Court Opinion

ID: 4629730
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:05:59.198217+00
Date Added: 2024-06-11T07:57:25.554965
License: Public Domain

JULIA WILLMS SLOAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Sloan v. CommissionerDocket No. 84886.United States Board of Tax Appeals36 B.T.A. 370; 1937 BTA LEXIS 723; July 27, ,1937, Promulgated *723  Where a lessee made substantial improvements in a leased building, with the consent of the lessor and pursuant to the terms of the lease, and such improvements became at once the property of the lessor, held, (1) the increased value of the property constituted gain to the lessor; (2) it was proper for the Commissioner to estimate the depreciated value of the improvements, as of the termination of the lease, and determine a deficiency in income for the taxable year in the amount of an aliquot part of that value.  George M. Brady, Esq., for the petitioner.  A. E. Arent, Esq., for the respondent.  MILLER *370  This case arises on respondent's determination of a deficiency in petitioner's income tax for the calendar year 1933 in the amount of $394.81.  Of the three issues raised in the petition, the taxpayer waived one and one was stipulated, leaving as the sole issue whether the Commissioner erred in determining that $1,965.72 representing an aliquot part of the depreciated value of nonremovable improvements made by the tenant of certain property owned by petitioner was income to the petitioner in 1933.  Petitioner contends (1) that the improvements*724  did not enhance the value of the property by increasing its rentability for ordinary commercial purposes; and (2) that, in any event, any improvement of the property which would constitute income to the petitioner, was not realized as such in the year for which the deficiency has been found.  FINDINGS OF FACT.  Petitioner was, in 1928, the owner in fee simple of certain land in the city of Baltimore, Maryland, already improved by a building known as Nos. 306, 308, and 310 North Howard Street.  On June 21, 1928, she and her husband granted to the Oriole Cafeterias, Inc., a lease for 20 years from September 1, 1928, the relevant portions of which provided as follows: The lessee was to conduct a restaurant and to pay an annual rental of $16,000 for the first five years, $17,000 for the second five years, $18,000 for the third five years, and $20,000 for the last five years; the first four months' rent was to be "abated in event of the lessee taking the property in its present condition and of making its own alterations and improvements." The lessee covenanted to maintain the property in tenantable condition, damage by fire or unavoidable accident excepted; to pay all water rent, and*725  all taxes over $3,892.87 a year, and interest *371  on all assessments for special benefits over $2,000; and to pay fire insurance on a then agreed value of $40,000.  Paragraph 8 provided as follows: It is hereby agreed that no alterations, additions or improvements to the said buildings shall be made by the Lessee without the prior written consent of the Lessors, and that any alterations, additions and improvements made by the Lessee shall immediately be and become the property of the Lessors, without payment of compensation therefor to the Lessee, "but the said Lessee shall have the right or removing from said premises at the expiration of this lease, all lighting fixtures and trade fixtures which may have been installed by it, provided the said Lessee complies with its obligation to surrender the premises in a tenantable state and condition in all respects." Paragraph 9 provided: Inasmuch as the Lessee may desire to make as its own expense and risk and by its own employees certain specific changes and improvements in the demised premises after it enters into possession, it is expressly understood that none of said changes or alterations shall be made until the full*726  plans and specifications therefor have been submitted to and approved in writing by the Lessors, or their authorized representatives, and copies lodged with them; it is further agreed that the Lessee in making such changes and improvements as shall have been approved as aforesaid by the Lessors, may use all or any part of the old material now in or upon said premises as may be necessary.  But nothing in this clause shall, however, prevent the Lessee from making ordinary repairs, or alterations, which can be made without injury to the structure.  Paragraph 17 provided: The Lessors hereby covenant that Julia W. Sloan is the owner of the property hereby leased and has full power to execute this agreement.  