Case Name: Appeal of CAPITAL CITY INVESTMENT COMPANY
Court: United States Board of Tax Appeals
Jurisdiction: United States
Decision Date: 1926-09-22
Citations: 4 B.T.A. 933
Docket Number: Docket No. 5376
Parties: Appeal of CAPITAL CITY INVESTMENT COMPANY.
Judges: ARttNdell not participating.
Reporter: Reports of the United States Board of Tax Appeals
Volume: 4
Pages: 933–940

Head Matter:
Appeal of CAPITAL CITY INVESTMENT COMPANY.
Docket No. 5376.
Decided September 22, 1926.
Walter E. Barton, Esq., for the petitioner.
Arthur H. Fast, Esq., for the Commissioner.

Opinion:
OPINION.
Smith
: The Commissioner determined the value of the taxpayer's leasehold interest as of March 1, 1913, to have been $79,000. The taxpayer contends that the value was $238,120.59, of which amount $118,600 was the fair market value of the lease and $119,520.59 the fair market value of the buildings. In support of its claim.it has introduced in evidence the depositions of live individuals, citizens and residents of Des Moines, all of whom were acquainted with the property on March 1, 1913. The deponents were all requested to place a value upon the buildings upon the leased premises as of March 1, 1913, and also upon the lease without buildings on the land on the same date.
It does not appear from the record what, if any, buildings were located upon the property at the time the premises were first leased in 1895. The lease provided that the lessee should have the privilege of removing all his improvements made on or to the leased premises at the expiration of the lease. It also provided:
It is further agreed that in case the improvements, now or hereafter made by said Second party upon said premises, are at any time destroyed or made untenable by fire, the lessee hereof, his heirs or assigns, shall have the privilege of terminating this lease at the end of one year from date of said fire, paying during that year the rate of rental provided for in this lease; and he shall have and retain possession of the ground for six months after the date of fire; and the privilege of keeping this lease in force or terminating it as above provided for. At the expiration of said six months, unless he then elects to terminate [sic] this lease, the lessor, his heirs or assigns, shall have full possession of said premises with the right to improve the same, either personally or through another.
Apparently the lessee was not, in case of fire, required to rebuild the structures, if any, upon the premises at the time the lease was first entered into.
There has not been introduced in evidence any information as to the income of the taxpayer from the leasehold premises during any of the years prior to the date of the sale of the lease in 1919. The Board is not able to determine what income the taxpayer could reasonably have expected to receive during the life of the lease on March 1, 1913. The Commissioner has apparently based his March 1, 1913, value of the lease solely upon the expected rentals to be received during the life of the lease from March 1, 1913. Apparently he has not taken into consideration any prospective value of the lease arising from the fact that the site of the leased premises was the second best business location in the City of Des Moines. The testimony of the witnesses as to the value of the leasehold on March 1, 1913, appears to be predicated largely upon this factor. In our opinion the deponents are men well qualified to express an opinion as to the value of the leasehold premises on March 1, 1913.
One of the witnesses was W. E. Tusant, who testified that he had been a general contractor since 1909 in the City of Des Moines. He had been familiar with the Meek Block since 1909. He had made certain repairs and improvements to the leased premises from 1909 to 1915 or 1916. He stated that in his opinion it would have cost on March 1,1913, $165,826.80 to replace the buildings new and that their sound value on the same date was $142,602.96. This estimate was an estimate simply of the physical valuation of the buildings without reference to any lease whatever.
T. A. Harding testified that he was 74 years, old and that he had been engaged in the real estate business in Des Moines for a period of 35 years. He had sold almost all of the downtown business section once or twice and some of'these properties three times; he had valued property for the Federal and State Governments frequently and had valued property in the vicinity of the Meek Block for insurance companies. He placed a'value on the buildings as of March 1, 1913, of $80,000, and a value on the lease as of that date of $130,000. He further testified that he had an offer of $200,000 from a party to purchase the taxpayer's leasehold interest in 1912 or 1913 but that the taxpayer had rejected the offer. Upon cross-examination he was asked:
Q. Do you remember any of the details of tbis offer that was made in 1913?
A. I do not, except that the owners wouldn't accept it. I was simply concerned in making the deal and getting paid for it.
Q. The owners wouldn't accept it?
A. No, they wouldn't.
Q. Do you know the exact date when this offer was made?
A. I do not.
Q. Do you know whether it was in 1912 or 1913?
A. It might have been 1912, I have no means of refreshing myself.
Q. Yon don't know who made the offer?
A. I think it was the Iowa National Bank or some members of the Board of Directors of the Iowa National Bank.
Griff Johnson testified that he was 54 years old, resided in Des Moines, and that he has had charge of the investments of tñe Equitable Insurance Company of Iowa for 14 years. Prior to that time he was engaged in the mortgage, real estate, loan, and investment business. He has valued real estate in Des Moines. He has been familiar with the Meek Block nearly all of his life. He placed a value on the buildings of $125,000 to $150,000 and a value on the lease of $50,000, separate and apart from the buildings, as of March 1, 1913.
John Gibson testified that he was 55 years old, resided in Des Moines, and that he was president of the United States Bank. He has been acquainted with the Meek Block for 25 years. He valued the property at March 1, 1918, at $25,000 to $150,000, a.nd the lease at $10,000 a year, or $145,000.
