Court Opinion

ID: 4631657
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:10:06.457666+00
Date Added: 2024-06-11T07:57:45.488016
License: Public Domain

MYER DANA, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Dana v. CommissionerDocket No. 50248.United States Board of Tax Appeals30 B.T.A. 83; 1934 BTA LEXIS 1372; March 14, 1934, Promulgated *1372  1.  The petitioner in 1927 leased certain property to a corporation for 20 years.  Under the terms of this lease an existing lease between the parties at a lower rental was canceled and it was agreed that the old building on the leased property should be demolished and a new building erected by the lessor, title to the new building to vest immediately in the lessor.  The lessee agreed to bear a part of the cost of replacing the old building with a new building especially suited to its business.  Held, no deductible loss was sustained by the petitioner on account of the demolition of the old building in the taxable year and the respondent did not err in exhausting its unextinguished value over the 20-year term of the lease.  2.  The payment by the lessee of one half the cost of the new building covered the cost of the special construction and special features required by the lessee.  Since the value of these improvements by the lessee would be exhausted when the lease was ended, the respondent erred in adding to the petitioner's income for 1927 an aliquot part of the value thereof.  Francis C. Stetson, Esq., and Francis R. Lash, Esq., for the petitioner.  *1373 T. F. Callahan, Esq., for the respondent.  MATTHEWS*83  This proceeding is for the redetermination of a deficiency in income tax for the year 1927 in the sum of $2,333.20.  It is alleged in the amended petition that the respondent erred: (1) In disallowing as a deduction from income for the taxable year the sum of $13,787.27, which the petitioner claims to represent a loss due to the demolition of a building owned by him; and (2) in adding to the petitioner's income the sum of $740.80, representing one twentieth of that part of the cost of erection of a new building which was borne by the petitioner's lessee.  *84  The parties entered into a stipulation with respect to certain material facts and the petitioner presented additional evidence at the hearing, together with the testimony of three witnesses, from which we have made the following findings of fact.  FINDINGS OF FACT.  Petitioner is an individual, a resident of Brookline, Massachusetts, and has been engaged in the real estate business in Boston and Woburn since 1920.  In 1920 petitioner purchased for the sum of $25,000 certain land on which there was a three-story frame building known as*1374  Nos. 425-431 Main Street, Woburn, Massachusetts.  He made various repairs and capital improvements on this building, which he rented to various tenants for the years 1920 to 1926, inclusive.  In April 1926 the Ross Stores, Inc., leased from the petitioner the whole building for 20 years at an annual rental of $6,940, the lessee to go into possession as soon as the ground floor tenants should vacate.  They did vacate about April 1, 1927, and the lease went into effect.  The lessee operated chain stores, selling articles at prices from 5 cents to $1, and required that all its stores conform to a certain type of building especially designed for itself, with special features and of special construction.  Because of certain alterations and improvements in the building which the lessee desired to make in order to meet its special requirements, which would cost about $18,000 and which would have been made at the expense of the lessee under the terms of the lease, the lessee proposed to the petitioner that he should erect upon the premises a new building which would be particularly suited to its business.  It was estimated that such a new building would cost around $30,000, and the lessee*1375  was willing to pay one half the cost of demolishing the old building and erecting a new building, provided its share of the cost did not exceed $15,000.  Accordingly, a new lease for 20 years, beginning May 1, 1927, was executed by the parties on April 28, 1927, under the terms of which the old lease was canceled, the old building was to be demolished and a new building to be put up by the petitioner.  The lessee covenanted to pay all taxes, assessments, and other charges against the property during the term of the lease and to insure against fire, the lessor to rebuild in case of fire, up to $30,000.  The petitioner, as lessor, was to contract for the razing and demolition of the old building and for the construction of the new building.  The petitioner was to own the new building wholly at all times.  Under this new lease the rental was to be $7,120 per annum for the first five years, $7,720 per annum for the next five-year period, $8,380 per annum *85  for the third five-year period, and $9,106 per annum for the remaining period.  The depreciated cost to the petitioner of the old building at the time of demolition was $12,634.67, and the total cost of the new building*1376  was $29,632.28.  The lessee paid one half the cost of the new building, as agreed, or $14,816.14, which amount represented the cost of the special construction and special features necessary to erect the type of building required by the lessee.  