Cross v. Commissioner

MAURICE CROSS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Cross v. Commissioner Docket No. 32735. United States Board of Tax Appeals 24 B.T.A. 1079; 1931 BTA LEXIS 1545; December 4, 1931, Promulgated *1545 Charles L. Fleece, Esq., for the petitioner. Frederick K. Slanker, Esq., and George R. Sheriff, Esq., for the respondent. TRAMMELL *1079 This proceeding involves the redetermination of a deficiency in income tax for the year 1923 in the amount of $1,489.14. The proceeding was abandoned in so far as the taxable years 1924 and 1925 are concerned. The errors assigned are: (1) The disallowance of an amount claimed by the petitioner to have been expended for improvements to property acquired since March 1, 1913, in computing the amount of loss on a sale in 1913; (2) the amount of deductible loss sustained by the petitioner in the operation of a retail clothing store. FINDINGS OF FACT. The petitioner is an individual residing in New York City. Prior to March 1, 1913, he purchased certain lots improved by four old tenement houses known as premises 314, 316, 318, and 320 West 40th Street, New York City. The total March 1, 1913, value of said property and improvements was $85,000. The cost of the property in 1905 was $75,000. In 1923 petitioner sold all of this property together for $93,081.25. The depreciation sustained from March 1, 1913, to*1546 date of sale was $9,833.34. The Commissioner determined that the March 1, 1913, value of $85,000 reduced by the above amount of depreciation was $75,166.66, resulting in a taxable gain of $17,914.59. The petitioner in his return for 1923 shows a loss on the sale of this property. He added to the March 1, 1913, value the sum of $20,000 as being the cost of improvements since that date. At the time the petitioner purchased the above described property the buildings were more than sixty years old. They did not have any of the modern conveniences such as running water, electricity, bathtubs, toilets, hot-water system, etc. The petitioner could not keep tenants because the buildings had no improvements. Desiring to make improvements and renovations, the petitioner discussed the *1080 matter with contractors. He offered to sell the houses to one contractor. In 1918, instead of selling them, he leased them to Saludin & Jaffe, who were in the contracting business. The petitioner stated that he had to have $8,000 a year rental. The contractors stated that they would pay $5,000 a year rental and they, themselves, make the improvements and necessary installations and renovations. *1547 This proposition was accepted by the petitioner and both parties to the lease considered that $3,000 a year was allowed in consideration for making these improvements. The lease ran for ten years, five years of which was a straight and unconditional lease and the remaining five years contained a sixty-day clause permitting the petitioner to sell within that five-year period and giving the lessees sixty days notice to vacate. It was understood between the parties that if the petitioner sold the property within the first five years of the lease he would have to refund to the lessees on account of the unexpired lease on the basis of $3,000 a year on account of the payment by the lessees for the improvements. If the property was sold after five years and in the second term of five years, the petitioner was not required to make any adjustment on account of the improvements paid for by the lessees. The lessees paid out in making the improvements at least $20,000. The improvements, renovations, and alterations made by the lessees consisted of putting in dumb-waiters, letter boxes, alcoves and shafts, bathtubs, plumbing, hot-water system, flush toilets to replace the old hopper toilets, *1548 washtubs, sinks, electric lighting, wiring, connections and fixtures in all of the houses, dish closets, and clothes closets. They redecorated and painted all four of the buildings and put new glass in windows and new window frames. In order to put in a hot-water system it was necessary to excavate a place for same in the subbasement. A boiler room was made and a hot-water boiler in connection with the system was put in. New slate roofs were put on the houses to take the place of the old tin roofs. Various other things were done to renovate and completely overhaul the buildings. In connection with the operation of the retail clothing store the petitioner kept no books from which the income could properly be computed for tax purposes. He kept no inventories and the taxable years were not kept separately on the books so that the income derived or business done over different periods could be segregated. One period ran from December 11, 1922, to February 10, 1923. The profits from January 1, 1923, to February 10, 1923, were computed by an arbitrary estimate. The gross sales as stipulated by the parties for the year involved were $55,861. The respondent treated 7 per cent*1549 thereof as being taxable income. *1081 OPINION. TRAMMELL: In connection with the gain or loss on the sale of property the only question before us is the amount expended by the petitioner in making improvements, all the other factors being agreed upon. We think that the agreement whereby the rent was reduced from $8,000 to $5,000 per year and in consideration thereof the lessees were to make these improvements, amounts to the payment therefor by the petitioner. However, the property was leased in 1918 and was sold in 1923, a period in any event not to exceed five years. The petitioner therefore did not pay out through this process more than $15,000. It was the agreement of the parties that, if the lessees did not retain the property for a full five-year period, the petitioner would have to make a refund on account of the expenditures made by the lessees, and there being no evidence of any refund or any controversy raised as to whether any refund was made, we feel warranted in assuming that the lessees retained the property at least five years. We think, therefore, that the petitioner did in effect pay out for improvements and alterations $15,000. *1550 The Commissioner raises the point that some of the amounts paid out by the lessees under this arrangement were for repairs and any amount paid therefor should not be added to the capital value of the property; that any amount paid for repairs is not segregated from the amounts paid out for improvements, and therefore no amounts can be added on account of the improvements. We think, however, that the expenditures were for the general improvement, reconditioning, and renovating of the property. In this connection, in the case of , we said: While the characterization of some of the items is such that standing alone or made as periodic repairs they might be deductible as ordinary and necessary expenses, it is impractical from the evidence to make such a detailed classification of the items. Such a classification is not a mere matter of what an item is called, but whether it is a part of the entire capital investment in the improved property. To fix a door or patch plaster might very well be treated as an expense when it is an incidental minor item arising in the use of the property in carrying on business, and yet, as here, be properly capitalized*1551 when involved in a greater plan of rehabilitation, enlargement, and improvement of the entire property. See also . It is, therefore, our opinion that the amount of $15,000 should be added to the March 1, 1913, value in determining the profit on the sale of the property in 1923. With respect to the income from the retail clothing store, since it appears that the books, accounts, and records of the taxpayer were not kept in such a manner or method as to permit of a correct *1082 computation of income could be determined therefrom, the determination of the Commissioner by the use of average percentage tables is presumptively correct and will be upheld in the absence of evidence as to what the correct income is. See ; affirmed by the ; ; ; . The evidence introduced in this proceeding is not sufficient to overcome the prima facie correctness of the Commissioner's determination. *1552 The taxable income computed or estimated from the books and records would be no more than a guess and this is not sufficient. The petitioner, operating a retail clothing business, kept no inventories of merchandise in accordance with article 1585 of Regulations 62, promulgated pursuant to section 203 of the 1921 Act. This fact alone, without consideration of the insufficiency of the books and records otherwise, would prevent a proper determination of income. The petitioner has not shown that the determination of the Commissioner is erroneous. Judgment will be entered under Rule 50.