B. F. Kauffman testified that he was president of the Bankers Trust Company of Des Moines, and that he has been familiar with the Meek Block for 30 years. In his opinion the value of the buildings on March 1, 1913, was approximately $75,000, and the value of the leasehold $150,000. He further stated that in his opinion the value of the buildings and leasehold together as of March 1, 1913, was not $225,000, the sum of the value placed by him upon the buildings and the leasehold separately, but $200,000.
It will be noted from the foregoing that the March 1, 1913, value placed upon the buildings by the deponents varied from $75,000, in the case of Kauffman, to $150,000 in the case of Johnson and Gibson, and that the March 1,1913, value of the lease was variously estimated at from $50,000 by Johnson to $150,000 by Kauffman.
Nowhere does the evidence disclose the investment of the taxpayer in the buildings or. the March 1, 1913, value of its investment. Neither does the evidence disclose the net income from the lease for any j^ear. One of the witnesses estimated that the leasehold interest, without taking into consideration the buildings, should have produced a net income of $7,000 per year from March 1, 1913, to September 30,1927, and that a purchaser of the leasehold interest should have looked for a net income of at least $10,000 per year from March 1. 1913. In making such an estimate of value, the deponents did not take into account the speculative value of the lease. Apparently the leasehold interest had a considerable speculative value by reason of the fact that the site upon which the buildings were located was a valuable business site, and further by reason of the fact that appar ently the lessor was willing to sell at a reasonable price. Griff Johnson, one of the deponents for the taxpayer, was an officer of the Equitable Life Insurance Company of Iowa, which purchased the taxpayer's leasehold interest in 1919. He testified that the insurance company would not have considered purchasing the leasehold interest unless it could have gotten the fee to the land.
From a careful consideration of the entire record, we are of the opinion that the taxpayer's lease and interest in the buildings on March 1, 1913, had a fair market value of $130,000. The deduction for exhaustion of the leasehold interest for the taxable year should be computed upon the basis of such value.
In making his determination of the profit upon the sale of the leasehold interest the Commissioner deducted from the March 1, 1913, value an amount representing the exhaustion of the value of the leasehold interest from March 1, 1913, to the date of sale. He computed such exhaustion by spreading the March 1, 1913, value ratably over the unexpired term of the lease from March 1, 1913, and took as the amount of the exhaustion such proportion of the March 1, 1913, value as the number of months elapsing from March 1, 1913, to the date of sale bears to the total number of months of the unexpired term of the lease from the basic date. The taxpayer alleges error on the part of the Commissioner in deducting exhaustion in this manner from the March 1, 1913, value as a part of the computation of the profit realized by sale. It claims that for the purpose of ascertaining the loss sustained or gain derived from the sale or other disposition of an asset, section 202 of the' Eevenue Act of 1918 does not authorize or require the reduction of the cost or fair market value of the assets sold as of March 1, 1913, by an amount representing exhaustion; that is particularly the case where the taxpayer did not take a deduction for exhaustion in its income-tax returns; and more particularly where under the various income-tax acts or under Treasury Decisions promulgated by authority thereof the taxpayer was not permitted to take such deduction. In making such contention it relies upon the decision of the United States Supreme Court in Doyle v. Mitchell Bros. Co., 247 U. S. 179, wherein it was held that under the Excise Tax Act of August 5, 1909, the taxpayer was entitled to deduct from gross income the January 1, 1909, value of timber consumed in manufacturing lumber, the sale of which was the source of the gross income.
Section 202 of the Eevenue Act of 1918 does not declare that profit upon the sale of an asset shall be determined by deducting from the sale price the March 1, 1913, value. It simply provides, as was pointed out by this Board in Appeal of Even Realty Co., 1 B. T. A. 355, that the March 1, 1913, value is the basis for the determination of whether a gain or loss is derived, from the sale of an asset. As was pointed out in that decision, this basis may be reduced by losses sustained in respect of the property and may be increased by improvements. made to the property. ' The taxpayer contends, however, that such cases are not the taxpayer's case; that there is no legal assumption that the value of the leasehold as of March 1, 1918, suffered a decline between that date and the date of sale as the result of exhaustion; and that since for years prior to 1917 the taxpayer was not permitted under the statute to deduct from gross income any amount representing exhaustion of its leasehold, there is no warrant of law for deducting from the March 1, 1913, value the pro rata exhaustion of the value of the leasehold on that date in computing the amount of gain realized from the sale.
We are of the opinion that the cost, or in case of a leasehold acquired prior to March 1, 1913, the value on that date, is subject to exhaustion ratably over the period of the lease. We have so held in respect of tangible property. Appeal of Even Realty Co., supra. We have found no difference between tangiblé property and leasehold interests in this regard. Appeal of Grosvenor Atterbury, 1 B. T. A. 169. We have held that exhaustion actually occurring must be taken into consideration in computing the value of an asset having a definite life, usually spread ratably over such life, whether or not there is an actual decline in value year by year. Appeal of Union Metal Mfg. Co., 1 B. T. A. 395.
Order of redetermination will be entered on lb days' notice, under Rule 50.
ARttNdell not participating.
MtjRdock and SteRNhageN dissent.