Opinion ID: 1483983
Heading Depth: 1
Heading Rank: 3

Heading: Losses upon Sale or Abandonment of Certain Equipment.

Text: The taxpayer in 1929 sold or scrapped certain of its equipment before it had been used for the period of its expected life; this being due to changes in the industry that made it economical or necessary to substitute other equipment in its place. The question thereupon arose what loss it could claim under § 113(a) of the Revenue Act of 1928, 26 U.S.C.A. Int. Rev.Acts, page 380; the bases for that loss being measured by the original cost less salvage and allowable depreciation. § 111(b) (2), 26 U.S.C.A. Int.Rev.Acts, page 376. The Commissioner allowed a straight line depreciation on each item of property separately; that means that he divided the original cost into as many years as the property would remain in service and deducted that fraction of the cost for every past year. What was left he allowed the taxpayer to deduct as loss  less any salvage, or amount realized. This reduced the cost much below what was left of it after subtracting the sum of those deductions which had in fact been allowed to the taxpayer for the past years. The Tax Court has found that these past depreciation allowances were calculated in accordance with a composite rate; it relied for this upon a stipulation which, as it believed, agreed that the depreciation had been so computed. The taxpayer denies that the Tax Court properly understood the stipulation, and asserts that in fact the depreciation was not computed under a composite rate, but under what it describes as a general average over-all rate, not compounded of individual lives or weighted according to costs. In the view we take it will not be necessary to construe the stipulation, or say whether the Tax Court was right, for it makes no difference whether the deductions were computed under a composite rate, or a general average over-all rate,  whatever that may mean. No matter what the rate actually used, so far as it differed from straight-line depreciation, it could not be used after the taxpayer withdrew any part of the equipment before it had lived out its industrial life. A taxpayer may not reserve any part of the depreciation which is allowable in any year; he must submit to a reduction of his cost by the full amount of the depreciation which he could then have taken. United States v. Ludey, 274 U.S. 295, 47 S.Ct. 608, 71 L.Ed. 1054; Kittredge v. Commissioner, 2 Cir., 88 F.2d 632. Thus the question is, not what deductions had been in fact allowed in the past, or  what is the same thing  what part of the original cost remained actually unamortized; but what deductions were allowable: i. e. what deductions the law would have allowed the taxpayer to take, if it had chosen to take them. So far as it did not, it lost them. When deductions are computed under a composite rate, a group of items is for convenience dealt with as one; and in finding the final fractional coefficient used to calculate the yearly depreciation of each item, it is assumed that all the items will continue in the group during their entire expectancy. If the taxpayer withdraws any item before that time, the past deductions allowed upon its cost cease to be those allowable, because one of the premises on which they were agreed to be allowable  the continuance of the item in the group  is then no longer true. The only allowable deduction thereupon becomes the proper deduction, if the item is treated separately. Nor does it make any difference whether some other conventional rate: e. g. a general average over-all rate, has been applied in the past. So far as the allowances computed by such a rate in the past varied from the straight-line depreciation of any particular item, it would seem that that must have been because another expectancy was substituted for that of the particular item. Certainly, if in the case at bar that rate did make this assumption (the retention of all the items for the duration of their industrial life), the taxpayer did not prove it. Indeed it is not easy to see how any general average over-all rate could have failed to include such a factor. For these reasons we hold that the depreciation was correctly computed. A subsidiary question arises over the sale in 1929 of ten tank cars for $1,500 apiece. The depreciation upon these had been figured at an agreed rate in earlier years and the taxpayer had been allowed a corresponding deduction. When they were sold the question arose  under the Commissioner's theory just mentioned  as to the proper aggregate depreciation computed upon them separately. The taxpayer had not however proved their expectancy, relying upon the agreed average rate, or composite rate. The Tax Court, not knowing the expectancy of the tank cars, assumed that they had an added life of one year after they were sold, under the rule which we laid down in Cohan v. Commissioner, 2 Cir., 39 F.2d 540. This obviously would, and did, result in practically extinguishing the cost altogether, leaving less than $3,000 out of an original cost of over $31,000. Thus the Commissioner found and the Tax Court agreed that the sale resulted in a gain which was set off against losses in that group and in other groups. The first question is whether the set-off was right. The item arises under Art. 4(a) of the amended petition for the year 1929 in which the taxpayer sought relief against an assessed deficiency. Clearly it was proper for the Commissioner to show the sale price of the cars as a means of proving an offset to any depreciation; and this he did show. The taxpayer on the other hand had to show the loss which involved the depreciation. It was moreover permissible, a gain being once proved, to offset it against a loss arising under Art. 4(f) (1) (a) of the petition in which the taxpayer claimed an overpayment. The Commissioner could not indeed increase the deficiency without asserting a claim before the Tax Court, but he could bring the whole account into hotchpot in order to defeat the taxpayer's claims. We are not satisfied however with the computation of the expectancy of the tank cars. It seems to us plain that a car which had cost only $3,000 ten years before, and which sold for $1,500, must have had more than one year's future use in it. To suppose that at second hand it would fetch half its original cost, although it would become useless almost at once, is not tenable on any theory. The case will be sent back for a more liberal allowance, and possibly the Tax Court will find it desirable in its discretion to admit evidence as to the expectancy of the cars.