Ben T. Wright, Inc. v. Commissioner

BEN T. WRIGHT, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Ben T. Wright, Inc. v. Commissioner Docket No. 12164. United States Board of Tax Appeals 12 B.T.A. 1149; 1928 BTA LEXIS 3393; July 5, 1928, Promulgated *3393 1. Section 331 of the Revenue Acts of 1918 and 1921 held to apply only to invested capital and not to the basis for computing allowances for the exhaustion, wear and tear of assets. 2. The cost of alterations of the petitioner's building, made pursuant to orders of city authorities, which bettered the working conditions of the petitioner's employees, held to be a capital expenditure and not deductible as an ordinary and necessary expense. Donald E. Currier, C.P.A., for the petitioner. Alva C. Baird, Esq., for the respondent. MARQUETTE *1149 This proceeding is for the redetermination of deficiencies in income tax asserted by the respondent in the amounts of $1,395,69 for the year 1918; $106.69 for the year 1919; $2,545.99 for the year 1920, and $89.10 for the year 1921. The deficiencies arise by reason of the disallowance by the respondent of deductions claimed by the petitioner with respect to (1) exhaustion of a leasehold, and (2) cost of alterations of a building. FINDINGS OF FACT. The petitioner is an Illinois corporation with its principal office and place of business at 1111 North Clark Street, Chicago. During the*3394 years 1918 to 1921, inclusive, it was engaged in the business of operating an automobile sales agency and garage for selling, repairing and servicing Ford automobiles under a franchise, or agency, from the Ford Motor Co. On December 1, 1916, one Thomas C. Roney, who was a lessee in possession of an old car barn on North Clark Street under a lease running until February 1, 1927, sold the lease to Ben T. Wright and Archie C. Rockwell for $8,000. The rent reserved in the lease was $168.42 per month, which obligation Wright and Rockwell assumed. Wright, Rockwell, and Wright's mother then formed a partnership which remodeled the building at considerable expense and used it as an automobile sales room, garage, repair shop, and service station. The interests in the partnership were: Ben T. Wright, 34.7 per cent; Archie C. Rockwell, 17.4 per cent, and Mrs. J. C. Wright, 47.9 per cent. In October, 1917, the Rockwell Wright Co., the petitioner herein, was incorporated with a capital stock of $50,000, which was issued to Ben T. Wright, 50 per cent; John C. Wright, father of Ben T. Wright, 25 per cent, and Archie C. Rockwell, 25 per cent. *1150 The Rockwell Wright Corporation*3395 purchased the assets of the partnership, subject to its liabilities, and issued its capital stock therefor, of which the amount of $39,628.32 was issued for the leasehold and improvements. The leasehold at the time it was turned over to the corporation had a fair market value of $50,000. In the year 1918 the petitioner's name was changed to the Wright-Kenderdine Co. and in 1924 to Ben T. Wright, Inc., the present name. In the year 1920 the petitioner purchased a two-story brick building which had been a garage and repair shop, and which adjoined the leased premises occupied by the petitioner. The walls and foundation of this building were sufficient to carry two more stories. The petitioner used the building for a garage and repair shop for several months without making any alterations. Late in the year 1920 the city authorities demanded that the building be better ventilated and the petitioner accomplished this by putting in larger and what are known as ventilating windows. In installing these ventilating windows it was necessary to remove considerable brick work from the walls of the building and they were thereby so weakened that they could not carry the weight of any*3396 additional stories. Other methods of ventilating were feasible but more expensive to install. Prior to the demands by the city, the petitioner's employees had caused some trouble, apparently with respect to the question of ventilation. In the year 1923 the petitioner remodeled the building, and in connection with the remodeling a portion of the walls was strengthened by additional steel and a stronger foundation. The cost of this strengthening does not appear, as it was part of a lump-sum contract. In the years 1926 and 1927 the petitioner added another story to the building and was obliged to reinforce the remainder of the wall at a cost of $3,876. The petitioner in its income-tax returns for the years 1918 to 1921, inclusive, deducted in each year an allowance for the exhaustion of its leasehold computed upon the basis of a fair market value of $50,000 at the time it was acquired from the partnership. The petitioner also deducted from gross income for 1920 the amount it had expended in altering its building in that year. The respondent disallowed the deduction. OPINION. MARQUETTE: It is the contention of the petitioner that in computing its net income for each of*3397 the years 1918 to 1921, inclusive, it is entitled to deduct, as an allowance for the exhaustion of the leasehold which it acquired from the partnership of Wright, Rockwell & Wright, an amount computed on the basis of a fair market value of $50,000 at the time of such acquisition, and that it is also entitled to *1151 deduct in computing its net income for the year 1920 the amount it expended in that year in altering its building, and the amount it was subsequently required to expend in 1926 and 1927 on account of the damages done to the building by such alterations. The respondent urges that under section 331 of the Revenue Acts of 1918 and 1921 the basis for computing the exhaustion of the leasehold is the cost thereof to the partnership, and that the amounts the petitioner expended in altering and strengthening its building are capital expenditures and not deductible from income. Upon consideration of the evidence presented we are of the opinion that the leasehold in question had a fair market value of $50,000 at the time it was acquired by the petitioner from the partnership. The partnership originally paid $8,000 for the lease and expended a considerable amount in improving*3398 the building on the premises. The rent reserved in the original lease was $168.42 per month, but at the time the property was sublet to the petitioner it had a monthly rental value of from $750 to $800 per month. The value which we have found for the lease is established by the testimony of several witnesses who are familiar with the property and real estate values in the vicinity. Their testimony, which we need not set forth at length, clearly shows that the leasehold was worth at least $50,000 when the petitioner acquired it. While under section 331 of the Revenue Acts of 1918 and 1921 the leasehold can not be included in the petitioner's invested capital at any greater amount that it could have been included in the invested capital of the partnership, its fair market value at the time the petitioner acquired it is the proper basis for computing the allowances for its exhaustion. In , in passing upon the identical question here presented, this Board said: Reaching the conclusion that Giles, who owned the assets which were exchanged for the stock, actually had control of the issuance of all the stock, we conclude that a situation*3399 is presented which brings the case within the scope of section 331 of the Revenue Act of 1918. The fact that the case comes within the scope of section 331, however, applies only to the invested capital feature and has no relation to the valuation of the leases for the purpose of deductions on account of the exhaustion thereof. Therefore, the allowance which the petitioner is entitled to deduct for the exhaustion of its leasehold should be computed on the basis of $50,000. We have carefully considered the evidence relative to the second issue presented by the record but it fails to convince us as to the soundness of the petitioner's contention. It is not certain from the evidence that the placing of ventilating windows in the petitioner's building was wholly due to the city's requirement rather than to a voluntary desire of the petitioner to placate its workmen and provide *1152 them with better working conditions for the mutual benefit of employer and employee, but even if these changes were wholly nonvoluntary on the petitioner's part, we think the cost thereof is not a proper deduction from the petitioner's income. It is probably true that the changes weakened the*3400 walls of the building, but they also bettered the working conditions in the building. To that extent, at least, they added to the value of the property. It may also be noted that the petitioner had a choice of at least one other method of providing better ventilation which would not have weakened the walls. That the choice made required a later additional expense in order to restore the walls of the building to their original carrying capacity, is not, in our opinion, a ground for treating as an ordinary and necessary expense that which is properly a capital expenditure. We hold that the amounts in question were capital expenditures and therefore not deductible from income. Judgment will be entered under Rule 50.