Court Opinion

ID: 4616139
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:33:52.221045+00
Date Added: 2024-06-11T07:55:04.044442
License: Public Domain

FIRST NATIONAL BANK OF KEY WEST, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.First Nat'l Bank v. CommissionerDocket No. 45186.United States Board of Tax Appeals26 B.T.A. 370; 1932 BTA LEXIS 1318; June 10, 1932, Promulgated *1318  1.  Held, upon the evidence, that petitioner is not entitled to obsolescence deductions in the years 1925, 1926 and 1927 upon its banking property.  2.  Held that the petitioner's action in charging a portion of a debt to a reserve for loss in the year 1927 meets the requirement of the charge-off of a debt ascertained to be worthless within the meaning of section 234(a)(5) of the Revenue Act of 1926, and that the petitioner is entitled to deduct such amount from gross income of that year.  3.  Amounts collected in the taxable years in question upon the principal loans written off in previous years as uncollectible are income to petitioner in the years collected.  Frederick L. Pearce, Esq., for the petitioner.  O. J. Tall, Esq., for the respondent.  MCMAHON *370  This is a proceeding for the redetermination of asserted deficiencies in income tax for the years 1925, 1926 and 1927 in the respective amounts of $1,216.83, $2,892.74, and $2,163.19.  It is alleged in the petition that the respondent erred in (1) failing to deduct from petitioner's income of the years 1925, 1926 and 1927 any allowance for obsolescence of its banking building, *1319  alterations and fixtures; (2) failing to allow petitioner a deduction from income for a debt ascertained to be recoverable only in part and charged off in the sum of $15,000 in the year 1927; (3) adding to the petitioner's income for the years 1925, 1926 and 1927, the respective amounts of $2,375, $980.02 and $1,965.27, representing amounts collected in the respective years upon loans written off in previous years as uncollectible; (4) failing to allow the petitioner a deduction from income for accrued interest paid in the sum of $2,190.62 upon the acquisition of bonds in the year 1926; and (5) failing to find a refund of income tax due the petitioner for the year 1927.  At the hearing assignment of error (4) as set forth above was abandoned by petitioner.  FINDINGS OF FACT.  The petitioner is a national bank, with principal office at Front and Duval Streets, Key West, Florida.  The business center of Key West about 1890 or 1891 was at the northwestern end of the island in the immediate vicinity of the petitioner's banking building.  The only means of transportation *371  in and out of Key West at that time was by water, and all the boat lines and shipping interests were*1320  located near the bank.  The Florida East Coast Railroad was built into Key West on overseas arches from the mainland in 1912, but the permanent construction was not completed until about 1915.  The railroad came into Key West from the east and its terminus was about one mile by land from the petitioner's bank.  The steamship lines that were affiliated with the railroad then moved nearer to the railroad piers and terminal.  In the spring of 1915, due to the outbreak of the World War, shipping at Key West was stimulated.  When the United States entered the war there was increased business activity over the entire island, and in 1918 and 1919 the business buildings in the neighborhood of the bank were generally occupied.  The petitioner was doing such a large volume of business that the bank examiners and the comptroller of the currency recommended enlarging its banking quarters.  The petitioner did make improvements in 1918 at a cost of over $50,000.  The petitioner's investment at that time in the land, bank building and furniture and fixtures was prior to 1918 about $40,000.  The war activities did not terminate in Key West until the latter part of 1921 or the early part of 1922*1321  when a submarine base, which had cost the Government about $2,500,000, was completed.  During the two or three years following 1922 business in Key West was in a very depressed state.  Those individuals who had places of business in the proximity of the bank began to move further uptown in the center of the section that had become the new retail district.  This was a gradual movement extending over several years.  The next big event in business in Key West was the Florida land boom.  It was in full force about the summer of 1925, and petitioner's business was good, reflecting the general prosperity of the community.  There was not much industrial business, but there was a tremendous gambling in real estate, just as there was all over Florida.  In 1925 there were business houses in the neighborhood of the bank, but in the latter part of 1925, after the crest of the Florida land boom had passed, the remaining businesses in the neighborhood began to move, leaving the bank the sole place of business in that neighborhood, with one or two exceptions.  