And the Lessors further covenant that during the term of this lease they shall not, and will not, directly or indirectly, use, or permit the use of the premises Nos. 300, 302, 304 N. Howard Street, all or any of said three premises (which said three premises are owned by Julia W. Sloan and lie immediately to the south of the property hereby leased) for the purpose of a restaurant and cafeteria business, but nothing in this paragraph shall be construed to prohibit said Lessors from*727  using or permitting the use of said properties Nos. 300, 302, 304 N. Howard Street, or any one or all of them, to be used as a drug store which might serve light lunches and refreshments, or as a department store which might have a lunch room as a minor or incidental branch of its business, with the understanding that such lunch room or space in such a department store shall not be conducted or operated on the first floor of any of said premises, nor shall any direct advertisement or display of said lunch room or space be made in the front portion of said premises, Nos. 300, 302, 304 N. Howard Street, or any one or all of them.  The other provisions are not relevant here.  Dunnock, the president and principal owner of Oriole Cafeterias, Inc., took possession under this lease in 1928 and made substantial changes in the building which then stood on the site in order to adapt it for the purposes of a cafeteria.  All the alterations, additions, *372  and improvements were made following the prior written consent of the lessor, according to the terms of the lease.  The next preceding tenant had been the Blum Furniture Co. and before that Acker, Merrall & Condit Co., fancy grocers. *728  During these prior occupancies the building had been an ordinary two story structure, with a center entrance and with large plate glass show windows on each side.  The Oriole Cafeterias, Inc., the new tenant, spent $68,187.65 in changes in the front and first floor of the building in 1928 and $31,447.98 on the second floor in 1929.  The most obvious change was in the front, which was the only part completely rebuilt.  The lessee removed the show sindows on both floors; put in a revolving door to the street with two small windows, about two feet by six, on each side; and, on the second floor, a French window and six sash windows.  The front was entirely refaced in Indiana limestone and had a handsome appearance.  The old stairs were removed and new stairs built against the front wall, which led to wash rooms for customers below.  The old elevator was removed, and dumb waiters and dish conveyors were installed in the rear.  The front room of the first floor, which was reserved for customers, was materially changed by the building of interior double arches, about twenty-two feet wide, which lowered the ceiling level on the sides of the arches (and of the room) to about six feet and*729  lowered it in the center of the arches to slightly less than twelve feet above the floor.  This required removal of the old metal ceilings and much new plaster work.  The old ceiling of the first floor was thirteen feet and of the second twelve feet.  Commercial houses in Baltimore generally have a ceiling elevation of twelve feet or a little more for the first floor.  Blind windows were built in the front cafeteria room for ornamental purposes; partitions, paneling and railing were installed, and a four-inch facing of brick was laid over the inside plastered walls of the same room, also for ornamental purposes, while tile was laid over the old floor.  The changes in the rear or service room consisted mainly of the installation of fixtures necessary to carry on the cafeteria's work.  These included fans, the dish conveyors referred to above, which were extended to the second floor, motors to operate them, dishwashers, gas ranges, ovens, and refrigerators.  A celotex ceiling was built in the service room to lessen the noise, making it one foot lower than the front.  New plumbing was put in throughout, more than would be necessary for an ordinary commercial building and some of which*730  could be used only for a cafeteria.  New electric wiring and fixtures were installed.  The old heating system was removed and the building connected with the city gas heating system.  The old plumbing and heating systems were in good condition.  A ventilation system was installed by the lessee, but it *373  was not efficient and a new one using the same ducts was later put in.  A new roof was built, which would have been necessary in any case.  The cost of reconstruction of this building at the time of the hearing would be about the same as in 1928 and 1929.  The new building as a structure (leaving out of account trade fixtures) is considerably more valuable than the old, since it is much more elaborate and attractive.  All parts of the old building incorporated in the new will have the same life as the new, which will be about twenty-five or thirty years, if the roof is kept in good repair, and will still be in fairly good condition even after fifty years.  