These special features were valuable only to the lessee and their value would be exhausted at the expiration of the lease.  The cost of the new building to the petitioner was $14,816.14.  The petitioner has owned the new building wholly since the date of its erection.  The fair market value of the new building in 1927 was its total cost, which was $29,632.28.  Later in 1927 the Ross Stores, Inc., assigned the lease to the A. A. Adams Stores, Inc., which failed in March 1930.  Thereafter petitioner changed the building so as to allow occupancy by two stores.  In filing his income tax return for 1927 petitioner took as a deduction the amount of $14,410 shown on his books as the depreciated value of the old building.  Upon audit of the petitioner's return for 1927 the respondent disallowed this deduction and allowed a deduction of $631.73, which latter amount represents one twentieth of the depreciated value of the old building.  The respondent*1377  made a net figure of the amount disallowed, $14,410, and the amount allowed, $631.73.  In doing so he erroneously used the figure $14,419 instead of $14,410 and subtracted from it $631.73, so that the figure disallowed to which the taxpayer has excepted in his petition is $13,787.27, the difference between $14,419 and $631.73.  The respondent further increased petitioner's income by $740.80, representing one twentieth of $14,816.14, which latter amount is one half the cost of the new building and was borne by the Ross Stores, Inc.  OPINION.  MATTHEWS: With the exception of the fair market value of the new building, there is no controversy with respect to the material facts of this case, which are comparatively simple.  The petitioner owned a building in the Boston suburb of Woburn, Massachusetts, which he leased in 1926 to the Ross Stores, Inc., for 20 years.  The lessee operated chain stores and desired to have a building which would conform to a certain type used by it for all its stores.  After considering remodeling the petitioner's old building at a cost of approximately $18,000, the lessee learned that a new building with the same requirements would cost around $30,000, *1378  and a proposition *86  was made to the petitioner, which he accepted, that he should erect a new building.  The petitioner, as lessor, and the Ross Stores, Inc., as lessee, agreed in 1927 to cancel the old lease, to tear down the old building, and to build a new building to be occupied by the lessee under a new 20-year lease at an increased rental, title to the new building to vest immediately in the petitioner.  The lessee agreed to pay one half of the cost of demolishing the old building and erecting a new building, provided the total cost did not exceed $30,000, any excess over this amount to be paid by the petitioner.  The old building was accordingly torn down in 1927 and the petitioner is claiming herein that he sustained a loss in that year in the amount of $12,634.67, which sum represents the depreciated value of the old building at the time of its demolition.  It is the respondent's position that the unextinguished cost of the old building should be treated as a part of the petitioner's capital investment, to be exhausted over the 20-year term of the lease, and the respondent has allowed a deduction in the taxable year of only $631.73, or one twentieth of $12,634.67. *1379  The second issue presented is closely related to the first and grows out of the same transaction.  The respondent has treated one half of the cost of the new building, $14,816.14, which was that part borne by the lessee, as income to the petitioner to be apportioned over the term of the lease, thereby increasing the petitioner's income for 1927 by $740.80.  The petitioner is contending that the new building had a fair market value in 1927 of not more than $15,000, and insists that his income should be increased by only $183.86, which is the difference between $15,000 and the sum paid by the lessee as its share of the cost of the new building.  We cannot agree with the petitioner's contention that he has sustained a deductible loss, within the meaning of section 214(a)(4) of the Revenue Act of 1926.  It is provided in section 215(a)(2) that in computing net income no deduction shall in any case be allowed in respect of any amount paid out for new buildings or for permanent improvements or betterments to increase the value of any property or estate.  The facts of the instant case present a situation where there was a substitution of assets, a new building advantageously leased for*1380  an old building demolished, so that the demolition of the old building did not give rise to any deductible expense in 1927.  Its unextinguished cost should be exhausted over the life of the lease.  In other words, the value of the old building was to be paid for in the annual rental to be paid under the terms of the new lease.  This case is not distinguishable in principle from many cases decided by this Board and by the courts, and is governed by those decisions.  ; ; *87 ; ; affd., ; certiorari denied, ; ; affd., ; certiorari denied, ; ; affd., ; certiorari denied, ; . It is recognized that there are certain differences in the particular facts of the cases cited, but these differences*1381  are not of such a character as to make inapplicable to the instant case the principle applied in these decisions.  