The retail center of the business at the close of 1925 was about one-half mile above the bank, separated from the bank by a residential*1322  section.  The street car line had operated a loop extending two or three blocks around the bank, but this loop was abandoned and the cars thereafter ran along Duval Street, a block above the petitioner.  The Overseas Automobile Highway was started from the *372  mainland to Key West in 1925 and was completed in 1927 or 1928.  It came into Key West from the eastern end of the island.  The moving of the business center created a great deal of dissatisfaction among the petitioner's customers.  Petitioner was then in an isolated location entirely away from the business district.  In 1925 the petitioner's directors discussed many times the necessity of providing new banking facilities elsewhere in order to hold their business.  There was not then, nor has there been since, any other bank in Key West.  However, if another bank had been organized, petitioner would have had to take steps to provide a new bank location at some other locality or the new bank would have gotten the bulk of petitioner's business, providing they were properly financed and officered and had the confidence of the public.  Those persons doing a banking business have come to petitioner, but it is very unsatisfactory*1323  to both the petitioner and its clients.  In 1925 petitioner's directors investigated several sites and negotiated for a particular one in 1925, but none was bought as prices were too high.  The petitioner's directors decided at the end of 1925 that at the expiration of a period of five years normal conditions would prevail and that they would have to transfer their banking business to a new location.  It was decided at that time to start writing off their investment over such period.  At that time petitioner had an investment of about $80,000 or $90,000.  At the expiration of 1925 a substantial amount was written off petitioner's books for obsolescence and substantial amounts were also charged off each year since that time through 1929 and petitioner expected to make a similar write-off in 1930.  In the summer of 1930 petitioner acquired a site in the center of the new business district, approximately five blocks or 2,000 feet from its old bank building and expects to build there.  No steps have been taken to erect a new building, because of adverse business conditions.  Petitioner has offered its bank site and building for sale and would be glad to sell at any time if they could*1324  find a purchaser.  Petitioner has never received an offer to buy the buildings.  The petitioner's building could not now be sold at public auction for $10,000 because it could not be used for any purpose that would allow a return on an investment of $10,000.  The majority of the buildings, the water front properties and the piers are vacant and there is only one wholesale house left there.  The banking house of the Island City National Bank, which failed in 1913, was sold in 1918 or 1919 for $9,000.  It is located one block from the petitioner's bank building.  It is a larger building than the one in question herein, but is not as well built.  *373  The fixtures in the petitioner's bank building are of wood and are stained dark.  They probably could not now be sold for even a nominal value, because there have been so many bank failures in Florida that banking houses and furniture and fixtures are a drug on the market.  The population of Key West decreased from 20,000 in 1920 to about 12,000 in 1930.  In closing its books for the year 1925 the petitioner increased its deduction for depreciation to $9,000 to include obsolescence of its banking building, alterations and fixtures. *1325  In the determination of the deficiency alleged for the year 1925 the Commissioner allowed depreciation as follows: ClassificationCost to Dec. 31, 1925Reserve to Dec. 31, 1924Depreciation allowed for 1925Building$41,679.80$10,946.16$822.67Fixtures and alterations21,331.253,588.86639.94Furniture1,880.751,227.34150.57Machines5,361.493,718.00436.53Total70,253.2919,480.362,049,71In closing its books for the year 1926 the petitioner increased its deduction for depreciation to $20,000 to include obsolescence of its banking building, alterations and fixtures.  In the determination of the deficiency alleged for the year 1926 the Commissioner allowed depreciation as follows: ClassificationNet additions to cost year 1926Total depreciation allowed 1926Buildings$2,630.91$873,68Fixtures and alterationsNone.639.94Furniture648.58183.00Machines2,259.03864.90Total5,538.522,561.52In closing its books for the year 1927 the petitioner deducted the sum of $16,296.18 for depreciation, including obsolescence of its banking building, alterations and fixtures.  