The building is situated one block from the commercial and retail center of Baltimore, which is approximately at the intersection of Howard and Lexington Streets.  There are several motion picture houses and large department*731  stores near this neighborhood.  The trend of small retail business is away from this district, however, and toward the outlying residential sections, where little commercial blocks have developed.  The Oriole Cafeteria at this location has been highly successful, having over three thousand customers a day.  To restore the building to its former use as a shop a number of alterations must be made - among other, the front wall must be rebuilt to obtain show windows; a new elevator must be installed and the front inside stairs removed; and the decorative brick and the arched ceilings must be removed to obtain space for show cases.  These alterations would make useless the toilets and rest rooms, now located under the front sidewalk.  The alterations made by the tenant, although resulting in some impairment of value of the building for the purpose of a retail shop, enhanced its value for restaurant or cafeteria purposes.  It could be used also for a bank or for a night club.  The work was done on a "cost plus" contract, the total cost of the alterations in the building being $99,635.63.  This sum included refrigeration ($4,927), electric work contract and extras ($5,798.33), conveying*732  machine ($4,475), elevator, dumb waiter, and elevator doors ($3,657).  The evidence failed to indicate what part, if any, of these items or other items, appearing in the builder's itemized list of costs for the two years, constituted fixtures which were removable under the terms of the lease.  The builder's list was introduced in evidence and is incorporated here by reference.  The Commissioner conceded that the item for refrigeration represented a removable fixture; determined the total cost of improvements to be $91,655.75, i.e., $7,979.88 less than the total cost; and, after deducting depreciation at 3 percent annually over the term of the lease, until October 31, 1948, treated the remaining amount as a gain to the petitioner, *374  lessor.  The total allowance for depreciation so found was $53,160.29, and the gain taxable to petitioner $38,495.46.  This sum the Commissioner apportioned over the term of the lease, and added to petitioner's income for the taxable year 1933 the aliquot part for that year, $1,965.72.  OPINION.  MILLER: Two questions are raised by this case: (1) Whether petitioner realized any gain from the alteration, by the lessee, of the building which*733  she owned at 306-310 North Howard Street, Baltimore, Maryland, because of improvements thereto and a resulting enhancement of value of the building, and, if so, (2) whether such gain would be realized only after the sale of the property by the lessor, or whether it was realized when the improvements were completed and it then became proper for the Commissioner to spread, over the period of the lease, an aliquot portion of such gain as income for each year thereof.  (1) The value of the building was greatly increased by the improvements made by the lessee.  The alterations which were made produced a substantially new building, with an entirely new and handsome front and a new roof.  Old portions of the building were incorporated so skillfully into the reconstructed one as to give them permanence equal to that of the new additions.  The lease provided that upon its termination the lessee might remove all lighting and trade fixtures installed by it, provided that it surrendered the premises in a tenantable state and condition in all respects.  The petitioner failed to show what part of the cost of improvements was attributable to the installation of such fixtures; and thus failed*734  to sustain her burden of proof.  The Commissioner conceded approximately $8,000 for this purpose.  His determination under the circumstances is entitled to a presumption of correctness.  Petitioner's contention is based not so much on the theory that the lessee may remove lighting and trade fixtures pursuant to the terms of the lease as on the theory that improvements permanent in character, such as the stairway, ironwork, and flooring must be removed by the lessor "unless you find somebody who is willing to buy or rent that particular class of building"; and that when such improvements have been removed, the losses resulting from the destruction of the property would be greater than the value of the improvements.  We have considered and rejected the same argument, in Shelby D. Scott,9 B.T.A. 1929">9 B.T.A. 1929, as applied to a motion picture theatre.  In the instant case petitioner's argument is even less pertinent.  