Opinion
This case having been heard by the Court of Claims, the court, upon the evidence adduced, makes the following special findings of fact:
1. The plaintiff is a corporation organized under the laws of the state of New York, with its principal office at No. 654 Madison avenue, New York, N.Y.
2. On April 4, 1911, plaintiff acquired a leasehold interest from one Woodbury G. Langdon in the premises known as 719 Fifth avenue, in the city of New York, under a written lease. A copy of the said lease is attached to the plaintiff's petition on file herein as Exhibit A, and is by reference made a part of this finding.
3. It was provided in the said lease that the tenant should, upon entering into possession of the demised premises, erect and build thereon a modern and substantial twelve-story apartment and store building, which should be so constructed that the building might be altered into an office building, and it was further provided in said lease that the said building should be completed and ready for occupancy on or before the 1st day of October 1912.
In accordance with the terms of the agreement, the building, consisting of twelve stories, basement, and subbasement, three stores on the ground floor and one hundred and twenty rooms on the upper floors, was constructed at a cost of $438,921.19. The upper floors were operated as an apartment hotel. The completed building had a frontage of 52 feet 5 inches on Fifth avenue and 110 feet in depth easterly on Fifty-Sixth street. It had a useful life of 33 1/3 years.
4. The original lease was for a term of 21 years from July 1, 1911, with option to renew for two additional terms of 21 years each. The agreed rental was $45,000 per year from July 1, 1912 (when ground rental commenced), to July 1, 1921, and $50,000 per year for the balance of the original term. The lessee was further obligated to pay all taxes, assessments, water rents, and other payments which, in 1913, amounted to $18,000 a year. In addition, the lessee was required to insure the building at its own cost, for at least $300,000, in the name of and for the benefit of the lessor. In the event of the destruction of the building by fire or other casualty, the proceeds of such insurance were to be placed in trust under the joint control of the parties for the repair or replacement of the building. Upon failure by the lessee to restore the building within 18 months from the date of a fire, the insurance was to be forfeited to the lessor. The annual rental for the first and second renewals of the lease was, in the absence of agreement between the parties, to be equivalent of 4 1/2 per cent, of the value of the land at the beginning of the term, as determined in a manner set forth in the lease. At the end of the second renewal the lessor had the option of either renewing the lease for an additional 21-year period, or terminating the lease and acquiring the building at its appraised value at that time. The evidence shows that the renewal privilege was of no value to plaintiff.
5. On January 2, 1912, plaintiff leased the entire building, exclusive of the three stores on Fifth avenue, to the Langdon Leasing Company, at a net rental of $50,000 per annum, the lessee to pay the entire expense of maintaining the building, exclusive of ground rent, for the period commencing October 1, 1912, to June 30, 1932.
Prior to March 1, 1913, the corner store on Fifth avenue was rented for 10 years at an annual rental of $18,000 for the first 5 years, and $20,000 for the second 5 years, with the privilege of renewal for an additional term of 10 years at $25,000 per year. The southerly store of the building was leased on January 1, 1913, for a term of 10 years at a rental of $11,000 a year. A smaller store was unrented at March 1, 1913.
Out of a total of one hundred and eighteen rooms in the hotel, forty-eight had been rented on March 1, 1913, at a total annual rental of $50,350.
6. The gross income of the taxpayer is derived solely from rentals, and the average gross income received during the years 1913 to 1928 was in the sum of $98,961 per year. Its net income before allowance for interest, depreciation, and federal taxes, for the same period, averaged $37,415.18 per year.
7. Plaintiff duly filed its income and excess profits tax returns for the years 1920 and 1921, and deducted from the gross income reported depreciation on building at the rate of 5 per cent, per annum on the cost thereof, and also deducted for the exhaustion and/or amortization of the value of its leasehold at the rate of 5 per cent. per annum. Upon examination and audit of said returns, the Commissioner of Internal Revenue made an allowance of 2 per cent. per annum for depreciation on the cost of said building of $438,921.19, and disallowed any deduction for exhaustion and/or amortization of the value of said leasehold interest.