In the determination*1326  of the deficiency alleged for the year 1927 the Commissioner allowed depreciation as follows: ClassificationNet additions to cost year 1927Total depreciation allowed 1927BuildingsNone.$906.56Fixtures and alterationsNone.639.94FurnitureNone.215.43Machines$2,856.501,579.34Total2,856.503,341.27*374  The petitioner collected in the years 1925, 1926 and 1927, the sums of $2,375, $980.02, and $1,965.27, respectively, upon the principal of loans which had been written off in prior years as uncollectible.  The amounts so collected were not included in the petitioner's income reported upon its return for the respective years.  In the determination of the deficiencies, the respondent has added the above sums to the income of the petitioner for the respective years of the collections.  The parties entered into the following stipulation of facts, which we incorporate as a part of our findings of fact: Prior to October, 1927, one Florida Lightbourne was indebted to the petitioner upon obligations in the sum of $17,365.70 which were overdue and unpaid.  In October, 1927, the petitioner obtained judgment against the said debtor in*1327  the sum of $17,365.70.  Diligent search for assets subject to levy and sale under execution disclosed only ten shares of stock of the petitioner standing in the name of the said debtor.  The said stock was known to be worth about $200.00 per share at that time.  Nothing was collected upon the said judgment prior to December 31, 1927.  The said ten shares of stock of the petitioner were sold under execution on January 10, 1928, for the sum of $2,097.88, leaving a balance of the judgment of $15,267.82 unsatisfied.  Of this balance $15,000.00 was charged to the reserve for loss and the balance of $267.82 was written off to bad debts in January, 1928.  This balance of $267.82 only, was claimed as a deduction upon the petitioner's income tax return for 1928 and allowed by the respondent.  No further sums have since been collected upon the said judgment.  The federal income tax returns of the petitioner have been rendered upon the cash basis with bad debts treated pursuant to the actual bad debt method (rather than the reserve method).  The cost and book value of the land, the site of the petitioner's banking building, was in the years under consideration in this proceeding $9,193.69. *1328  The directors determined that the Lightbourne obligations were worthless, except what would be recovered on the bank stock at the close of the year 1927.  In closing the petitioner's books on December 31, 1927, a reserve for loss was set up on account of the Lightbourne debts in the amount of $15,000.  It was calculated that the petitioner would lose on that judgment about $15,000.  The amount of $15,000 was transferred to a reserve account set up to take care of that specific loss.  The above amount of $15,000 was not claimed as a deduction upon the petitioner's income-tax return for the year 1927.  The petitioner knew it had a loss in that amount, but it had had numerous losses after the boom, it already had $16,014.28 in bad debts to charge off, and it wanted to keep its loss account down to as small a figure as possible.  The amount of $15,000 was therefore transferred to reserve account to take care of that specific loss.  In the balance sheet as of the end of the year 1927, which was included in petitioner's return for the year 1927, this reserve of $15,000 was offset against accounts *375  receivable.  The respondent has allowed no part of the amount of $15,000 as*1329  a deduction for the year 1927.  No reserve for bad debts had been set up for any item other than the Lightbourne item.  The other bad debts in the sum of $16,014.28 were claimed upon the return for the year 1927 and have been allowed as a deduction from income, on the specific bad debt basis.  OPINION.  MCMAHON: Petitioner assigns as error the respondent's failure to deduct from its income for the years 1925, 1926 and 1927, any allowance for obsolescence of its banking building, alterations and fixtures.  Section 234 of the Revenue Act of 1926 provides for the deduction by corporations of a "reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence." The petitioner contends that, due to the beginning of the shifting of the business center of Key West, Florida, away from the location of the petitioner's building in the latter part of 1925, its officers were justified in determining at that time the petitioner's building would become obsolete at the end of five years and that it is entitled to deductions in each of the years 1925, 1926 and 1927 of a pro rata portion of its capital investment*1330  in the bank.  Obsolescence, we have held, is the state or process of becoming obsolete, and the state of obsolescence is reached when the property is no longer useful for the purpose for which it was acquired.  