Opinion
Docket No. 21439.
1954-07-13
ALBERT L. ROWAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
S. L. Mayo, Esq. , and J. Edwin Fleming, Esq. , for the petitioner. J. Clifton, Maxwell, Esq. , for the respondent.
1. A taxpayer who inherited a one-third interest in property on which a building had been constructed by the lessee without cost to the lessor, under a 66-year lease was not entitled to a depreciation allowance on the building. The term of the lease extended beyond the useful life of the building and since the taxpayer would not sustain any economic loss as the building wore out and could not sell his interest in the building apart from the land or the rentals, he has no statutory basis for a depreciation allowance. Commissioner v. Pearson, 188 F. 2d 72, and Commissioner v. Moore, 207 F. 2d 265,certiorari denied347 U. S. 942, followed. J. Charles Pearson, Jr., 13 T. C. 851; Mary Young Moore, 15 T. C. 906; and Charles Bertram Currier, 7 T. C. 980, overruled.
2. When the lease referred to in headnote 1 above was entered into by the parties there were two buildings situated upon the property, which had an adjusted basis to the lessor of $35,000. They were demolished by the lessee to make way for the construction of the new building. The lessor, Ellen Rowan, until her death in 1940 claimed, and was allowed, on account of the demolition of these buildings an annual amortization deduction of $583.33 based on recoverable cost and the remaining 60-year period of the lease. Petitioner in his returns for each of the taxable year claimed for depreciation or amortization $194.45, which represented his alleged one-third interest in his mother's adjusted basis ($35,000) in the demolished buildings which she had been amortizing at $583.33 per year. Held, the unrecovered basis of the decedent in the demolished buildings was an income tax advantage to which she was entitled and which was not wholly availed of in her lifetime. Held, further, this tax advantage was not of such nature as to be subject to transmission by inheritance to her heirs. An heir, such as petitioner, acquires basis in an inherited interest by virtue of section 113(a)(5), Internal Revenue Code. The Commissioner is sustained in the disallowance of this deduction. S. L. Mayo, Esq., and J. Edwin Fleming, Esq., for the petitioner. J. Clifton, Maxwell, Esq., for the respondent.
The Commissioner has determined deficiencies in petitioner's income tax as follows:
+----------------+ ¦Year¦Deficiency ¦ +----+-----------¦ ¦1943¦$1,010.61 ¦ +----+-----------¦ ¦1944¦1,023.82 ¦ +----+-----------¦ ¦1945¦901.51 ¦ +----------------+
The deficiency for 1943 is due to three adjustments made by the Commissioner which were as follows:
+--------------------------------------+ ¦(a) Attorney's fee disallowed¦$166.66 ¦ +-----------------------------+--------¦ ¦(b) Capital loss disallowed ¦3,125.00¦ +-----------------------------+--------¦ ¦(c) Depreciation disallowed ¦194.45 ¦ +--------------------------------------+
Only adjustments (b) and (c) are contested and similar adjustments for 1944 and 1945 are contested. These adjustments were explained in the deficiency notice for 1943, as follows:
(b) The deduction of $3,125.00 claimed as a capital loss is not allowable for the reason that the value at date of inheritance of the property inherited by you, upon which the claimed deduction is based, consists solely of the value of the land which is non-depreciable.
(c) The deduction of $194.45 claimed by you on your return as depreciation is not allowable.
The same type of disallowance of the deductions for 1944 and 1945 is explained in the deficiency notice in the same manner as the above.
The petitioner assigned error as to the foregoing adjustments as follows:
(a) For each taxable year the Commissioner erred in denying a deduction, labeled a capital loss, for depreciation or amortization, of $3,125.00, or other appropriate sum, on his property rights in land and improvements known as the Gulf States Building, Dallas, Texas (a building built by the tenant under a lease for a term of years extending beyond the life expectancy of the building).
(b) For each taxable year the Commissioner erred in denying a deduction for depreciation or amortization, of $194.45, or other appropriate sum, on his remaining, adjusted cost basis, inherited from the original lessors, in leased improvements demolished by the tenant during the term of the lease.
FINDINGS OF FACT.
