Court Opinion

ID: 4628410
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:03:18.192856+00
Date Added: 2024-06-11T07:57:12.558532
License: Public Domain

E. M. DIEBOLD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Diebold v. CommissionerDocket No. 32988.United States Board of Tax Appeals19 B.T.A. 438; 1930 BTA LEXIS 2393; March 31, 1930, Promulgated *2393  Where a lease containing a provision that upon termination thereof at any time all improvements made by the lessee are to become the property of the lessor is mutually canceled prior to the expiration of its term, and a new lease is entered into between the same parties for the same premises at an increased rental, the unextinguished cost of improvements made by the lessee at the date of termination of the first lease remains a capital item and should be returned to the lessee by means of deductions from gross income over the term of the new lease or remaining life of the improvements, whichever is shorter.  T. F. Ryan, Esq., for the petitioner.  F. R. Shearer, Esq., for the respondent.  LOVE *438  This proceeding is for the redetermination of deficiencies in income tax for the years 1924 and 1925 in the amounts of $593.98 and $2,946.97, respectively.  The only issue is whether the respondent erred in refusing to allow the petitioner to deduct from gross income for the year 1924 the unextinguished cost on December 31, 1924, of certain improvements to leased property made by the petitioner as lessee, where the lease involving the property in question*2394  was mutually canceled, effective December 31, 1924, and a new lease for the same premises was entered into by the same parties, effective the same date.  FINDINGS OF FACT.  The petitioner is an individual who for the past 28 years has been engaged in the retail lumber and planing mill business in the city of Pittsburgh.  The business has always been conducted either under the corporate or trade name of E. M. Diebold Lumber Co.  A corporation by that name existed from about 1911 to 1921 or 1922, at which time the petitioner, who had always owned substantially all of the stock of the corporation, caused the corporation to be dissolved and the assets distributed to, and the liabilities assumed by, himself.  On May 1, 1911, the corporation (E. M. Diebold Lumber Co.) leased from James A. Johnston and H. J. Bock certain real estate in Pittsburgh, herein referred to as the Brushton Avenue property, for a period of 16 years, or until May 1, 1927, at an annual rental of $2,800, except that the rent for the first year was $2,400.  The lessee was also to pay, as additional rental, all city and county taxes, all *439  water rents, all insurance premiums on insurance taken out on the*2395  buildings on the leased premises and certain other items and obligations immaterial to the issue in this proceeding.  The lease contained no renewal privileges.  The next to the last paragraph of the lease provided: It is further understood and agreed that should the tenant decide at any time during said term that the buildings now on premises are not suited or sufficient to its purposes, it may remove said buildings or add thereto, provided always that it shall and will erect in lieu thereof, other buildings of equal or greater value, and all buildings so erected or other improvements and additions made by the tenant on the leased premises shall revert to and become the property of the parties of the first part (the lessors) upon any expiration of this lease by reason of limitation, or by reason of bankruptcy, insolvency, or by reason of any forfeiture resulting from a violation of the terms of this lease or by reason of any other expiration or surrender, and it is further understood and agreed that at such time any buildings erected or improvements made by the lessee shall not be considered or claimed to be trade fixtures.  At or about the time of the dissolution of the corporation*2396  the above mentioned lease was assigned to the petitioner, along with the other assets and liabilities of the corporation.  During the years 1921 to 1923, inclusive, the petitioner, in his individual capacity, constructed a mill building on the Brushton Avenue property at a total cost to him of $50,684.88.  During the years 1922 to 1924, inclusive, the petitioner was allowed as deductions from gross income on account of the exhaustion, wear and tear of the mill building constructed by him, the total amount of $32,654.95.  On December 31, 1924, the unextinguished cost of the mill building amounted to $18,029.93.  During the year 1924 the petitioner decided that it would be necessary to construct an office building on the Brushton Avenue property at a cost of approximately $10,000.  In view of the above-quoted provision of the May 1, 1911, lease, together with the fact that it only had about three more years to run, the petitioner approached the lessors with a view of obtaining either a renewal or extension of the existing lease.  At first the lessors specifically refused to grant any extension or renewal on the ground that in a short time they would be vested with the possession*2397  and ownership of the mill building already erected on their premises by the petitioner.  After various negotiations the lessors finally offered the petitioner the following proposition, which he accepted, namely, that the existing lease be canceled, effective December 31, 1924; and that a new lease for a period of 10 years from December 31, 1924, be entered into between the same parties at a substantial increase in rental.  