8. On August 6, 1925, plaintiff appealed to the United States Board of Tax Appeals, and the Board held that plaintiff was entitled to 3 per cent. per annum as a deduction for depreciation on the cost of said building, and was not entitled to any amount by reason of the exhaustion, amortization, or depletion of said leasehold interest. On April 14, 1927, the said Board entered its final order of redetermination, wherein it determined a deficiency in tax for the year 1920 in the amount of $2,181.10 and for the year 1921 in the amount of $8,127.91.
9. The foregoing amounts were subsequently assessed by the Commissioner of Internal Revenue and paid by the plaintiff on June 13, 1927, together with interest, making the total sum so paid $12,827.55.
10. On September 7, 1927, the plaintiff duly filed with the collector of internal revenue, Second district or New York, its claim for refund of $12,827.55, representing income and profit taxes for the years 1920 and 1921.
11. On December 10, 1927, plaintiff was advised of the rejection of its claim for refund.
12. The value of plaintiff's leasehold interest in the premises on March 1, 1913, including and after the improvements had been made thereon, was not in excess of its cost to plaintiff. Frank S.Bright, of Washington, D.C. (H. Stanley Hinrichs, of Washington, D.C., on the brief), for plaintiff.
Francis T. Donahoe, of Washington, D.C., and Frank J. Wideman, Asst.Atty.Gen. (James A. Cosgrove, of Washington, D.C., on the brief), for the United States.
Before BOOTH, Chief Justice, and GREEN, LITTLETON, WILLIAMS, and WHALEY, Judges.
GREEN, Judge.
The plaintiff brings this suit to recover $12,827.55, with interest thereon, alleged to have been overpaid on its income taxes for the years 1920 and 1921, and for which amount the plaintiff duly filed a claim for refund.
It appears that the plaintiff leased the premises known as 719 Fifth avenue, New York City, for 21 years from July 1, 1911, at an agreed rental of $45,000 a year from July 1, 1912, when ground rental commenced, to July 1, 1921, and $50,000 a year for the balance of the original term, with an option to renew the same on certain conditions. Under the terms of the lease, the plaintiff was required to construct a building thereon, and erected a twelve-story apartment and store building upon the demised premises. After the erection of the building, the plaintiff leased the entire building, with the exception of three stores on Fifth avenue, at a net rental of $50,000 a year, the lessee to pay the entire expense of maintaining the building, exclusive of ground rent, for the period commencing October 1, 1912, to June 30, 1932.
When the plaintiff filed its income and excess profits tax returns for the years 1920 and 1921, it deducted from the gross income reported depreciation on the building at 5 per cent. per annum on the cost thereof, and also deducted for exhaustion or amortization of the value of its leasehold at the rate of 5 per cent. per annum. The Commissioner of Internal Revenue, however, only made an allowance of 2 per cent. for depreciation on the cost of the building, and disallowed any deduction for exhaustion or amortization of the value of the leasehold interest. The plaintiff appealed to the Board of Tax Appeals, and the Board held that plaintiff was entitled to 3 per cent. per annum as a deduction for depreciation on the cost of the building, but was not entitled to any amount by reason of exhaustion or depletion of the leasehold interest. In accordance with the order of the Board, the Commissioner subsequently assessed a deficiency for the year 1920 in the amount of $2,181.10 and for the year 1921 in the amount of $8,127.91, which the plaintiff paid, and then filed a claim for refund thereof on the ground that the Commissioner should have made the allowances set forth in its original return. This claim for refund was rejected, and the issue in the case arises on its rejection.
The case is presented as one which turns upon the amount of depreciation of the building erected upon the leased premises, and also upon whether there should be any allowance for exhaustion or amortization of the value of the leasehold interest in determining the amount of plaintiff's taxable income.