Some of the facts are stipulated and are found accordingly. Petitioner, a single individual during the tax years 1943 to 1945, inclusive, was a resident of Dallas, Texas. He filed individual income tax returns for the years involved with the collector of internal revenue, Dallas, Texas.
Under date of March 1, 1919, petitioner's parents, Charles T. Rowan and Ellen Rowan, executed a lease on their community property described as lot 8, block 69 1/2, according to the official map of the city of Dallas. This property is in the center of downtown Dallas and is now known as the Gulf States Building property. The lease was for a term of 66 years and 10 months, beginning March 1, 1919, and ending December 31, 1985.
On July 14, 1919, Charles T. Rowan executed a warranty deed conveying his entire interest in the property to his wife, Ellen Rowan. Charles T. Rowan died July 30, 1924.
On August 10, 1924, Ellen Rowan, then a widow, executed a warranty deed conveying her interest in the property in equal shares to her son, Albert L. Rowan, the petitioner, and her two daughters for a recited consideration of $10, love and affection, and other considerations paid. The deed was filed for record July 16, 1940, and was recorded in the deed records of Dallas County, Texas. Ellen Rowan, petitioner's mother, died June 20, 1940.
The Federal estate tax return filed for the estate of Ellen Rowan did not include the Gulf States Building property but reference was made in Schedule A thereof to the ‘Property at Main & Akard * * * not part of estate by reason of Deed from Ellen Rowan to Albert L. Rowan, et al.’ and in Schedule G entitled ‘Transfers During Decedent's Life’ of the return appears the same property, that is ‘50 feet North side Main, 100 feet West side Akard, Block 69 1/2 City of Dallas.’ However, no value for the property was included in the gross estate because of the deed dated August 10, 1924, referred to above, whereby Ellen Rowan conveyed her interest in the property to her three children, her two daughters and petitioner.
On the ground that there was no delivery of the deed to the children, and other grounds, respondent adjusted the Federal estate tax return of Ellen Rowan to include the Gulf States Building property in her gross estate, assigning a total value of $412,500 to the property, giving the following explanation:
This property was under a 66-year lease at $16,500 per year net rental, payable monthly; is centrally located and improved with an excellent office building of about fourteen stories and any improvements on the lot will revert to the lessors at the expiration of the lease in 1985. Recommended value based upon allowance to the estate of a four per cent return on their investment. The respondent also included in this estate other property, not involved in this proceeding, which was not included in the estate tax return as filed, assigning thereto a value of $25,000. These adjustments were agreed to and as a result of the adjustments a substantial additional estate tax in the amount of $70,649.05 was paid accordingly. Interest due on the estate tax deficiency from September 20, 1941, to January 20, 1942, was assessed in the amount of $1,412.98, and paid. $On the basis of the estate tax return which was filed, no State inheritance taxes were due; but after the estate tax return was adjusted, State inheritance taxes in the amount of $10,169.71 were assessed and paid. The estate tax deficiency, interest thereon, and State inheritance taxes amounted to a total of $82,231.74. The estate of Ellen Rowan had been distributed to her children at the time these adjustments were made and each child, including petitioner, paid one-third of the total amount, or $27,410.58.
The lease, dated March 1, 1919, was a type commonly referred to as a net lease and provided that the lessee pay to the lessor the sum of $15,000 as yearly rental for the premises each year from March 1, 1919, to and including December 31, 1925, and the sum of $16,500 as yearly rental for the premises for each and every year from January 1, 1926, to and including December 31, 1985.
At the time the lease was entered into on March 1, 1919, there stood on the property two 3-story buildings. It was provided that the lessee would cause to be constructed upon the leased premises a building of steel and fireproof construction, the building to cost not less than $100,000 and to be not loess than 4 stories in height and built sufficiently strong to support a total of 10 stories.
The lease provided that all improvements in existence and those to be constructed were immediately to become and remain the property of the lessors and stated as follows:
All improvements now on said premises and from the beginning continuously down to the completion and thereafter of any improvements put upon the leased premises shall become and remain the property of the Lessors, free of any liens thereon or interest therein granted by or claimed through Lessees. * * * The lessee further covenanted:
ARTICLE XIV. Upon the termination or forfeiture of this lease peaceable possession of the premises in question shall be delivered over to the Lessors or their representatives, wear and tear excepted, in a good tenantable condition. The lease, however, contains no penalty provisions against lessees for failure to maintain the premises in good tenantable condition or to return to lessors a property of value equal to that originally leased.