Columbia Malting Co.,1 B.T.A. 999">1 B.T.A. 999; Manhattan Brewing Co.,6 B.T.A. 952">6 B.T.A. 952; Frederick C. Renziehausen et al.,8 B.T.A. 87">8 B.T.A. 87; and TennesseeFibre Co.,15 B.T.A. 133">15 B.T.A. 133. In the last cited case we stated: Webster's New International Dictionary defines "obsolescent" or "obsolescence," "to wear out gradually; to fall into disuse," and the word "obsolete" is defined to mean "no longer in use; disused; neglected; as, an obsolete word; an obsolete statute." Obsolescence as used in the statute is the state or process of becoming obsolete and the provision allowing a deduction therefor is intended to care for losses of capital which take place over a longer period than the taxable year.  William Zakon,7 B.T.A. 687">7 B.T.A. 687. The state of obsoleteness is reached when the property which can not be used for any other purpose is no longer economically useful for the purpose for which it was acquired, *1331 Frederick C. Renziehausen et al.,8 B.T.A. 87">8 B.T.A. 87, and is therefore abandoned.  * * * In Frederick C. Renziehausen et al., supra, we stated: The right to an obsolesence deduction must be based upon substantial reasons for believing that the assets would become obsolete prior to the end of their ordinary useful life; and it must have been known, or believed to have been known, to a reasonable degree of certainty, under all the facts and circumstances, when that event would likely occur.  *376  In the instant proceeding, considering all the evidence, we conclude that the petitioner was not justified in concluding that the bank property would have to be abandoned and would become obsolete as claimed by petitioner.  The petitioner was the only bank in Key West and the shifting of the business center would not deprive petitioner of its business, since all businesses requiring banking services would have to continue patronizing petitioner.  There was no showing that in the latter part of 1925 there was any likelihood that any other bank would be established there or that petitioner would lose any of its business.  We do not believe that there was*1332  any probability that a new bank would be established, particularly since in 1913 another bank had failed.  The evidence discloses that the petitioner did not at any time actually lose any of its business due to the moving of the business center.  Furthermore, from the evidence it appears that petitioner made additions to its building in 1926 at a cost of $2,630.91.  This is inconsistent with the petitioner's claim that its building was becoming obsolete.  At the time of the hearing in this proceeding, which was on November 12, 1930, the petitioner was still occupying the same bank building and for all we know may still be occupying it.  Thus, at about the end of the claimed obsolescence period the property in question had not become obsolete and there was no showing that it would become obsolete or if so, when it would do so.  It is true that petitioner had purchased a lot in the new business center, only five blocks or 2,000 feet from the bank building in question, but at the time of the hearing no steps had been taken toward erecting a new building and it was not shown when, if ever, petitioner would construct a new building.  *1333  There was testimony offered for the purpose of showing that the bank building in question could not be sold at public auction for $10,000, but even if this be so, it does not necessarily give rise to a right to an obsolescence deduction.  We have heretofore held that mere decline in value of the property does not give rise to a right to a deduction.  Washington Catering Co.,9 B.T.A. 743">9 B.T.A. 743, and United Business Corporation of America,19 B.T.A. 809">19 B.T.A. 809. The petitioner relies upon Burnet v. Niagara Falls Brewing Co.,282 U.S. 648">282 U.S. 648, wherein the Supreme Court stated that obsolescence may arise as the result of the shifting of business centers.  However, as stated hereinabove, the petitioner has not shown that its property was becoming obsolete.  Obsolescence is a question of fact, to be determined from the evidence in each case.  Columbia Malting Co., Supra;Corsicana Gas & Electric Co.,5 B.T.A. 565">5 B.T.A. 565; and Conley Tin Foil Corporation,17 B.T.A. 65">17 B.T.A. 65. In *1334 Burnet v. Niagara Falls Brewing Co., supra, the taxpayer, as held by the Supreme Court, was *377  abundantly justified in the early part of 1918 in concluding that its property would become useless for the purpose for which it was acquired, but this is not true in the instant proceeding.  In that case the taxpayer had claimed deductions for obsolescence in the years 1918 and 1919 on account of the imminence of national prohibition.  At the time the taxpayer determined the obsolescence period it could not foresee the definite date that prohibition would go into effect.  The Supreme Court in 1931 took judicial notice that the Eighteenth Amendment to the Constitution took effect on January 16, 1920, which was after the obsolescence period claimed by the taxpayer, and used that fact in arriving at its conclusion that the taxpayer's property did become obsolete, and also in determining that the obsolescence period consisted of the years 1918 and 1919.  