379 Madison Ave., Inc. v. Commissioner

*29 This is an appeal for the redetermination of a deficiency in income tax for 1923 determined by the respondent in the amount of $3,723.15.

The issues are as follows: (1) The petitioner alleges that the useful life of the office building of the petitioner will extend no longer than July 1, 1943, and the annual deductions for depreciation and obsolescence should be computed accordingly; (2) the petitioner alleges that an amount of $22,765.10, cost of alterations made at the expense of tenants, should not be included in the amount of cost of the building returnable to the petitioner through depreciation allowances; *30 (3) the petitioner alleges that interest on borrowed money, ground rentals and real estate taxes paid in 1922 and 1923 were capitalized in error as cost of construction of the building of the petitioner whereas they should be allowed in the respective years*1940 as deductions from income; (4) the petitioner alleges that an amount of $1,000,000 contributed in cash by the lessor as part of the cost of construction of the office building was not a loan to the petitioner and the amount should not be included in the cost returnable to the petitioner through allowances for depreciation; (5) the respondent alleges that an amount of $41,209.17 included by the petitioner in its deductions of rent paid in 1923, and allowed in the deductions by the respondent in computing net income, was in fact the aggregate of bonuses paid in obtaining tenants for the building operated by the petitioner, which bonuses should be capitalized as cost of securing the tenants and deducted pro rata over the terms of the tenancies; (6) the respondent alleges error in that in computing the deficiency a net loss of $366.88 for 1922 has been allowed as a credit against net income for the taxable year, whereas there is actually no statutory net loss for 1922. The respondent moves that in consequence of the foregoing the deficiency should be redetermined in the amount of $9,104.91.

FINDINGS OF FACT.

The petitioner is a New York corporation, incorporated on June 5, 1922, and*1941 was organized for the following purposes:

The purposes for which said corporation is to be formed are to do any or all of the things hereinafter set forth, to the same extent as natural persons might or could do, viz:

To take, buy, purchase, exchange, hire, lease or otherwise acquire real estate and property either improved or unimproved, and any interest or right therein, and to own, hold control, maintain, manage and develop the same, in any State of the United States.

To purchase, exchange, hire or otherwise acquire such personal property, chattels, rights, easements, permits, privileges and franchises as may lawfully be purchased, exchanged, hired or acquired under the Business Corporations Law of the State of New York.

To erect, construct, maintain, improve, rebuild, enlarge, alter, manage and control directly, or through ownership of stock in any corporation, any and all kinds of buildings and structures which may at any time be necessary, useful or advantageous in the judgment of the Board of Directors, for the purposes of the corporation, and which can lawfully be done under the Business Corporations Law.

To sell, manage, improve, develop, assign, transfer, convey, *1942 lease, sublease, pledge or otherwise alienate or dispose of, and to mortgage or otherwise encumber the lands, buildings, real property, chattels real, and other property of the corporation, real and personal, and wheresoever situate, and any and all legal and equitable rights therein.

*31 To borrow money, with or without pledge of or mortgage on all or any of its property, real or personal, as security, and to loan and advance money upon mortgages on personal and real property, or on either of them, so far as is permitted by law to corporations organized under said Business Corporations Law.

To buy, sell and deal in, with or without guaranty of payment thereof, bonds and mortgages, and other like securities and other kinds of property, whether real or personal so far as is permitted by law to corporations organized under said Business Corporations Law.

To purchase, acquire, hold, sell, assign, transfer, mortgage, pledge and otherwise dispose of the shares of capital stock, bonds, debentures or other evidence of indebtedness of any corporation, domestic or foreign, and while the holder thereof, to exercise all the rights, and privileges of ownership, including the right*1943 to vote thereon, and to issue in exchange therefor its own stock, bonds and other obligations.

To do and transact all business incident to, necessary, suitable or advisable for, or in any wise connected with any or all of the purposes for which this corporation is formed as those purposes are above set forth.

The foregoing enumeration of specific powers shall not be held to limit or restrict in any manner the general powers of the corporation, and the enjoyment thereof, as conferred by the laws of the State of New York, upon corporations organized under the provisions of the Business Corporations Law.