We do not think that the situation is the same as it would be if plaintiff had owned the building. The fact is that the plaintiff acquired no title thereto, but simply a leasehold interest. As we view it, the case is simply one in which the plaintiff acquired a lease under terms which required it to make a large investment in a building to be constructed on the leased premises. At the expiration of the lease, the evidence showed that the renewal privilege had no value, and, if the lease was not renewed, the building became the property of the lessor. The money which plaintiff had put into the building was a capital investment, and the plaintiff had nothing to show for it when the lease expired. In our opinion, the deduction must be made from plaintiff's gross income in the same manner as it would be in any other case of a capital investment which dwindled in value each year until it was worth nothing. The building cost $438,921.19, and, as before stated, was ready for occupancy and leased for the period from October 1, 1912, to June 30, 1932. We think that the loss of the amount so invested should be apportioned over the rental period and a deduction made from the gross income of plaintiff each year accordingly. In making this holding, we differ from the decision of the Board of Tax Appeals when this case was before it. At that time the Board seems to have held that in cases involving leases for a period of years, with the option to renew for an additional period, the cost of such leases should be written off over the original period plus the renewal period. Subsequently, in another case (Bonwit Teller & Co. v. Com'r, 17 B.T.A. 1019, 1026), the Board applied this rule, but the decision was reversed in the Circuit Court of Appeals. Bonwit Teller & Co. v. Commissioner, 53 F. (2d) 381, 82 A.L.R. 325, certiorari denied 284 U.S. 690, 52 S.Ct. 266, 76 L.Ed. 582. In the case before us, the fact that the renewal privilege was worthless makes it clear that the loss was complete when the lease ended and that the renewal period should not be considered.
As before stated, the plaintiff claims to be entitled to an allowance for exhaustion or amortization of the leasehold value. The defendant, on the contrary, contends that the leasehold had no value. The Commissioner found that the value of the leasehold interest on March 1, 1913, exclusive of the value of the improvements thereon, was $110,799 and the testimony of expert witnesses presented by plaintiff, if accepted, would show the value to be much larger at that date. The sole witness presented by defendant on this subject testified that the leasehold interest had no value when it acquired. The testimony of plaintiff's witnesses was given in response to hypothetical questions, which unfortunately were not based entirely on facts supported by testimony, but, on the contrary, in some respects were inconsistent with the undisputed facts in the case which renders their statements of little or no value. On the other hand, the amount fixed as the rental value between plaintiff and the lessor is strong evidence of its actual value, and by some authorities considered the best evidence. The evidence shows definitely that there was no rise but, if anything, a depreciation in rental values between the time the original lease was executed and March 1, 1913. The amount subsequently received by the plaintiff for rentals and its net income from the premises are not admissible as evidence of the value of its leasehold interest on March 1, 1913. The plaintiff was taking some risk when it executed the lease and naturally expected, if matters went well, to receive a profit. No one would otherwise lease the premises and agree to put up an expensive building. Nor do we think that the building added anything to the value of the leasehold over and above the expense of its erection. We conclude that the leasehold had no value March 1, 1913, which could be made the subject of exhaustion or amortization when considered apart from the building which had to be constructed at plaintiff's expense and on the termination of the lease became the property of the lessor.
It follows from what we have said above that we have only to consider the amount of the annual deduction to which plaintiff was entitled on account of the loss of its investment in the building. The only evidence that we have as to the time these expenditures were made is that the building was completed, ready for occupancy, and was leased from October 1, 1912, to June 30, 1932, a few months less than 20 years. We think it would be sufficiently accurate to allow the plaintiff to write off from its investment 5 per cent. each year, and that this amount should be allowed for 1920 and 1921, the years involved in this suit.
The plaintiff is entitled to recover, but the entry of judgment will be suspended pending a submission by the parties of a computation of the tax liability consistent with this opinion.