Her own witness testified that the trend of small retail business is away from the area in which her building is located, because of the growth of such shops in outlying centers of the city.  On the other hand, *375  because of the presence of motion picture*735  theatres and large department stores in this area, the Oriole Cafeteria seems to be ideally located and the prospect of successful renting of the building for such purposes seems even more favorable than for a small retail shop.  It is true the evidence indicated that the building, after the alterations, was not so well adapted for the purpose of a retail shop and that to reconvert it for that purpose would require tearing out the present front, reinstalling show windows, removing the arched ceiling and the front stairs, reinstalling an elevator, and various other changes.  In short, the new building would not be suitable for a retail shop without complete reconversion.  Moreover, the petitioner contends that the improvements, while admittedly increasing the building's value as a cafeteria for so long as it should be occupied by the present lessee, were of such a peculiar and eccentric character that they really decreased its value.  However, these facts and contentions are fully met by abundant evidence of the highly successful business conducted by the lessee, Oriole Cafeterias, Inc.  Petitioner's witnesses were all skeptical in the beginning as to the wisdom of the changes proposed*736  and as to the possibility of such success, but they enthusiastically admitted their error in the light of subsequent events.  The property admittedly was bringing a higher rent than in previous years and the lease provided for an increase in rent than in previous The marked success of the tenant's business, however unexpected it may have been to the petitioner, showed every indication of continuing.  In these circumstances, we think the fact that the building might not be used as a retail shop without substantial changes is immaterial, and the possible necessity of the building's reconversion may be disregarded.  Shelby D. Scott, supra.We hold, therefore, that the petitioner realized income from the alterations made by the lessee, because of the enhanced value of the property which resulted therefrom.  (2) The second question is, When did the improvements made by the lessee become income to the petitioner?  It was expressly provided by paragraph 8 of the lease that "any alterations, additions and improvements made by the Lessee shall immediately be and become the property of the Lessors, without payment of compensation therefor to the Lessee", with a right reserved*737  to the lessee to remove on expiration of the lease all lighting and trade fixtures.  It was further provided by paragraph 9 that no improvements were to be made by the lessee without the approval of the lessors in writing.  This approval was given.  By article 63 of Regulations 74, the Commissooner established the following practice: ART. 63.  Improvements by lessees. - When buildings are erected or improvements made by a lessee in pursuance of an agreement with the lessor, and such *376  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.  * * * The Commissioner has since construed this article to include improvements permitted to be made by the lessee, although*738  not required under the lease, G.C.M. 10969, C.B. XI-2, p. 64.  In the instant case it is apparent that the Commissioner has used the alternative method of apportioning, over the period of the lease, the income realized in the year of the completion of the improvements.  This method has been approved in our earlier decisions, Shelby D. Scott, supra;Joseph L. B. Alexander,13 B.T.A. 1169">13 B.T.A. 1169; Cataract Ice Co.,23 B.T.A. 654">23 B.T.A. 654; W. H. Martin,24 B.T.A. 813">24 B.T.A. 813; Louise C. Slack et al., Executors,35 B.T.A. 271">35 B.T.A. 271; Emma C. Morphy,35 B.T.A. 289">35 B.T.A. 289. The petitioner relies on Hewitt Realty Co. v. Commissioner, 76 Fed.(2d) 880, in which the Circuit Court of Appeals for the Second Circuit, reversing this Board, 29 B.T.A. 1205">29 B.T.A. 1205, rejected the Commissioner's method of determining realization of income, as constitutionally unsound.  In the recent case of Emma C. Morphy, supra, we gave careful consideration to the decision in *739 Hewitt Realty Co. v. Commissioner, supra, and, relying upon the cases of Miller v. Gearin,258 Fed. 225, and Cryan v. Wardell,263 Fed. 248, came to the conclusion that, since no other court had adopted the theory of the Hewitt Realty Co. case, we should adhere to our former opinion and again sustain the validity of the contested regulations.  See also United States v. Boston & Providence Railroad Corporation, 37 Fed.(2d) 670. Pursuant to that conclusion we sustain the Commissioner here.  Decision will be entered under Rule 50.