Case Name: Appeal of Lenox Land Co.
Court: United States Board of Tax Appeals
Jurisdiction: United States
Decision Date: 1927-01-26
Citations: 5 B.T.A. 1206
Docket Number: Docket No. 1083
Parties: Appeal of Lenox Land Co.
Judges: 
Reporter: Reports of the United States Board of Tax Appeals
Volume: 5
Pages: 1206–1211

Head Matter:
Appeal of Lenox Land Co.
Docket No. 1083.
Promulgated January 26, 1927.
W. H. Cloud, Esq., and Eugene M. Lynn, C. P. A., for the petitioner.
Arthur J. Seaton, Esq., for the Commissioner.

Opinion:
OPINION.
Lansdon:
Each party insists that the only problem presented is the determination of the cash value of the leasehold in question when it was acquired by the petitioner in exchange for shares of stock at March 17, 1908. At the same time the parties agree that such valuation must be the basis for the computation of the petitioner's invested capital, and also for the determination of the annual exhaustion of the capital value of the leasehold. In the light of the statutory provision for excess-profits credits and of the rule established by the Board in the Appeal of Grosvenor Atterbury, 1 B. T. A. 169, and the Appeal of Hotel de France Co., 1 B. T. A. 28, it is obvious that we must find the value at March 17, 1908, as an element of invested capital, and at March 1, 1913, as a basis for annual exhaustion for years subsequent thereto.
The petitioner contends that at March 17, 1908, the leasehold had a value of not less than $400,000. In our judgment the facts adduced are not sufficient to establish such value. The leasehold cost the petitioner $53,000 in 1895. Early in 1908, the property was improved by the completion of a six-story steel and brick building at a cost of $105,991.80. At March 17, 1908, little, if any, income had been received from the improved property, but space in the building had been leased on terms that yielded an average annual net income for the years 1908 to 1912, inclusive, in the amount of $31,659.20. All such income accrued subsequent to the date with which we are concerned, and, while it may have some weight as corroborative evidence of value ascertained by appraisement or otherwise, it is clear that it can not be used as the basis for our determination. It is necessary, therefore, to resort to collateral evidence, and to consider the opinion of a witness reputed to be an expert in the valuation of real property in Kansas City.
In support of its contention the petitioner called three witnesses— a real estate operator and two certified public accountants. The real estate man testified that the entire property, made up of the fee, the leasehold, and the building, had a value of $800,000 at March 17, 1908. He was unable to show that any sales of similar property in the same locality at about the same time supported his estimate. With $800,000 as the basis of his computation, and, taking into consideration the rentals reserved and also the peak rental which was not established until 1919, the witness estimated the value of the fee to have been $280,000. He arrived at this figure by capitalizing its earnings at 5 per cent. Subtracting the amount so obtained and the cost of the building from the assumed basic value of $800,000, he reached the conclusion that the leasehold had a value of $115,000 at the date of acquisition.
The first accountant corroborated the testimony of the real estate operator. By applying Hoskold's formula for finding the present worth of future income to the average net annual receipts from subleases for the five years from 1908 to 1912, inclusive, and subtracting the cost of the building from the result, he arrived at a value of $415,000. The second accountant testified that a 99-year lease is in effect a title to the fee, and that annual reductions from reserved rentals for the purpose of extinguishing capital value are so small that for all practical purposes they may be ignored.
The Commissioner contends that the leasehold had a value of only $191,364.80 at the date of its acquisition. To support his estimate he proved that a leasehold on an equally desirable property just across the street, on which ground rentals in the amount of $20,000 were reserved, was sold for $100,000 at about the time the petitioner acquired the property in question, but offered no other evidence to sustain his position.
We are unable to accept either the petitioner's or the Commissioner's estimates of value. The methods used by witnesses for the petitioner are empirical and involve so many doubtful and unknown factors that they can not safely be used as the basis for our determination. The Commissioner's argument that the value should be measured by the selling price of a 99-year lease on a similar property just across the street is of slight weight, since cross examination of witnesses disclosed that such sale was made in conditions that prevented the owner from realizing full market value for the property.
We are convinced that the leasehold in question had a fair market value at March 17, 1908, in excess of the amount found by the Commissioner, but substantially less than that asserted by the petitioner, and we have fixed such value at $225,000, which should be included in the petitioner's invested capital for the taxable year. It is in evidence that at March 20, 1916, the petitioner paid the owner of the fee $30,000 in consideration for certain modifications in the terms of the lease. The payment was made from surplus or from additional amounts paid in to the petitioner by its stockholders, and, in either event, should be included in the computation of the petitioner's statutory invested capital for the taxable year.
Having determined the value of the leasehold in question for invested capital purposes at March 17, 1908, and at January 1, 1919, it now becomes necessary to ascertain its value at March 1, 1913, as a basis for annual deductions for exhaustion.
Before we proceed with a computation of value we must first determine the term of years to be used as the time factor of our calculations. In the light of all the conditions contained therein, is the lease for a term of 81½ years or 12½ years from March 1, 1913 ? Do the recapture clauses constitute a practical termination of the lease at the end of each revaluation period ? A careful study of the terms of the instrument here in question indicates that it is no more than a lease for ten years, in which the lessor grants the lessee an option of renewal on certain conditions that are specifically set forth. The lessee is under no obligation to renew his tenancy at any rental fixed in the lease or in advance of the reappraisal provided. Without action and acceptance on its part of new terms that never can be known in advance of ten-year appraisals, the lessee is free to retire and remove his property from the ground. So far as it relates to any term beyond which a revaluation of the ground has been made and a new rental rate accepted by the lessee, the instrument is a unilateral contract unenforceable against the lessee, who has perfect liberty to exercise his option and continue his tenancy under the new terms fixed by appraisal or to withdraw if his interests or inclinations prompt such action.
We can not know that the net differential between ground rental and income from subleases will continue beyond the first recapture date. By that time it is fair to assume that 6 per cent on the increasing value of the fee will absorb most of the differential. During the same period the building will have depreciated physically and will have become more and more unsuitable for profitable business uses, and, by 1925, it will be necessary to expend large amounts in modem- izing the original structure or in its demolition and the construction of a new building in keeping with the economic possibilities of the location. It is impossible to forecast the effect of these factors on the differential in rentals which may be entirely absorbed or greatly increased, but it is so indefinite and uncertain that it can not be used as a factor in computing value for the leasehold beyond the recapture date at which the lessee has the privilege of cancellation and surrender. We are of the opinion, on the evidence, that the value of the leasehold at March 1, 1913, should be computed on the basis of the 12½ years to elapse before another revaluation is due to be made.
In arriving at the value at March 1, 1913, of the leasehold here in question, which we have set forth in our findings of fact, we have considered ground rentals, gross income for the five years preceding that date, the differential between ground rentals and gross income, the capital value of the improvements, and the remaining effective term of the lease. The petitioner is entitled to annual deduction from its gross income of aliquot parts of $160,000 from March 1, 1913, to July 28, 1925.
Judgment will be entered on 15 days' notice, under Rule 50.