Hart v. Commissioner

*955 This proceeding is for the redetermination of deficiencies in income tax asserted by the respondent in the amount of $7,919.88 for the year 1919, $3,379.50 for the year 1920, and $3,810.70 for the year 1922. The only question for determination is whether the respondent erred in disallowing deductions taken by a partnership of which the petitioner was a member for depreciation of certain leaseholds and contracts. One other error was assigned by the petitioner but was abandoned at the hearing.

FINDINGS OF FACT.

The petitioner is an individual residing at Los Angeles, Calif. During the years 1919 to 1922, inclusive, he was and had been since some time prior to March 1, 1913, a member of the partnership of Hart Brothers. During the years 1919 to 1922, inclusive, Hart Brothers operated the new Rosslyn Hotel located at the northwest corner of Fifth*3994 and Main Streets, Los Angeles. On March 1, 1913, they were operating and had been operating for many years the old Rosslyn Hotel at Los Angeles.

The old Rosslyn Hotel occupied premises 180 feet front and 158 feet depth on the west side of Main Street, beginning at a point 120 feet north of the northwest corner of Fifth and Main Streets. It consisted of a four-story building owned by the Ball Estate and one Johnson, and a six-story building owned by Hohnson. The part of the four-story building owned by the Ball Estate will be hereinafter called Property A, the part thereof owned by Johnson will be called Property B, and the six-story building owned by Johnson will be called Property C.

The buildings were all class C construction, that is they were brick and wood, with wood joists, and they contained 280 rooms, a lobby, a dining room, a bar, and certain space rented for stores. About 50 per cent of the rooms had baths. The space available for stores fronted 125 feet on Main Street, of which the hotel bar occupied 20 *956 feet. Property A contained 70 rooms and had a frontage of 60 feet on Main Street. Properties B and C contained 210 rooms and had a frontage of 120*3995 feet on Main Street, of which not to exceed 65 feet was available for rent, the remainder being occupied by the ladies' parlor and dining room.

Ball Leases.

(1) Lease dated December 17, 1907, and expiring December 31, 1913, covering part of Property A. Monthly rental, $750.

(2) Lease dated August 20, 1908, and expiring December 31, 1913 covering that part of Property A not covered by lease No. 1. Monthly rental, $150.

Johnson Leases.

(3) Lease dated April 2, 1906, and expiring December 31, 1913, covering Property B. Monthly rental, $1,175.

(4) Lease dated January 1, 1907, and expiring December 31, 1913, covering property C, excepting a double store room therein. Monthly rental, $1,350.

(5) Lease dated December 11, 1911, covering double store room in Property C, excepted from lease No. 4. Monthly rental, $700.

None of the leases enumerated contained any provision giving the lessee the right to renew it.

On December 11, 1911, Hart Brothers and Johnson entered into a new lease, hereinafter called lease No. 6, covering all of Properties B and C (properties covered by leases 3, 4 and 5, above). This new lease was for a term of ten years beginning January 1, 1914. *3996 The monthly rental thereunder was $4,200.

On March 1, 1913, Hart Brothers and the Ball Estate entered into a new lease, hereinafter called lease No. 7, covering all of Property A (the same property covered by leases 1 and 2, above). This new lease was for a period of ten years beginning January 1, 1914. The monthly rental thereunder was $1,400.

On October 6, 1911, Hart Brothers entered into a written contract with the Century Building Co. and others with respect to certain real estate at the northwest corner of Fifth and Main Streets, Los Angeles, adjoining Property C, above mentioned, and hereinafter called Property D.