We appreciate that in Burnet v. Niagara Falls Brewing Co., supra, the Supreme Court by way of dicta recognizes that a shifting of the business center may give rise to obsolescence; but it is*1335  obvious that it is not sufficient to merely show that a business center has shifted; and that in addition it must be shown that it was reasonable to expect that the shifting of the business center would cause the obsolescence.  This latter the petitioner has failed to show.  On the other hand, it has produced proof which supports the inference that it was not reasonable to expect that the shifting of the business center would actually cause obsolescence within the alleged five-year period.  Mere inconvenience to petitioner and its patrons occasioned by added distance of a few blocks of driving or walking, under the circumstance herein, is not sufficient to establish obsolescence.  After carefully considering all the evidence, we hold that petitioner is not entitled to the claimed deductions in the years 1925, 1926 and 1927 for obsolescence of its property, and the respondent's determination in this regard is approved.  Petitioner contends that it is entitled to a deduction in the amount of $15,000 from gross income for the year 1927, representing that portion of the Florida Lightbourne debt which was ascertained to be worthless in that year.  Section 234(a)(5) of the Revenue*1336  Act of 1926 provides: (a) In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: * * * (5) Debts ascertained to be worthless and charged off within the taxable year (or in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt be charged off in part.  From the evidence it clearly appears that the petitioner did ascertain that debt to be worthless to the extent of $15,000 in the year *378  1927.  The petitioner has followed the practice of charging off actual bad debts rather than employing the reserve method.  During the year 1927 the petitioner charged off specific debts in the approximate amount of $16,000 but did not include therein the item of $15,000, but set up a reserve for loss in the amount of $15,000 on account of the Lightbourne debt.  It is the contention of the respondent that since petitioner has failed to show that it had permission from the Commissioner to use the reserve method, petitioner is not entitled to deduct from gross income the item of $15,000 which*1337  was charged to a reserve.  However, as stated in Ewald & Co.,18 B.T.A. 1130">18 B.T.A. 1130, 1132, "The right of a taxpayer to the deduction provided in the statute above quoted is not to be destroyed because of its initial failure to put its claim on the technically proper ground." If the amount of $15,000 was charged off within the meaning of the statute, then the petitioner is entitled to the claimed deduction.  Whether a charge-off has been effected is not dependent upon any special form of bookkeeping, but must be determined from the circumstances in each case.  Ewald & Co., supra.At the hearing the president of petitioner testified as follows: Q.  In other words, the amount of $15,000 was not claimed as a deduction from taxable net income in this return? A.  I do not think so.  The Lightbourn matter was like this: We knew we had the loss, but we had $16,000 to charge off that year, and I did not want to make it thirty-two or thirty-three, so we transferred that $15,000 to a reserve account to take care of that specific loss.  I personally was misinformed that we could do that, otherwise we would have charged it right into the bad loss, because it*1338  was not anything else but a bad loss.  * * * Under substantially similar circumstances we have heretofore held that a charge-off was effected.  O. S. Stapley Co.,13 B.T.A. 557">13 B.T.A. 557; Dillon Supply Co.,20 B.T.A. 404">20 B.T.A. 404; McMinnville Manufacturing Co.,19 B.T.A. 486">19 B.T.A. 486; and Poel & Kelly, Inc.,19 B.T.A. 1317">19 B.T.A. 1317. Upon the authority of those cases we hold that the petitioner is entitled to deduct the amount of $15,000 from its gross income of 1927. The petitioner alleges that the respondent erred in adding to its income for the years 1925, 1926, and 1927, respectively, amounts of $2,375, $980.02, and $1,965.27, collected in those years upon the principal of loans written off in previous years as uncollectible.  From the evidence we can not determine that these amounts were not properly charged off in the prior years, and therefore, under our decisions in Excelsior Printing Co.,16 B.T.A. 886">16 B.T.A. 886, and Iberville Wholesale Grocery Co., Ltd.,17 B.T.A. 235">17 B.T.A. 235, we hold that the *379  respondent properly included such amounts in gross income in the years in which they were collected.  *1339 Judgment will be entered under Rule 50.