Currier v. Commissioner

Charles Bertram Currier and Catherine B. Currier, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent Currier v. Commissioner Docket No. 8189 United States Tax Court 7 T.C. 980; 1946 U.S. Tax Ct. LEXIS 59; October 16, 1946, Promulgated *59 Decision will be entered under Rule 50. Petitioner, devisee of an interest in income-producing building erected prior to decedent's death by lessee, held, entitled to deduct her share of total depreciation on building, based upon value of building at date of decedent's death, notwithstanding that building may have cost decedent nothing and was occupied under lease which extended beyond useful life of building, and lessee was under obligation, upon expiration of lease, to yield up building in first-class condition and repair. Reisinger v. Commissioner (C. C. A., 2d Cir.), 144 Fed. (2d) 475, distinguished. Philip Nichols, Esq., for the petitioners. J. B. Haslam, Esq., for the respondent. Opper, Judge. Hill, J., dissenting. OPPER *980 This proceeding involves an income tax deficiency of $ 118.91 for the year 1941. By amended answer respondent sought an increase of $ 26 in deficiency, but on brief has waived this issue. Petitioners not only challenge the deficiency, but claim an overpayment in tax for the year in the amount of $ 100.25. The issue to be decided is whether respondent erred in denying a deduction for depreciation*60 to one of the petitioners, a life beneficiary of a testamentary trust, on a building built during decedent's lifetime by the tenant under a lease for a term of years extending beyond the agreed life expectancy of the building. Some of the facts have been stipulated. *981 FINDINGS OF FACT. The stipulated facts are hereby found accordingly. Petitioners, who are husband and wife, are residents of Boston, Massachusetts. Their joint tax return for the year 1941 was filed with the collector of internal revenue, Phoenix, Arizona, on March 16, 1942, the petitioners at that time having been residents of Tuscon, Arizona. Hereinafter Catherine B. Currier will be referred to as petitioner. Petitioner's father, William O. Blake, executed his last will and testament on February 23, 1934, and a codicil thereto on March 6, 1934, the latter not being material to this proceeding. By his will he devised the residue of his property in trust for the benefit of his wife for her life, and thereafter for the equal benefit of his four daughters, of whom petitioner was one, during the life of each, with remainders over to their appointees, there being provision for disposition in default of appointment. *61 Petitioner's father died on November 10, 1934; her mother, on November 23, 1940. The residue of the estate included an 11-story building, known as the Blake Building, located in Boston, Massachusetts, which was then under a lease to George A. Carpenter, dated November 15, 1904, for a term of 75 years from August 1, 1908. The trustees in 1941, acting under the authority of the will, retained 32 per cent of the net income of the trust, before making any deduction for depreciation on the Blake Building, and distributed the remaining 68 per cent of the trust income in equal parts to the four beneficiaries. The trustees claimed a deduction of 32 per cent of the depreciation based on a value of $ 400,000, an estimated life of 50 years, and a consequent rate of 2 per cent. In computing their net income for 1941 petitioners claimed as a deduction for depreciation of the building the amount of $ 1,316, thereby seeking to claim 17 per cent of the total amount of depreciation. Respondent disallowed this deduction, with the following explanation in his notice of deficiency: The amount of depreciation deducted by you as an offset to fiduciary income from the William O. Blake Trust is not allowable*62 as a deduction. The property upon which depreciation is claimed, erected by the lessee in 1908 during the lease term, represents an investment of the lessee, with no cost to the lessor which would constitute a basis for the allowance of depreciation. The improvements had no fair market value on March 1, 1913 in the hands of the lessor since the property was subject to lease for a longer term than the estimated life of the improvements. As grounds for a claim for refund, filed on March 15, 1945, for $ 100.25, income tax paid for the year 1941, petitioner stated that she was entitled to deduct depreciation in the amount of $ 2,445.64, representing her share of depreciation on the building, which was alleged to *982 have a value of $ 594,686 on November 10, 1934, and to be subject to depreciation at a rate of 2 1/2 per cent. Under the terms of the lease of 1904, which was modified from time to time, decedent and his wife, as lessors, and Carpenter, as lessee, leased the premises upon which the Blake Building was subsequently erected, for an annual rental of $ 70,000. The lessee covenanted to remove the existing buildings and to erect a new building of at least 5 stories in height, *63 which was modified by later agreement to provide for the erection of an 11-story building. The building and improvements were to be and remain the property of the lessors. The lessee further covenanted: * * * to keep said buildings, fixtures and improvements in good and tenantable condition and repair, and upon the expiration or other sooner determination of this lease, yield up the demised premises and all buildings and improvements thereon, including all fixtures added by the Lessee, although they be such as Lessee in the absence of agreement, has the right to remove, in first class condition and repair without any compensation thereof. Among the modifications of the original lease were the following: (1) Agreement of March 20, 1908, providing for the erection of the 11-story building, and also modifying an earlier agreement of May 16, 1905, in that the lessors agreed to furnish the additional funds necessary to erect an 11-story building, in view of the fact that the amount realized upon a taking of part of the property for public purposes, by the city of Boston, was insufficient. The lessee agreed to pay 4 per cent interest on such additional sum, and a plan was formulated *64 for liquidation of one-half thereof by annual payments and the remainder by payments into a sinking fund. (2) Agreement of November 1, 1918, made subsequent to the erection of the building, modifying an agreement of April 24, 1912, by providing, in lieu of annual payments of $ 10,000 to the lessors, annual payments of $ 10,000, beginning March 7, 1922, to the bank holding the mortgage on the Blake Building until $ 300,000 of the mortgage was liquidated; and the liability of the lessee for the cost of the building was limited to $ 300,000. (3) Agreement of January 1, 1934, modifying the method of rental payment. (4) Agreement of December 20, 1935, entered into by Blake's executors and the trustees under his will, reciting that $ 210,000 of the $ 300,000 mortgage remained unpaid and providing a means whereby the lessee's administrator was to manage the building as agent of the owners. (5) Agreement of January 1, 1938, between the same parties, providing for suspension of the lease until February 1, 1959, lessee's administrator continuing to act as manager of the building. *983 The Blake Building was completed on January 1, 1911, at a cost of $ 447,232.25. Its agreed estimated useful*65 life is 50 years from its completion. The building is an 11-story, steel frame building, with full basement and partial subbasement; its outer walls are of terra cotta masonry and large areas of glass on the street fronts. Its content is 1,154,000 cubic feet. It is located in the downtown retail district of Boston. On the Federal estate tax return filed for the estate of William O. Blake the value of the building and of the land was not segregated and was reported in the amount of $ 412,188.17 over and above an existing mortgage of $ 735,000. The reported value was not adjusted by respondent for estate tax purposes. The board of assessors for the city of Boston assessed the Blake Building and land for each of the years 1934 and 1935 as follows: Land value $ 1,365,000 Building value 135,000 Total value 1,500,000 A building appraiser was of the opinion that the building had a fair market value as of November 10, 1934, of approximately $ 600,000. His opinion was based on the cubical content of the building and cost of construction, his estimate reflecting replacement value of a new building as of that date. A second witness, a builder and appraiser, estimated the*66 replacement cost new of the building as of November 10, 1934, at $ 594,686. Another witness, a real estate broker and appraiser, was of the opinion that the fair market value of the building as of November 10, 1934, was $ 482,100. His estimate was based on capitalization of estimated earnings. The estimated value was reached by capitalizing at 5 per cent the assumed net rental which would be received from an assumed one-story and basement building erected on the lot; the value thus computed was assumed to be the value of the land. He then deducted the assumed value of the land from his estimated value of the actual building, which he determined by capitalizing the leasehold rental of $ 70,000 at 6 per cent. The Blake Building had a fair market value as of November 10, 1934, of $ 250,000. OPINION. Respondent makes no effort to meet petitioner's contention that the doctrine of Reisinger v. Commissioner (C. C. A., 2d Cir.), 144 Fed. (2d) 475, is inapplicable to inherited property. That doctrine deprives a lessor of depreciation deductions if the lessee has furnished the improvements upon which depreciation is claimed. *984 Cf. Therese C. Johnson, 7 T. C. 465.