legislation requiring a cash basis taxpayer to treat any prepayment of interest as paid in the period to which the interest is allocable.
See
I.R.C. § 461(g).
While conflicting legislative history can be cited, most of the statements in the committee reports accompanying the legislation indicate that
no inference should be drawn concerning the deductibility of prepaid interest paid before the effective dates of the new rule. It is expected that deductions for such prepayments will be determined according to the criteria of present law.
S.Rep.No.94-938, 94th Cong., 2d Sess. 105 (1976), U.S.Code Cong. & Admin.News 1976, p. 3541. Moreover, the taxpayer is incorrect in his contention that the amendment would be unnecessary if Revenue Ruling 68-643 properly interpreted the then existing law. While this legislation controls transactions within the scope of that Ruling, the amended legislation also requires accrual of the interest deductions in situations not covered by Revenue Ruling 68-643. That Revenue Ruling treated prepayments for less than twelve months in advance on a case by case basis. In addition, cases under that Revenue Ruling required a showing that the prepayment of interest materially distorted the taxpayer’s income.
See Burck
v.
Commissioner, supra,
at 773-74. The amended section 461 now automatically disallows a deduction for any prepayment of interest, even those for less than twelve months, which is properly allocable to another taxable year and without any necessity of showing that income was distorted. Since this new subsection 461(g) extends to transactions beyond the reach of Revenue Ruling 68-643, the validity of that Ruling would not reduce the need for this legislation.
The Tax Court correctly applied Revenue Ruling 68-643 to the facts presented here. Only two days of the approximately thirty months for which the interest was paid occurred in the 1968 taxable year. The amount of the prepayment was substantial, $500,000. In fact, if deductible, this prepayment, along with other deductions, would enable the taxpayer to claim a net loss in a year in which he received more than $650,000 of income. “The Commissioner has broad powers in determining whether accounting methods used by a taxpayer clearly reflect income . .”
Commissioner v. Hansen,
360 U.S. 446, 467, 79 S.Ct. 1270, 1282, 3 L.Ed.2d 1360 (1952). Under this standard, the Tax Court’s determination that taking the entire deduction in 1968 under these circumstances had the effect of materially distorting income was correct and should not be upset.
The only remaining point is Anderson’s allegation that the agreement to purchase the property and to prepay the interest was a binding contract prior to Novem
ber 27, 1968 and thus was not covered by Revenue Ruling 68-643. While the parties engaged in negotiations before November 27, the record does not support a finding that a contract was reached prior to December 27, 1968. The only basis for such a finding would be the Letter of Intent dated August 2, 1968.
But under California law this document is insufficient for a contract.
There is no meeting of the minds of the' parties while they are merely negotiating as to the terms of the agreement to be entered into. To be final the agreement must extend to all the terms which the parties intend to introduce, and material terms cannot be left for future settlement .
Dillingham v. Dahlgren,
52 Cal.App. 322, 329, 198 P. 832, 835 (1921). In particular, a binding contract for the sale of property must specify “the seller, the buyer, the price to be paid, the time and means of payment, and the property to be transferred . . .
King v. Stanley,
1948, 32 Cal.2d 584, 197 P.2d 321
(en banc).
The Letter of Intent fails to comply with these standards. The purchase price, a critical item in a contract, was increased by almost $300,000 between the signing of the Letter and the signing of a final contract. While Anderson contends that the parties agreed that the final price would depend on the costs of completing the project, the Letter of Intent provided no method for determining the price and instead left the matter to future negotiations. The Letter also failed to state any time for the transaction to occur. From the record it does not appear that Lytton could compel Anderson to pay interest for any time prior to the signing of the promissory note in December. Finally, the Letter clearly contemplated the possibility that the transaction would not be consummated since it stated that the Letter was null and void if a later written agreement was not reached and only prohibited the sale of the property to third parties for a period of twenty-five days. The record does not include sufficient evidence of any prior oral contract to support a conclusion that the Tax Court erred in its decision that no contract existed prior to November 27, 1968. Hence, taxation of this transaction is governed by Revenue Ruling 68-643 and the deficiency was properly assessed.
AFFIRMED.