In order to construct the new building as provided in the lease, lessee, without additional payment to lessor, removed the existing improvements which had been on the premises at the inception of the lease. When these buildings were demolished in 19268 Ellen Rowan had an adjusted basis therein of $35,000. She claimed and was allowed in her subsequent income tax returns the annual sum of $583.33 as an amortization deduction based on the remaining 66-year period of the lease.
The lessee in 1928 constructed a building on the property to a height of 10 stories at a cost of approximately $500,000, and in 1935 an additional 6 floors and penthouse were completed at a cost, including air conditioning and other necessary alterations, of $485,205.91. This structure is known as the Gulf States Building and is the improvement in question. Its estimated useful life is 50 years from its completion in 1928. The entire building is of brick, concrete, and steel construction with a full basement.
Petitioner inherited from his mother, Ellen Rowan, on June 20, 1940, an undivided one-third interest in all the property in the estate of Ellen Rowan. At the time petitioner inherited this property, as well as at all times material hereto, the lease referred to above was in effect. Petitioner, since inheritance, has held the property for business use and production of income.
The city of Dallas assessed values for the Gulf States Building and land for the year 1940, as follows:
+------------------------+ ¦Land value ¦$348,753¦ +---------------+--------¦ ¦Building value ¦488,647 ¦ +---------------+--------¦ ¦Total value ¦837,400 ¦ +------------------------+
No outstanding mortgage existed against the Gulf States Building in 1940.
The parties stipulated that the fair market value of the Guld States Building was at least $500,000 on June 20, 1940.
Petitioner, for each of the years involved, claimed as a deduction for depreciation or amortization of the Gulf States Building property the amount of $3,125, thereby seeking to amortize over the remaining term of approximately 44 years of the lease, $137,500 representing the fair market value of petitioner's one-third undivided interest in the Gulf States Building property. This value was based on one-third of the total valuation ($412,500) used by respondent in adjusting the estate tax return of Ellen Rowan.
Petitioner also claimed for depreciation or amortization for each year involved a deduction of $194.45 which represented his one-third interest in his mother's adjusted basis ($35,000) in the demolished buildings which she had been amortizing at $583.33 per year.
In including in the gross estate of Ellen Rowan for estate tax purposes $412,500 as the value of the Gulf States Building property on June 20, 1940, respondent did not segregate in any way that aggregate value between land, building, and leasehold interest.
The fair market value of the Gulf States Building property on June 20, 1940, without taking into consideration the outstanding lease on the property was as follows:
+--------------------+ ¦Land ¦$300,000 ¦ +--------+-----------¦ ¦Building¦738,000 ¦ +--------+-----------¦ ¦Total ¦$1,038,000 ¦ +--------------------+
The fair market value of Ellen Rowan's entire interest in the Gulf States Building property on June 20, 1940, that is to say including her interest in the land, building, and the lease, was $412,500. The Commissioner in arriving at this valuation for estate tax purposes in the case of Ellen Rowan did so without ascribing any valuation to Ellen Rowan's reversionary interest in the land and building at the end of the term of the lease. His valuation was based upon capitalizing the annual rental for the land of $16,500 at 4 per cent per annum. The fair market value of the land only on June 20, 1940, subject to the lease and without assignment of any of the rentals under the lease, was nominal only.