An agreement of lease dated May 25, 1922, hereinafter referred to as the lease, signed on the date, and acknowledged by the officers of the respective corporations on June 8, 1922, was entered into by the New York State Realty and Terminal Company, as lessor, a subsidiary of the New York Central Railway Company, and the petitioner, as lessee, of certain land and small buildings located at the corner of East 46th Street and Madison Avenue, New York City. The lease provided, so far as material here, as follows:

AGREEMENT OF LEASE, made this 25th day of May, 1922, between New*1944 York State Realty and Terminal Company, hereinafter throughout described as Lessor, and 379 Madison Avenue, Inc., a corporation organized and existing under the laws of the State of New York and having its principal office at 681 Fifth Avenue, Borough of Manhattan, City of New York, hereinafter throughout described as Lessee:

Whereas, the Lessor and Lessee are entering into a building agreement, bearing even date herewith, (hereinafter referred to as the Building Agreement), with respect to the construction of a Building upon that portion of the parcel of land hereinafter described not excepted from this lease; the said parcel of land and the Building to be constructed thereon being sometimes hereinafter referred to as the demised premises:

Now, Therefore, This Agreement Witnesseth:

That the Lessor has agreed to let, and hereby does let unto the Lessee, and the Lessee has agreed to take and hereby does take and hire from the Lessor for the term, at the rentals, and additional rentals, and upon the covenants, conditions, limitations and agreements herein contained and with the exceptions and reservations herein set forth, all that parcel of land in the Borough of Manhattan, City*1945 of New York, bounded and described as follows: [Description omitted.]

*32 For the term of twenty years and eleven months to commence on the first day of August, 1922, and to end on the first day of July, 1943, at the annual rental or sum of Sixty Two Thousand Five Hundred Dollars ($62,500) lawful money of the United States during the portion of the term from August 1st, 1922, to August 1st, 1923, payable in equal monthly installments of Five Thousand Two Hundred and Eight and Thirty Three Hundredths Dollars ($5,208.33) in advance on the first day of August, 1922, and on the first day of each and every month thereafter during said portion of said term, and at the annual rental or sum of One Hundred and Twenty-five Thousand Dollars ($125,000) lawful money of the United States during the portion of said term from August 1st, 1923, to August 1st, 1933, payable in equal monthly installments of Ten Thousand Four Hundred Sixteen and Sixty six Hundredths Dollars ($10,416.66) in advance on the first day of August, 1923, and on the first day of each and every month thereafter during the portion of said term prior to August 1st, 1933, and at the annual rental or sum of One Hundred*1946 and Thirty-five Thousand Dollars ($135,000) lawful money of the United States, during the portion of said term subsequent to August 1st, 1933, payable in equal monthly installments of Eleven Thousand Two Hundred and Fifty Dollars ($11,250), in advance on the first day of August, 1933, and on the first day of each and every month thereafter during the remainder of the term of this lease (the rental herein provided for is hereinafter referred to as the Ground Rental), and at the additional rentals hereinafter provided.

* * *

That the Lessee shall also apy to the Lessor, as additional rental hereunder (hereinafter referred to as the Building Rental):

(a) Prior to the first day of August, 1923, such sum of lawful money as shall be equal to the interest at the rate of seven (7) per centum per annum on the amounts paid by the Lessor towards the cost of the Building under Paragraph "Fourth" of the Building Agreement from the dates of said respective payments to August 1st, 1923; said payments shall be made semiannually and the final payment shall be made on the first day of August, 1923, and each of said payments shall be for the rental accrued at the rate per centum aforesaid from*1947 the dates of said respective payments or from the last payment of such rental by the Lessee, as the case may be, to the date of such payment;

(b) Subsequent to August 1st, 1923, in equal monthly installments, an annual sum of lawful money equal to seven (7) per centum of the aggregate amount paid by the Lessor towards the cost of the Building under Paragraph "Fourth" of the Building Agreement, as such amount is reduced from time to time by the payments made in reduction of the principal sum thereof under Paragraph "Seventh" hereof. In case all payments provided to be made by the Lessor under said Paragraph "Fourth" shall not have been made on or prior to August 1st, 1923, said annual sum payable by the Lessee hereunder shall be increased as payments shall thereafter from time to time be made by the Lessor under said Paragraph "Fourth" by a sum equal to seven (7) per centum of the amount so paid by the Lessor from the time of such payments, and when all payments shall have been made by the Lessor under said Paragraph "Fourth," then the payments to be made by the Lessee subsequent to such time under this subdivision (b) shall be an annual sum of lawful money of the United States equal*1948 to seven (7) per centum of the aggregate amount paid under said Paragraph "Fourth" as such amount is reduced from time to time by the payments made under Paragraph "Seventh" as aforesaid. The *33 payments herein provided for shall be amde monthly, the first payment being made on the first day of September, 1923, and the other payments being made on the first day of each and every month during each and every year thereafter during the continuance of this lease, until the payments made under Paragraph "Seventh" hereof with the payments made under this subdivision (b) shall aggregate a sum equal to the amount paid by the Lessor towards the cost of the Building under Paragraph "Fourth" of the Building Agreement, and the interest on said sum (as reduced from time to time by the payments under Paragraph "Seventh" hereof) at the rate of seven (7) per centum per annum from August 1st, 1923, to the date of such final payment.