In accordance with the above oral agreement a written lease was executed on July 31, 1924, to become effective on December 31, 1924.  *440  Inadvertently the lessee was named in the lease as the "E. M. Diebold Company, a corporation." The petitioner has always paid the rent provided for in the second lease and has always considered himself as the lessee thereunder.  The provisions of the July 31, 1924, lease were substantially the same as those in the May 1, 1911, lease, except that the term in the new lease was for a period of 10 years from December 31, 1924, and the annual rental was $10,000.  During the years 1924 and 1925 the petitioner in his income-tax returns for those years deducted from gross income on account of the exhaustion, wear and tear*2398  of the mill building the amounts of $13,178.07 and $20,780.42, respectively.  The respondent determined that on the basis of the May 1, 1911, lease the amount of the exhaustion, wear and tear of the mill building for the year 1924 was $10,730.12; that the remaining unextinguished cost of the mill building on December 31, 1924, was $18,029.93; that the unextinguished cost of $18,029.93 represented a part of the cost of the new lease; that for the purposes of exhaustion the cost of the new lease in the amount of $18,029.93 should be spread over the term thereof, namely, 10 years; and that the allowable deduction to the petitioner for the year 1925 on account of the exhaustion of the cost of the new lease was $1,802.99.  OPINION.  LOVE: The question involved in this proceeding is what part of the cost of constructing the mill building should be allowed the petitioner as a deduction from gross income in each of the years 1924 and 1925.  As set out in our findings the total cost of constructing the mill building was $50,684.88.  The petitioner now concedes that he was in error in claiming on his returns for the years 1924 and 1925 the amounts of $13,178.07 and $20,780.42, respectively. *2399  He now contends that by reason of the fact that the May 1, 1911, lease was canceled, to take effect on December 31, 1924, thereby vesting in the lessors the legal title to the improvements erected by him, he is entitled to deduct from gross income for the year 1924 not only the exhaustion of $10,730.12 allowed by the respondent, but also the remaining unextinguished cost of the improvements on December 31, 1924, in the amount of $18,029.93, or a total deduction for the year 1924 of the amount of $28,760.05.  He further concedes that if he is right in his present contention, then the amount of $1,802.99 allowed by the respondent as a deduction from gross income in 1925 should now be disallowed.  The respondent contends that his determination, the substance of which we have set out in our findings, was proper.  *441  Both parties have accepted the petitioner as the lessee under the lease entered into on July 31, 1924, and for the purpose of this opinion we will regard him as such.  The respondent in support of his contentions relies upon the decisions of this Board in *2400 ; and . Both cases are directly in point and are decisive of the question here presented.  See also ; and . The petitioner in his brief attempts to distinguish the facts in the instant case from those in the Gladding Dry Goods Co. case, supra, on the ground that in the latter case the existing lease was extended, whereas in the instant case it was canceled and a new lease entered into.  Upon this distinction he argues that in his case there was a moment when technically "possession and ownership" of the improvements passed out of the lessee and into the lessor; that "the natural consequence thereof was that the lessee no longer owned these mill buildings nor could he set up any depreciation therefor on his books after said cancellation"; and that "the obvious result then is that lessee as of December 31, 1924, lost the undepreciated portion of the cost to him of the buildings." The controlling factor is not whether the existing lease was*2401  "extended" or "canceled." It was "extended" in the Gladding case and "canceled" in the Pig & Whistle Co. case, supra, yet we reached the same result in both cases.  As we said in the Gladding case (p. 339): The material elements are, the person who makes the investment, use of the property, and the period over which that investment is to be recovered out of income.  Before the petitioner agreed to cancel the old lease and enter into a new lease the fact existed that on the basis of the existing lease there would remain on December 31, 1924, with respect to the cost of erecting the mill building an unextinguished cost of $18,029.93.  He could either continue to operate under the old lease and have the use of the property until May 1, 1927, or he could agree to the terms proposed by the lessors whereby he would have the use of the mill building for another decade, provided the remaining useful life of the building at that time was at least 10 years, which fact has not been questioned.  The facts show that he accepted the lessor's terms to cancel the old lease and enter into a new one.  Under such circumstances, and in the absence of any evidence showing that*2402  the remaining useful life of the mill building was less than the term of the second lease, we think the amount in dispute should remain *442  capitalized and returned to the petitioner in the form of deductions from gross income over the term of the new lease.  The respondent's determination is approved.  Judgment will be entered for the respondent.