A comparison of the computations of estate tax as reported and adjusted by the respondent follows:
+-----------------------------------------------------------------------------+ ¦ ¦Original return¦Revenue agent's ¦ ¦ ¦ ¦report ¦ +---------------------------------------+---------------+---------------------¦ ¦Net estate for basic tax ¦0 ¦$404,242.86 ¦ +---------------------------------------+---------------+---------------------¦ ¦Net estate for additional tax ¦$18,952.68 ¦464,242.86 ¦ +---------------------------------------+---------------+---------------------¦ ¦Gross basic tax ¦0 ¦12,712.14 ¦ +---------------------------------------+---------------+---------------------¦ ¦Credit for estate and inheritance taxes¦0 ¦10,169.71 ¦ +---------------------------------------+---------------+---------------------¦ ¦Net basic tax ¦0 ¦2.542.43 ¦ +---------------------------------------+---------------+---------------------¦ ¦Total gross taxes (basic and ¦558.10 ¦81,376.86 ¦ ¦additional) ¦ ¦ ¦ +---------------------------------------+---------------+---------------------¦ ¦Gross basic tax ¦0 ¦12,712.14 ¦ +---------------------------------------+---------------+---------------------¦ ¦Gross additional tax ¦558.10 ¦68,664.72 ¦ +---------------------------------------+---------------+---------------------¦ ¦Net additional tax ¦558.10 ¦68,664.72 ¦ +---------------------------------------+---------------+---------------------¦ ¦Total net basic and additional taxes ¦558.10 ¦71,207.15 ¦ +---------------------------------------+---------------+---------------------¦ ¦Total tax assessed ¦ ¦558.10 ¦ +---------------------------------------+---------------+---------------------¦ ¦Deficiency ¦ ¦70,649.05 ¦ +-----------------------------------------------------------------------------+
Interest in the amount of $1,412.98 was assessed for the period September 20, 1941, to January 20, 1942. The gross deficiency in estate tax was $80,818.76, the inheritance tax credit was $10,169.71, and the net deficiency was $70,649.05.
OPINION.
BLACK, Judge:
The amount of petitioner's income is not in dispute in this proceeding. The things which are in dispute relate to certain deductions claimed by petitioner on his return and which have been disallowed by the Commissioner in his determination of the deficiencies.
Issue 1.
We will address ourselves to the first issue which is raised by the pleadings.
In 1919, petitioner's mother owned improved property which, for a net annual rental, she leased for 66 years and 10 months, a term expiring at the end of 1985. The lease required the lessee at his own cost to demolish the existing buildings on the property and construct thereon a multistory office building. This was completed in 1928, with additions made in 1935. The lease expressly provided for ownership of the new building to be in the lessor, subject, of course, to the lease. The new building had an estimated useful life of 50 years from 1928, a life expiring in 1978. Upon the death of petitioner's mother, June 20, 1940, petitioner, one of three children, inherited an undivided one-third interest in the land and new building, subject to the lease.
In view of the foregoing facts, petitioner, in his brief, propounds the first issue as follows:
Under such circumstances is petitioner entitled to an annual deduction for depreciation or amortization by reason of his ownership (one-third interest) of said building which he acquired by inheritance and held for business use and production of income?
Petitioner contends that he is entitled to such an allowance as is posed by the foregoing question and that added to his basis under section 113(a)(5) of the Code should be $18,860.50, attributable to the building, of the $27,410.58 which petitioner paid as estate and inheritance taxes by reason of the inclusion of the Gulf States Building property in the estate of Ellen Rowan, deceased, from whom petitioner inherited his interest. Section 113(a)(5) and (b) of the Code which deals with unadjusted and adjusted basis and section 114 which deals with basis for depreciation and depletion are printed in the margin.
SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.(a) BASIS (UNADJUSTED) OF PROPERTY.—The basis of property shall be the cost of such property; except that—* * * * * * *(5) PROPERTY TRANSMITTED AT DEATH.—If the property was acquired by bequest, devise, or inheritance, or by the decedent's estate from the decedent, the basis shall be the fair market value of such property at the time of such acquisition. * * ** * * * * * *(b) ADJUSTED BASIS.—The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided.SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.(a) BASIS FOR DEPRECIATION.—The basis upon which exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the adjusted basis provided in section 113(b) for the purpose of determining the gain upon the sale or other disposition of such property.
In J. Charles Pearson, Jr., 13 T. C. 851, we had this same issue before us. Helen Blesi Pearson, who was one of the petitioners in that proceeding, is a sister of Albert L. Rowan, the petitioner here, and is one of the three children who survived their mother, Ellen Rowan. In that case we decided the issue in favor of the taxpayers, largely upon the authority of Charles Bertram Currier, 7 T. C. 980. Our decision was appealed to the Court of Appeals for the Fifth Circuit and that court reversed us, Commissioner v. Pearson, 188 F.2d 72, certiorari denied 342 U. S. 861.