* * *

Seventh: That the Lessee shall also as additional rental hereunder, pay to the Lessor on the first day of August, 1924, and on the first day of August in each and every year thereafter, during the term of this lease the annual sum of Fifty Thousand ($50,000) *1949 lawful money of the United States (hereinafter sometimes called the Sinking Fund Rental) which sum so paid shall be deemed an installment payment on account of the sum advanced by the Lessor towards the cost of the Building under Paragraph "Fourth" of the Building Agreement between the parties hereto, and from and after the date of each payment, the sum upon which the Building Rental is to be computed under Subdivision (b) of Paragraph "First" hereof shall be reduced by the amount of such payment.

* * *

Thirteenth: That either the Lessor or the Lessee shall have the right, not earlier than nine months prior to the date of the expiration of the term of this lease and not later than six months prior to the date of the expiration of the term of this lease, to serve upon the other party hereto a notice in writing to the effect that the party serving such notice elects that this lease shall be renewed for a further term of twenty-one (21) years from the date of the expiration of the term of this lease. In the event that either party shall elect to renew this lease as aforesaid and shall serve notice of election as aforesaid, then upon the expiration of the term hereof, a renewal lease*1950 shall be executed by and between the parties hereto, whereby the Lessor shall let unto the Lessee, and the Lessee shall take and hire from the Lessor, the parcel of land above described with the exceptions and reservations above set forth, for the term of twenty-one (21) years from the date of the expiration of the term hereof, subject to the rights of the Lessor and the Railroad Companies, their and each of their successors and assigns, in and to the use and possession of the portions of the parcel of land above described, excepted from this lease as aforesaid, and in and to the subsurface of the street and Reserved Strip adjoining the demised premises, all as herein provided, and at the annual Ground Rental of One Hundred and Thirty Thousand Dollars ($130,000) or such other amount as shall be fixed upon as hereinafter provided, and at the other additional rentals herein contained, and upon the other terms, covenants, conditions, limitations and agreements herein contained, except that said renewal lease shall provide that upon the expiration of said first renewal term, either party shall have the right to require a second renewal lease as provided in Paragraph "Fourteenth" hereof, *1951 and except also that said renewal lease shall provide that from and after the time that the payments made by the Lessee on account of the annual Sinking Fund Rental of Fifty Thousand Dollars ($50,000), referred to in Paragraph "Seventh" of this lease, during the renewal term of this lease, together with the payments made under said Paragraph "Seventh" during the first term of this lease shall aggregate the *34 sum paid by the Lessor towards the cost of the Building under Paragraph "Fourth" of the Building Agreement, then the Lessee shall during the remainder of the term of the renewal lease be released from the annual Sinking Fund Rental provided for in Paragraph "Seventh", and from the Building Rental provided for in Paragraph "First."

Fourteenth: That if, upon the expiration of the term of this lease, this lease shall be renewed, as provided in Paragraph "Thirteenth" hereof, then the said renewal lease to be executed in that event shall provide that upon the expiration of the term of said renewal lease either the Lessor or the Lessee shall have the option (unless the Lessor shall elect that this lease shall not be renewed as provided in Paragraph "Sixteenth" hereof), not*1952 earlier than nine months prior to the date of the expiration of said first renewal term and not later than six months prior to the date of the expiration of said first renewal term, to serve upon the other party hereto a notice in writing to the effect that the party serving such notice elects that this lease shall again be renewed for the further term of twenty-one (21) years from the date of the expiration of the first renewal term of this lease. In the event that either party shall elect again to renew this lease and shall serve notice of such election as aforesaid, then, upon the expiration of the first renewal term, a second renewal lease shall be executed by and between the parties hereto, whereby the Lessor shall let unto the Lessee, and the Lessee shall take and hire from the Lessor the said parcel of land above described with the exceptions and reservations above set forth, for the term of twenty-one (21) years from the date of the expiration of the first renewal term, subject to the rights of the Lessor, and the Railroad Companies, their and each of their successors and assigns, in and to the use and possession of the portions of the parcel of land above described, excepted*1953 and reserved as aforesaid, and in and to the subsurface of the street and Reserved Strip adjoining the demised premises, all as herein provided, and at the annual Ground Rental of One Hundred and Thirty Thousand Dollars ($130,000), or such other amount as shall be fixed upon as hereinafter provided, and at the other additional rentals herein contained, and upon the other terms, covenants, conditions, limitations and agreements herein contained, except that the second renewal lease shall provide that upon the expiration of the term thereof neither party shall have the right to require a further renewal lease, and except also that said second renewal lease shall provide that if the Lessee shall have theretofore made the payments under Paragraph "Seventh" aggregating the amount paid by the Lessor towards the cost of the Building under Paragraph "Fourth" of the Building Agreement, then the Lessee shall also during said second renewal term be released from the further payment of the Sinking Fund Rental provided for in Paragraph "Seventh" and from the further payment of the Building Rental provided for in Paragraph "First."