The agreement provided that Hart Brothers would organize a corporation which would lease Property D for the period November 1, 1913, to December 31, 1955, at a rental of $3,916.66 for November and December, 1913, and $23,500 per year thereafter, and would also erect a class A building thereon at a cost of $700,000, exclusive of furnishings, of which amount the Century Building Co. was to pay $395,250. The contract also provided that the lessee would pay all taxes on the property. It further provided that if the Century Building Co. failed to execute and*3997 deliver the lease it would pay to Hart Brothers, $100,000 as liquidated damages, and that if *957 Hart Brothers should refuse or fail to accept the lease they would pay $150,000 to the Century Building Co. as liquidated damages. The lease provided by the contract of October 6, 1911, was not executed until subsequent to March 1, 1913. The respondent in computing the petitioner's distributive shares of the net income of Hart Brothers for the years 1919, 1920, and 1922, did not deduct any amount for the exhaustion of the leases and contracts herein mentioned.

OPINION.

MARQUETTE: The petitioner contends that on March 1, 1913, the partnership of Hart Brothers held leases on Properties A, B, and C, mentioned in the findings of fact, which had a fair market value of at least $150,000 on that date; that the contract to lease Property D had a fair market value of at least $175,000 on March 1, 1913, and that the partnership in computing its net income for the years 1919, 1920, and 1922, is entitled to a deduction for the exhaustion of the leases and the contract.

It is well settled that a partnership in computing its net income is entitled to deduct a reasonable allowance for*3998 the exhaustion, wear and tear of property used in a trade or business, and such property may include leaseholds and contracts. The basis upon which the allowance is computed is the cost of the property, or if the property was acquired prior to March 1, 1913, the fair market price or value thereof on March 1, 1913. These propositions are almost axiomatic and need no citations to support them.

One of the leaseholds owned by the partnership of Hart Brothers during the years 1919, 1920, and 1922, for the exhaustion of which the petitioner contends they are entitled to an allowance, was lease No. 7, which covered Property A. This lease was not acquired by the partnership prior to March 1, 1913, and under the rule just stated the basis for computing the depreciation allowance is cost. We find, however, that the lease cost the partnership nothing except the annual rentals, and these rentals it is entitled to deduct as a necessary business expense. The partnership is therefore not entitled to any deduction for the exhaustion of lease No. 7.

The petitioner testified that leases 6 and 7 had a value of at least $150,000 on March 1, 1913. He introduced other witnesses who testified*3999 that these leases had a value on that due of at least $100,000. No attempt was made to value each lease separately. The values ascribed by the witnesses were based upon an estimated rental value of $12 per month for each of the 280 rooms in the property, a rental value of $23 per month for each front foot of store space, and a rental value of $50 per month for each front foot of the space occupied by *958 the bar. The evidence shows that the property covered by lease No. 6 contained 210 rooms and that the frontage available for store space did not exceed 65 feet, the remainder of the frontage being occupied by the ladies' parlor and dining room. The partnership paid a monthly rental of $4,200 for this property during the life of the lease. Allowing a monthly rental value of $12 per room and a monthly rental of $23 per front foot for the available store space, as claimed by the petitioner, we find that the total rental value of the property covered by lease No. 6 was, on this basis, not to exceed $4,015 per month, which is less than the amount the partnership was obligated to pay under the lease. The evidence fails to establish that lease No. 6 had any fair market price*4000 or value on March 1, 1913, and the partnership is, therefore, not entitled to any allowance for the exhaustion of that lease during the years 1919, 1920 and 1922.

The petitioner introduced evidence attempting to establish that the contract to lease Property D made by the partnership on October 6, 1911, had a fair market value on March 1, 1913, of at least $175,000. This valuation is based on the theory that the rental value of Property D on March 1, 1913, was in excess of the rental payable under the lease. While it may be true that the annual rental value of the land on March 1, 1913, was greater than the annual rental provided by the lease, that fact alone, in view of the other provisions of the contract to lease, does not establish any value for the contract. The partnership was by the agreement obligated to do other things than pay an annual rental, to wit, pay the taxes and construct a building costing $700,000, of which at least $304,750 was to be paid by the partnership. The evidence fails to show, in our opinion, that the contract in question had any fair market value on March 1, 1913, and we therefore hold that the respondent properly refused to allow the partnership*4001 to take any deduction for the exhaustion thereof.

Judgment will be entered for the respondent.