Inasmuch as the present taxpayer is not the same as were the taxpayers in the Pearson case, supra, it is manifest that the decision in that case is not res judicata here. The respondent does not contend that it is. He does contend, however, that the decision of the Fifth Circuit is controlling in the instant case under the doctrine of stare decisis. Petitioner contends that his evidence is more complete in the instant case than was the taxpayers' evidence in the Pearson case, and that in view of his more complete evidence the reversal by the Fifth Circuit of cour decision in the Pearson case is not controlling.
Petitioner relies heavily upon Charles Bertram Currier, supra, and upon our decision in Mary Young Moore, 15 T. C. 906. In this latter case, we relied upon the Currier case and upon our decision in J. Charles Pearson, Jr., supra, which had not at that time been reversed. When petitioner's brief was filed in the instant case our decision in Mary Young Moore, supra, had not been reversed. However, since petitioner's brief has been filed the Moore case has been reversed by the Court of Appeals for the Ninth Circuit. See the opinion of that court in Commissioner v. Moore, 20m F. 2d 265, certiorari denied 347 U. S. 942. The first issue ruled upon by the Ninth Circuit in the Moore case, as we understand it, was substantially the same issue as we have in Issue 1 in the instant case. In deciding that issue adversely to the taxpayer's contention the court held that a taxpayer, who inherited a one-half interest in property from her mother on which a building had been constructed by the lessee under a 99-year lease, at no cost to the lessor, was not entitled to a depreciation allowance on the building. The court pointed out that the term of the lease extended beyond the useful life of the building, and since the taxpayer would not sustain any economic loss as the building wore out and could not sell her interest in the building apart from the land or the rentals, the value of her interest in the building was zero and she could not take depreciation on the building.
In view of the reversal by the Fifth Circuit of our decision in the Pearson case, supra, and the reversal of our decision in the Moore case, supra, by the Ninth Circuit, we think we should reexamine the issue involved.
We are confronted with somewhat the same situation here as we were confronted with in Estate of William E. Edmonds, 16 T. C. 110, in which we said:
So the question we face here is whether we will stand by our decision in the Strauss case and respectfully decline to follow the Second Circuit's decision, or whether we will accept it as laying down the correct law and follow it in the instant case. It, of course, goes without saying that the reversal by the Second Circuit of our decision in the Strauss case makes the law for that case. Inasmuch, however, as the Tax Court must endeavor to make its decision uniform for all taxpayers within the United States, we cannot discharge that duty by following a circuit court's decision in a subsequent case by a different taxpayer if we think it is wrong, even though it would go to the same circuit in which we were reversed, and even though the facts are the same as the case in which we were reversed. If we did so, it would only result in confusion and unequal treatment of taxpayers merely because they live in different circuits. Therefore, when, as here, we have been reversed we must examine carefully the reversal to see whether or not we will follow the court in its reversal, not only in cases which lie within the jurisdiction of that particular circuit, but all other circuits as well. This we have done in the instant case. * * * We then went on to hold that in our opinion the Court of Appeals for the Second Circuit had laid down the correct rule of law in the Edmonds case, supra, and that we would follow it and no longer follow our own decision in Estate of Max Strauss, 13 T. C. 159, revd. 183 F. 2d 288, certiorari denied 340 U. S. 853. In conformity with the statement of our position in those matters taken from the above quotation from the Edmonds case, supra, we have carefully considered the first issue in the instant case in the light of the reversal by the Fifth Circuit of our decision in the Pearson case, supra, and of the reversal by the Ninth Circuit of our decision in the Moore case, supra, and we conclude that they law down the correct rule of law to be applied in situations covered by our first issue here. The effect of those decisions, as we understand them, especially the decision of the Ninth Circuit in reversing us in Mary Young Moore, supra, is to hold that in situations such as we have here where the term of the lease extended beyond the useful life of the building and where the taxpayer would not sustain any economic loss as the building wore out and could not sell her interest in the building apart from the land or the rentals, the value of her interest in the building was zero and she could not take depreciation on the building.