Fifteenth: That in case of the removal of this lease for a first*1954 or second renewal term, as provided in Paragraph "Thirteenth" or "Fourteenth" hereof, the annual Ground Rental payable during the renewal term in question shall be the annual sum of One Hundred and Thirty Thousand Dollars ($130,000) or such larger sum as shall be determined upon as herein provided. If the Lessor shall be of the opinion that the annual Ground Rental of One Hundred and Thirty Thousand Dollars ($130,000) is less than the proper annual Ground Rental to be paid by the Lessee during the renewal term in question, then the Lessor shall, at least four months prior to the date of the expiration of the term of renewal term of the lease then expiring, notify the Lessee in writing of the annual sum which, in the opinion of the Lessor, would be a proper annual Ground Rental during the renewal term in question. If the *35 Lessee shall not, within twenty days after the service of said notice, advise the Lessor in writing that the annual Ground Rental so named by the Lessor is unsatisfactory, then the annual Ground Rental so named by the Lessor shall be the annual Ground Rental payable during the renewal term in question and shall be payable at the times and in the manner*1955 above provided.

* * *

In case five (5) per centum of the value of said parcel of land as fixed by said arbitrators as aforesaid shall be in excess of the sum of One Hundred and Thirty Thousand Dollars ($130,000), the annual Ground Rental payable hereunder during the renewal term in question shall be such annual sum as will equal five (5) per centum of the value of said parcel of land as fixed by said arbitrators as aforesaid. * * *

* * *

In case this lease shall terminate without renewal as above provided upon the expiration of the first renewal term hereof, by reason of the service by the Lessor of notice of its election that there be no renewal, and after service by the Lessee of notice of its election that there be renewal, then, upon such expiration, the Lessor shall pay to the Lessee the then value of the Building constructed upon the parcel of land above described, (excepting the portion thereof constructed below the planes and easterly of the line shown on Plot Plan No. 1 as marking the westerly limit of the excepted spaces), and in case the Lessor and the Lessee shall be unable to agree upon such value, then such value shall be determined by three arbitrators chosen*1956 as provided in Paragraph "Fifteenth" hereof, and the award of said arbitrators, or of a majority of them, shall be binding and conclusive upon the parties hereto. The expense of any such arbitration shall be borne as provided in said Paragraph.

* * *

Eighteenth: This lease shall be and hereby is declared to be subject and subordinate to the lien of any mortgage and the interest thereon covering the rights of the Lessor in the premises above described, placed thereon by the Lessor to secure payment of a principal sum not exceeding One Million Dollars ($1,000,000), and bearing interest at a rate not to exceed six and one-half (6 1/2) per centum per annum, and falling due in installments if the Lessor so desires, but in no event later than August 1st, 1936 and containing such other provisions as are usually found in trust mortgages of Railroad or Terminal Companies; it being understood that the entire principal amount of said mortgage may not be advanced thereon prior to the date hereof, but that this lease shall be subject to the aggregate principal amount of said mortgage of One Million Dollars ($1,000,000), even if no portion thereof be advanced thereon prior to the date hereof, *1957 and the Lessee does hereby covenant and agree that upon reasonable request of the Lessor, it will execute such further instrument of subordination as may be required by the Lessor or the Trustee under such mortgage, and will aslso provide in any leases made by it and in any mortgage made by it pursuant to the provisions of Paragraph Third hereof that such leases and such mortgage are subordinate to the entire principal amount of said mortgage for One Million Dollars ($1,000,000) above mentioned. The Lessor, however, does hereby covenant and agree that it will pay the principal amount secured by any such mortgage and the interest thereon as the same shall by the terms thereof become due and payable, without default and delay, and that any mortgage so made as aforesaid shall provide for an aggregate annual payment on account of the principal of said mortgage subsequent to August 1st, 1924, of at least One Hundred Thousand Dollars ($1,000,000). *36 The Lessor does also covenant and agree to indemnify and save harmless the Lessee from all and every loss and expense that may be occasioned by any action or proceeding taken under said mortgage by reason of any default or delay occurring*1958 in the performance of any of the terms of provisions therein to be performed by the Lessor, and in case of any such default the Lessee may apply any sums payable hereunder as rentals towards the curing of such default and deduct the sums so paid from the rentals payable hereunder by the Lessee subsequent to such time.