*67 But the function of the owner's investment, which in such cases is otherwise absent and which the depreciation deductions are hence not required to replace, cf. Detroit Edison Co. v. Commissioner, 319 U.S. 98, is, in the case of inherited property, performed by the intervention of the estate tax upon the improvements transmitted from decedent to devisee. The basis of inherited property is accordingly not cost, as it was in the Detroit Edison and Reisinger cases, and to say that a property cost the taxpayer nothing makes no contribution to the solution of the present question. As opposed to cost, the basis of property acquired by devise is categorically fixed by statute as fair market value on the date of acquisition. Internal Revenue Code, sec. 113 (a) (5). Hence, if we can discover the fair market value of the property in question at the date of decedent's death, Augustus v. Commissioner (C. C. A., 6th Cir.), 118 Fed. (2d) 88, (or the figure at which it was returned for estate tax purposes, which is recognized as the equivalent, Regulations 103, sec. 19.113 (a) (5)) the upshot would ordinarily be its*68 basis for depreciation in petitioner's hands, without any reference to its "cost." Having acquired a basis by the incidence of the estate tax, the gradually disappearing value of a wasting asset can not be replaced except by periodic depreciation adjustments. This must be true notwithstanding that the long term lease, subject to which the property was inherited, appears to extend beyond the building's anticipated useful life. At least by the end of the lease term the property will be returned with a worthless building, and petitioner's capital will have been correspondingly reduced, unless the provision in the lease requiring the tenant to return the improvements in first class condition and repair has the effect asserted by respondent, that the building would have to be replaced at that time by the lessee, and hence that no diminution in the lessor's interest could take place for which depreciation need be allowed. Cf. Mississippi River & Bonne Terre Ry., 39 B. T. A. 995. This raises a narrow question which has been narrowly dealt with by the courts. It reduces to the precise effect of the tenant's obligation to "keep said buildings, fixtures, and*69 improvements in good and tenantable condition and repair, and upon the expiration or other sooner determination of this lease [to] yield up the demised premises and all buildings and improvements thereon * * * in first class condition and repair * * *." If this imports an obligation to "return to it [the lessor] replaced buildings equal to the value of the property originally leased," it eliminates the prospect of loss and with it the depreciation deductions. See Atlantic Coast Line R. Co. v. Commissioner (C. C. A., 4th Cir.), 81 Fed. (2d) 309; certiorari denied, 298 U.S. 656. Otherwise, the deduction is permissible. *985 Alaska Realty Co. v. Commissioner (C. C. A., 6th Cir.) 141 Fed. (2d) 675. While the answer here is not without some difficulty, it seems clear at least that the obligation assumed was to return the same building, not a new one. Granted that such a structure had been maintained with scrupulous care, and that its condition would be as good as such care could make it, it does not seem practical to expect that a 50-year old edifice would be as valuable as one half*70 its age. We find no suggestion that the tenant would be required to make good that difference in value. See St. Paul Union Depot Co. v. Commissioner (C. C. A., 8th Cir.), 123 Fed. (2d) 235. The consequence is that petitioner will suffer some loss from depreciation, and hence that some corresponding deduction must be allowed. Terminal Realty Corporation, 32 B. T. A. 623. It accordingly becomes necessary to dispose of the contested question of basis. This, as we have already noted, involves the figure at which the property was returned for estate tax purposes, or its fair market value at the date of death, which are synonymous. The only difficulty here is that the property was included on the estate tax return with one aggregate figure for land and improvements combined. We conceive the sole remaining task as requiring a segregation of the two values. The witnesses, all of whom were produced by petitioner, were not able to shed sufficient light on this aspect of the problem for us to profit greatly by their testimony. Two appraised the building on a replacement basis, with no discount for depreciation or obsolescence. *71 The third valued the land and deducted this from an assumed total value at variance with that used by the executors. By combining the proffered testimony, however, and adding other facts appearing in the record, we have arrived at the valuation of $ 250,000, as set forth in our findings. The annual depreciation deductions can readily be computed by using that basis, since there is no apparent disagreement between the parties as to the remaining useful life of the building, or as to the share of the total depreciation attributable to petitioner's interest. Decision will be entered under Rule 50. HILL Hill, J., dissenting: The basis for depreciation of the building in question in the hands of the legatees is the fair market value of the legatees' interest therein subject to the Carpenter leasehold at the time of decedent's death. Bueltermann v. United States, 155 Fed. (2d) 597. *986 The basis for depreciation of the building in the hands of such legatees as determined in the majority opinion is the fair market value thereof at decedent's death, unaffected by the existence of the leasehold estate. Since, in my opinion, the basis for *72 depreciation as determined by the majority is not the basis upon which petitioner is entitled to compute depreciation in respect of the building, I am unable to agree with the holding of the majority.