It seems plain that in the instant case the Commissioner in valuing the interest of Ellen Rowan in the Gulf States Building property at $412,500 did so solely by capitalizing the ground rental of $16,500 at 4 per cent for the remaining term of the lease. In arriving at his valuation of $412,500 at the time of her death, the Commissioner stated:
This property was under a 66-year lease at $16,500 per year net rental, payable monthly; is centrally located and improved with an excellent office building of about fourteen stories and any improvements on the lot will revert to the lessors at the expiration of the lease in 1985. Recommended value based upon allowance to the estate of four per cent return on their investment. What Ellen Rowan was receiving at the time of her death was ground rental of $16,500. She was receiving no rental from the building; she had no investment in the building. Ground rental was all that the heirs of Ellen Rowan, including petitioner, received from the property During the taxable years they were not receiving any rental income from the building itself. The rental income from the building was being received by the lessee who had erected the building on the leased land at his own expense. The lessee was the one to whom annual depreciation deductions on the cost of the building were properly granted. Cf. Reisinger v. Commissioner, (C. A. 2) 144 F. 2d 475. In this case the court said:
Only a taxpayer who has a depreciable interest in property may take the deduction, and that interest must be in existence in the taxable period to enable him to show a then actual diminution in its value. It is not enough that the taxpayer may in the future have to make an investment which will then depreciate in value. [Citing cases.] * * * It might be that if all that the heirs of Ellen Rowan, including petitioner, will ever receive from the Gulf States Building property is the $16,500 annual rentals which they now receive, they would be entitled to some kind of an amortization deduction. But we need not speculate upon what, if any, that amortization deduction would be, because the annual rental of $16,500 is not all that they will ever receive from the property. They are the owners of the property in fee simple subject to the lease. When the lease expires in 1985, they, or their successors in interest, will receive back the land, together with any building which may be upon it. The property at that time may well be worth more than the $412,500 at which it was valued by the Commissioner for estate tax purposes. For these reasons, we think petitioner is not entitled to take either depreciation or amortization deductions on any part of the $412,500 which respondent determined to be the value of Ellen Rowan's interest in the property at the time of her death.
As to the issue we have before us, we decide to follow the decisions of the Fifth Circuit in Commissioner v. Pearson, supra, and the Ninth Circuit in Commissioner v. Moore, supra, and we will no longer follow our decisions in J. Charles Pearson, Jr., Mary Young Moore, and Charles Bertram Currier, all supra, and they are, as respects this particular issue, overruled.
Respondent's action in each of the taxable years in denying petitioner a deduction of $3,125 as depreciation or amortization of the value of the Gulf States Building is sustained.
Issue 2.
When the lessee in 1926 demolished the old buildings on the property to make way for the new construction, petitioner's mother, Ellen Rowan, had a recoverable adjusted cost basis in these buildings of $35,000 and, hence, a depreciable interest in the property. Until her death in 1940, she claimed, and was allowed, an annual amortization deduction of $583.33 based on recoverable cost and the remaining 60-year period of the lease.
Petitioner states the second issue in his brief as follows:
Under such circumstances is petitioner entitled to an annual amortization deduction of $194.45 (one-third of $583.33) until the end of the lease in order that the unrecovered remaining basis (or economic, depreciable interest) of his mother in the demolished buildings may be recovered? This issue was not in J. Charles Pearson, Jr., supra, nor in Mary Young Moore, supra.
We think the Commissioner must be sustained on this issue. The unrecovered basis of the decedent, Ellen Rowan, in the demolished buildings (some $29,000) at the time of her death was an income tax advantage to which she was entitled and which was not wholly availed of in her lifetime. Death cut short this tax advantage before she had offset income to that extent. However, this tax advantage was not of such nature as to be subject to transmission by inheritance to her heirs. The buildings were no longer in existence when Ellen Rowan died and had long since been demolished. An heir such as petitioner acquires basis in an inherited interest by virtue of section 113(a)(5) of the Code, supra. So far as we can see petitioner acquired no interest in this amortization deduction which Ellen Rowan had been taking in her lifetime as her cost of the lease and therefore he has no basis for amortization under section 113(a)(5). The Commissioner is sustained in his disallowance of this deduction of $194.45 which petitioner claimed on his return.
Reviewed by the Court.
Decision will be entered for the respondent.