The same parties entered into a building agreement providing so far as material here as follows:

FIRST: That there shallbe prepared by Cross & Cross, architects, (hereinafter referred to as the Architects) working plans and working specifications for a high-grade building to be erected upon the portion of the parcel of land above described, not excepted from the Lease; said working plans and working specifications shall provide for a high-grade building of steel skeleton construction, of substantially twelve stories in height, and costing approximately One Million Eight Hundred Thousand Dollars ($1,800,000), hereinafter referred to as the Building.

* * *

(a) The payment required to be made on account of the Cost of the Building to the extent of Five hundred thousand (500,000) Dollars shall be made by the Lessee as the work of constructing the Building advances*1959 before any payments shall be required from the Lessor hereunder;

(b) When the Lessee shall have paid on account of the Cost of the Building the sum of Five hundred thousand (500,000) Dollars as aforesaid, and it shall be certified to the Lessor by the Architects, and approved by the Engineer, that the work has progressed to such point that payments to the extent of Five hundred thousand (500,000) Dollars have properly been made by the Lessee on account of the Cost of the Building, then the Lessor shall pay as provided in subdivision (d) hereof on account of the Cost of the Building such additional sums as may be required to complete the construction of the Building as aforesaid, not in excess, however, of the sum of One Million Dollars (1,000,000);

(c) All sums required to be paid on account of the Cost of the Building in excess of the sums provided to be paid by the Lessor under sub-division (b) hereof, shall be paid by the Lessee;

* * *

The payments to be made by the Lessor in accordance with the schedule contained in sub-division (d) are upon the proviso that the Cost of the Building shall equal or exceed the sum of One million five hundred thousand (1,500,000) Dollars, *1960 and in case the Cost of the Building shall be less than One million five hundred thousand (1,500,000) Dollars, then the aggregate of the payments to be made by the Lessor under sub-division (d) shall be reduced by the amount that the Cost of the Building is less than said sum of One million five hundred thousand (1,500,000) Dollars, each scheduled payment being reduced to such sum as together with the payments theretofore made by the Lessor under said schedule and the sum of Five hundred thousand (500,000) Dollars theretofore paid by the Lessee will not be in excess of the Cost of the Building accrued at the time of the request for payment made by the Lessee.

* * *

*37 SIXTH: That the Lessee shall cause the Building, including the work specified in sub-divisions (b) and (c) of Paragraph "Second" hereof, to be constructed with all reasonable expedition and shall have the Building completed and ready for occupancy on or before the First day of August, 1923, unless prevented by fire, lockout, strike or other cause or casualty beyond the control of the Lessee, and in case of failure to complete the Building prior to August 1st, 1923, by reason of any or all of said causes, *1961 then the Lessee shall have the same completed and ready for occupancy within such period after August 1st, 1923, as shall be equal to the time that the Lessee shall have been so delayed by any or all of said causes.

* * *

The building agreement was carried out. The building was started in June, 1922, and was ready for occupancy in May, 1923. The $1,000,000 contributed by the lessor was borrowed from the Guarantee Trust Company, the liability being evidenced by bonds secured by first mortgage upon the property repayable annually in amounts of $100,000. The petitioner furnished the necessary capital to pay the remainder of the cost of construction of the building. The capital stock of the petitioner amounted to $10,000. The remainder of the capital used was borrowed by the petitioner, part of the liability being secured by a mortgage upon its leasehold. Currently with the transactions the contribution of $1,000,000 was entered upon the books of the petitioner as a liability and the said $1,000,000 expended in cost of construction was charged to the asset account of the building. Subsequent to the taxable year these entries were reversed. The deduction for depreciation allowed*1962 by the respondent to the petitioner has been computed upon an amount of cost to the petitioner which includes the $1,000,000.

