Opinion
No. 343.
May 26, 1944.
Petition to Review a Decision of the Tax Court of the United States.
Petition by the Commissioner of Internal Revenue to review a decision of the Tax Court of the United States, 1 T.C. 365, redetermining deficiency in income tax assessed against Edna C. Gutman.
Affirmed.
The petitioner, residing in New York City, filed her income tax returns on the cash basis. The petitioner's father died on July 4, 1901, leaving a will by which he devised two-fifths of his residuary estate to his executors upon the following trust: "* * * to receive the rents, profits and income thereof during the life-time of my said daughter Edna and, during her minority, to apply the net rents, issues, profits and income thereof to her support, maintenance and education, and, from the time she attains majority until her death, to pay over to her the said net rents, issues, profits and income of said last-mentioned two-fifths in at least semi-annual instalments; * * *"
Provision was made for gifts over of the remainder interest upon the death of the petitioner, but no provision was made for apportionment of depreciation deductions between the life beneficiary and the trustees.
During both of the years 1937 and 1938, two parcels of improved real estate comprised a part of the corpus of the trust estate. A third parcel was acquired on February 21, 1938, and was retained as a trust asset throughout the remainder of that year. These properties were all situated in New York City, and had been acquired by the trustees, or their nominee, in lieu of or as the result of the foreclosure of mortgages covering them and held by the trustees.
The first parcel was acquired on June 13, 1934. At that time the mortgage covering it secured an unpaid principal balance of $18,500, and bore interest at the rate of 5½ percent per annum. The second was acquired on January 22, 1935. It had secured a mortgage in the amount of $15,000, which also bore interest at the rate of 5½ percent per annum. The third parcel was acquired on February 21, 1938. There remained unpaid on the mortgage covering it, the amount of $52,500, bearing interest at the rate of 4 percent per annum.
Attorney fees, arrearages in taxes and water rents, and the costs of certain structural changes and improvements deemed necessary to comply with local building regulations were paid by the trustees at the time of acquisition of the properties. In each instance, those payments were made out of principal funds of the estate.
Net rents from the three properties aggregated $1,756.22 for the year 1937 and $2,687.17 for the year 1938. Counsel advised the trustees that, under decisions of the courts of New York, they might incur the risk of a surcharge if they made distribution of any part of current income until the properties were disposed of by sale. The trustees, accordingly, made no distribution of net rents to petitioner in either 1937 or 1938. On her income tax return for 1937, petitioner claimed a deduction of $810 for depreciation of the real estate so held by the trustees. A corresponding claim in the amount of $1,185 was made on her return for 1938.
Income of the trust was reported on the cash basis. The return for 1937 showed $30.25 as tax due. No claim for depreciation of the real estate comprising trust assets was claimed for either that year or 1938, but a depreciation deduction in the amount of $1,185 was allowed by the Commissioner for 1938. The deductions were denied to the petitioner on the ground that the income from the properties in question was not currently distributable to her, nor reported by her in her income tax returns for the taxable years. Certain other adjustments to her net income were made, and the deficiencies determined.
The parties agreed that reasonable allowances for depreciation of the properties in question are $810 for 1937 and $1,185 for 1938.
Pertinent sections of the Revenue Acts of 1936 and 1938 read as follows:
"Sec. 23. Deductions from gross income. In computing net income there shall be allowed as deductions:
* * * * *"( l) Depreciation. A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. In the case of property held by one person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner of the property and shall be allowed to the life tenant. In the case of property held in trust the allowable deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or, in the absence of such provisions, on the basis of the trust income allocable to each."
* * * * * *"Sec. 162. Net income. The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that —
* * * * *"(b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year;
"(c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during each year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary." 26 U.S.C.A. Int.Rev. Code, §§ 23( l), 162(b, c).
Treasury Regulations 94, promulgated under the Revenue Act of 1936:
"Art. 23(1) — 1. Depreciation. — * * * In the case of property held in trust, the allowable deduction is to be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the will, deed, or other instrument creating the trust, or, in the absence of such provisions, on the basis of the trust income which is allocable to the trustee and the beneficiaries, respectively. For example, if the trust instrument provides that the income of the trust computed without regard to depreciation shall be distributed to a named beneficiary, such beneficiary will be entitled to the depreciation allowance to the exclusion of the trustee, while if the instrument provides that the trustee in determining the distributable income shall first make due allowance for keeping the trust corpus intact by retaining a reasonable amount of the current income for that purpose, the allowable deduction will be granted in full to the trustee.
The corresponding provisions of Article 23(1) — 1, Treasury Regulations 101, promulgated under the Revenue Act of 1938, are the same.
Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, Helen R. Carloss, and Helen Goodner, all of Washington, D.C., for petitioner.
Isidor Sack, of New York City, for respondent.
Before L. HAND, CHASE, and FRANK, Circuit Judges.
1. The Commissioner relies upon In re Chapal's Will, 269 N.Y. 464, 199 N.E. 762, 103 A.L.R. 1268 and In re Otis, 276 N.Y. 101, 11 N.E.2d 556, 115 A.L.R. 875, which we recently discussed in Johnston v. Helvering, 2 Cir., 141 F.2d 208. The Commissioner argues that this case is like one in which trustee has discretion to withhold income from a life beneficiary and thereby to make the withheld income part of the corpus. But here, although the trustees were obliged, under the New York decisions, not to pay the income from the properties until the "mortgage salvage operations" were completed, nevertheless that income was allocable in the taxable years to the taxpayer, for it could never become part of the corpus, be allocable to anyone other than the taxpayer. She was, therefore, entitled to deduct the depreciation from her gross income in the taxable years 1936 and 1938.
2. The Commissioner argues, in the alternative, that, if that be so, then she must be taxed in those years on the withheld income. Surely not. We agree with the Tax Court which said: "Depreciation is allowed by one section, section 23( l), of the Revenue Acts of 1936 and 1938. Taxability of income to the petitioner falls under section 161(a)(2) and section 162(b) of the same acts, providing taxation of income currently distributable to the beneficiary. Under the law of New York, it was not so currently distributable, for the amount of trust income could not be known until the end of the `mortgage salvage operation.'" 1 T.C. 365.
Affirmed.