Millinery Center Building Corporation v. Commissioner of Internal Revenue, 221 F.2d 322, 2d Cir. (1955)
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Scribd Government DocsMillinery Center Building Corporation v. Commissioner of Internal Revenue, 221 F.2d 322, 2d Cir. (1955)
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Scribd Government Docs221 F.
2d 322
55-1 USTC P 9377
MILLINERY CENTER BUILDING CORPORATION,
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent.
No. 127, Docket 23150.
United States Court of Appeals Second Circuit.
Argued March 15, 1955.
Decided April 14, 1955.
Charles Korn, New York City (Bernard Weiss, New York City, on the
brief), for petitioner.
Carolyn R. Just, Special Asst. to Atty. Gen. (H. Brian Holland, Asst. Atty.
Gen., and Ellis N. Slack, A. F. Prescott, and Louise Foster, Special Assts.
to Atty. Gen., on the brief), for respondent.
Before CLARK, Chief Judge, FRANK, Circuit Judge, and GALSTON,
District judge.
CLARK, Chief Judge.
This petition for review contests the finding of a deficiency in petitioner's
excess profits tax for 1945, based on the refusal to allow as a business expense
the amount paid to terminate an allegedly burdensome lease. The issue
concerns the tax consequences of a contract between the taxpayer and its
landlord whereby the taxpayer acquired the real estate in question and thus
obtained cancellation of the lease. The taxpayer as tenant and at its own cost
had erected a 22-story loft building on the leased premises, to belong to the
taxpayer only as long as the lease was in force and at termination to be either
razed or surrendered to the landlord, as the latter might direct. The lease had
been renewed by the tenant for an additional 21-year term just before the
contract of sale was entered into, although the tenant now urges that the annual
rental of $118,840 was excessive, notwithstanding the very substantial rents it
was collecting, sufficient at least to make the renewal desirable. Petitioner's
main argument throughout this litigation has been that the difference between
the purchase price of $2,100,000 and the unimproved value of the land,
$660,000, namely the sum of $1,440,000, should be deductible as an ordinary
business expense under I.R.C. 23(a), 26 U.S.C. 23(a), as the price of
cancellation of an onerous lease. Alternatively it suggested amortization of this
amount over the unexpired term of the lease, or its depreciation as an additional
cost of acquiring the already fully depreciated building. All this the Tax Court
denied, although six judges dissenting thought that some part of the purchase
price should be allocated to the additional rights thus acquired in the building
and then be recovered through depreciation. 21 T.C. 817.
2
The Tax Court refused to permit deduction under I.R.C. 23(a) because it
considered the $2,100,000 contract price as payment for one complete bundle
of rights of land ownership, more appropriately characterized as a capital asset
than as an ordinary business expense. With this conclusion we are in
agreement, despite the contrary opinion of the Sixth Circuit in Cleveland
Allerton Hotel v. C.I.R., 166 F.2d 805.1 Whatever may be the case where a
lease is cancelled without the purchase of a fee, we think that the situation here
at hand consists of the acquisition of a definite and substantial property interest,
so to be viewed for tax purposes. Petitioner, having certain rights in the
property, bought all the remaining ones up to full ownership and is in the same
situation as if it had bought out the share of a co-owner or an overriding
easement or, indeed, a piece of land next door. Because petitioner also
happened to be the tenant under the lease, its purchase resulted in the merger of
the leasehold in the fee and gave it a good bargain. But that fact, while it may
explain the motivation for the investment, cannot change its fundamental nature
from the acquisition of a capital asset to mere removal of a burden or repair of
plant. Post v. C.I.R., 2 Cir., 109 F.2d 135; Herzberg v. Alexander,
D.C.W.D.Okl., 5 F.Supp. 334; Boos v. C.I.R., 30 B.T.A. 882; and see Willcuts
v. Minnesota Tribune Co., 8 Cir., 103 F.2d 947, 952, certiorari denied
Minnesota Tribune Co. v. Willcuts, 308 U.S. 577, 60 S.Ct. 93, 84 L.Ed. 483.
We reach this result whether or not the lease was in fact onerous to the
taxpayer, as it contends; the Tax Court made no such finding and the evidence
in this respect is doubtful at best. But that merely goes to the desirability or
otherwise of the bargain; it does not define what was bought. We are equally in
accord with the Tax Court that the purchase price of the fee is not to be
amortized over the remaining term of the now nonexistent lease. Since the
taxpayer has acquired the complete title to the property in question, it obviously
no longer has a wasting asset to come to a necessary end twenty-one years
hence. See Post v. C.I.R., supra, 2 Cir., 109 F.2d 135; Friend v. C.I.R., 7 Cir.,
119 F.2d 959, certiorari denied 314 U.S. 673, 62 S.Ct. 136, 86 L.Ed. 538. But
we do think the view of the dissenting judges sound that here is a new purchase
price covering a building to be recovered taxwise, as is any building cost, over
the period of its usefull life.
3
The taxpayer's second alternative raised this issue in arguing that $1,440,000 be
added for depreciation purposes to the cost of the building which it erected on
the property. The cost of $3,000,000 originally invested by it in the building
was fully written off during the first 21-year term of the lease. From this, a
majority of the Tax Court concluded that no further depreciation was allowable,
since the taxpayer's cost of acquisition had been recovered. But the dissent
seems more in accord with the realities of this situation. The taxpayer in
acquiring this fee bought not only a reversionary interest in the land itself, but
also a reversionary interest in the building which under the lease it would have
had to surrender to the landlord when its term expired. A third-party purchaser
of such a fee would be entitled to allocate part of its cost to the building and to
depreciate it as such. Similarly, this taxpayer has made an additional investment
in the building which should give rise to an added depreciation deduction in
accordance with I.R.C. 23(l).
On the present state of the record we cannot determine how much of the
$2,100,000 purchase price is properly to be allocated to the land and how much
to the building. The Tax Court has found only that in its unimproved state the
land was worth $660,000. That appraisal cannot be considered as conclusive of
its present value, improved by a $3,000,000 building appurtenant thereto. We
doubt if a merely mechanical apportionment will adequately fix the intrinsic
value of the building reversion. Hence we must remand this case to the Tax
Court to take evidence, if desired, and otherwise to fix this value. See Cohan
C.I.R., 2 Cir., 39 F.2d 540, 543, 544. A similar adjustment should be made with
respect to the legal fees of $16,500 incurred by the taxpayer in connection with
this purchase. The value so found will be the cost to be recovered through
yearly depreciation.
Reversed and remanded for further proceedings in accordance with this
opinion.
This case is criticized in Notes, 48 Col.L.Rev. 967 and 1 Stan.L.Rev. 147. Both
notes suggest that the court erred in considering the investment to be other than
a capital asset. Both equally reject the solution of the Tax Court in that case and
this one that no depreciation whatever be allowed, suggesting as an alternative
amortization over the remaining term of the lease