In this case the old building was not torn down until after the petitioner had owned the property for seven years, and it was demolished in full contemplation of the new lease.  This was not an ordinary business replacement, for the evidence clearly shows that the moving cause of the destruction of the old building at that particular time in 1927 was the advantageous terms of the new lease.  We do not need to inquire as to the exact degree of advantage, as petitioner urges, which he gained by the new building and the substituted lease.  By the investment of new capital in the sum of $14,816.14, his share of the cost of the new building, the petitioner acquired legal title to a building which had been erected at a cost of $29,632.28 and which replaced an old building of the depreciated value of $12,634.67.  Under these circumstances it is obvious that no real loss was sustained.  Nor do we consider it significant that the special requirements of the Ross Stores, Inc., resulted in a building of special design which cost more than it might reasonably be worth for general*1382  rental purposes, for we must regard the value of the new building in the light of the 20-year lease to a satisfied tenant.  So far as we know, petitioner had every reason to believe when the new lease was made in 1927 that he had made a profitable investment in the 20-year lease, and the subsequent history of the lease, with its assignment by the Ross Stores, Inc., to the A. A. Adams Stores, Inc., and the failure of the latter company in March 1930, cannot be taken into account in considering the transaction as of 1927.  As was pointed out by the Supreme Court of the United States in , value must be determined as of a certain time on the basis of a more or less certain prophecy as to the future, and the subsequent failure of such a prophecy or prospect to be realized in fact cannot affect the determination as of the earlier date.  Accordingly, we hold that the petitioner is not entitled to a deduction for a loss on account of the demolition of the old building in 1927, and the respondent did not err in exhausting its unextinguished value of $12,634.67 over the 20-year term of lease. *88  It remains to determine*1383  whether the respondent erred in treating as income to the petitioner over the life of the new lease the lessee's share of the cost of the new building, which amounted to $14,816.14.  The petitioner does not deny that the entire new building became the petitioner's property under the lease when it was erected.  Under the provisions of article 48 of Regulations 69 1 the petitioner, as lessor, has the option of reporting as income when completed the fair market value of the improvements made by the lessee subject to the lease, or he may spread over the life of the lease the estimated depreciated value of such improvements at the termination of the lease and report as income for each year of the lease an aliquot part thereof.  The petitioner earnestly contends that the fair market value of the new building in 1927 was not more than $15,000 and that he should report only the amount of $183.66, instead of $14,816.14, as income growing out of improvements made by the lessee.  For the reasons growing out of improvements made by the lessee.  For the reasons stated above we suatain the respondent's determination that the fair market value of the new building in 1927 was its total cost, which*1384  was $29,632.28.  But it is the estimated depreciated value of the improvements at the termination of the lease which may be spread over the life of the lease, under article 48 of Regulations 69, supra, and the respondent has added to the petitioner's income an aliquot part of the fair market value of the improvements without any allowance for depreciation over the life of the lease.  The parties have stipulated that the amount paid by the lessee covered the cost of the special construction and the special features necessary to erect the type of building required by the lessee.  The record discloses that the value of these special features would be exhausted when the lease was ended, for they were required by the lessee and added nothing to the value of the building after the expiration of the lease.  We are, therefore, of the opinion that the depreciated value of these improvements at the termination of the lease should be taken to be zero.  In these circumstances we hold that the respondent erred in adding to the petitioner's income for 1927 the sum of $740.80 on account of the improvements by the lessee.  The proposed deficiency should be reduced accordingly.  *1385 Judgment will be entered under Rule 50.Footnotes1. ART. 48.  Improvements by lessees. - When buildings are erected or improvements made by a lessee in pursuance of an agreement with the lessor, and such buildings or improvements are not subject to removal by the lessee, the lessor may at his option report the income therefrom upon either of the following bases: (a) The lessor may report as income at the time when such buildings or improvements are completed the fair market value of such buildings or improvements subject to the lease.  (b) The lessor may spread over the life of the lease the estimated depreciated value of such buildings or improvements at the termination of the lease and report as income for each year of the lease an aliquot part thereof.  * * * ↩