During 1922 the petitioner expended $26,041.67 in payments of ground rentals under the lease; $2,700 for interest on borrowed money, and paid real estate taxes upon the leased ground in the amount of $9,092.49, or an aggregate for the three items of $37,834.16. These expenditures were capitalized upon the books as cost to the petitioner of construction of the building. Subsequent to the taxable year the charges were transferred to profit and loss as expenses. These items were not claimed as deductions in the return for 1922 originally filed by the petitioner.

The petitioner expended $20,833.33 for ground rentals under the lease during the period begun January 1, 1923, and ended April 30, 1923, and capitalized this amount upon the books as cost of construction of the building. Subsequent to the taxable year this charge was reversed, the rentals being transferred to profit and loss account.

In order to secure desirable tenants for the new building, the petitioner followed a procedure customary in New York City, by taking over from the prospective*1963 tenants the leases which they held on quarters in other buildings, the petitioner assuming the liability to meet *38 the rentals provided therein and undertaking at its own risk to endeavor to find tenants for the short remaining terms of the leases. Since the leases ran for only three or four years more, it was realized that in all probability it would be impossible to receive rents equal to the rental payments required to be made upon the leases, so that an ultimate loss was expected and was intentionally assumed as an incident to securing the desirable tenants for the new building. In this connection the following transactions were had: With reference to 381 Fourth Avenue taken over from Batten & Company, rentals paid in 1923 aggregated $24,318.36 and rents collected in that year aggregated $1,437; with reference to 25 West 45th Street taken over from Barton, Durstine and Miller, rentals paid in 1923 aggregated $16,890.83 and rents collected, $1,858.33; or an excess of rentals paid in 1923 over rents collected, amounting in all to $37,913.86. The excess of expenditures over receipts from the lease taken over from Batten & Company amounted over its entire remaining term*1964 to $39,493.03, and the excess of expenditures over receipts from the lease taken over from Barton, Durstine and Miller amounted over its entire remaining term to $35,325.05. In every year the expenditures exceeded the receipts. The Batten & Company lease on the new building was for a term of 10 years beginning in May, 1923, when the building was ready for occupancy, and at an annual rental of $52,150. The Barton, Durstine and Miller lease on the new building was for a term of 10 years, also beginning in May, 1923, at an annual rental of $35,000. Collections from these two tenants during 1923 for occupancy of the offices in the new building amounted as follows:

From Batten & Company, Feb. 9, $50,000; May 1, $2,150 - total, $52,150.

From Barton, Durstine and Miller, May 9, $2,916.67; June 11, $2,916.67; July 11, $2,916.66; Aug. 14, $2,916.67; Sept. 10, $2,916.67; Oct. 11, $2,916.66; Nov. 10, $2,916.67; Dec. 11, $2,916.67 - total, $23,333.34.

An amount of $22,765.10 cost of making alterations in the new building for the account of trnants and for which they had agreed to pay was charged on the books to the cost of the building.

The cost reflected upon the books as of May 1, 1923, is*1965 in the amount of $1,511,590.82, of which the items here debated are ground rentals, $26,041.67; interest in 1922, $2,700; real estate taxes in 1922, $9,092.49; ground rentals in 1923, $20,833.33; alterations at the cost of tenants, $22,765.10, and cost contributed by lessor, $1,000,000, or an aggregate of $1,081,432.59, leaving a net undisputed book cost of $430,158.24.

In addition to its activities incident to carrying out the agreement relative to the erection of the office building, the petitioner was engaged during the fall of 1922 in securing tenants for the new *67 building, collecting advance payments in the amount of $49,083.33 to apply upon the rents from three tenants after the building was ready for occupancy, and incurring cost in the form of commissions in the amount of $13,339.17 due agents for securing tenants.

The building which the petitioner caused to be erected was 150 feet high and had 12 stories. The building site upon which it was erected was of a size sufficient to permit of the erection of a building having not to exceed 70 stories and the foundation of the building was suitable for a building much higher than that erected. The superstructure, *1966 however, was not suited to the imposition of additional stories so that remodeling is not feasible, and a proposition of increasing the height and the number of stories of the present building involves the necessity of taking down the superstructure and erecting a new building upon the present foundation. There is also a probable financial obstacle to remodeling or rebuilding in that parts of the building are under lease until 1943 at comparatively low rentals, so that the cost of buying out the tenants would probably be excessive. When, in 1922, this building project was conceived and the building erected, there were no large buildings in the vicinity. There has occurred, however, a subsequent development of the neighborhood and the values of the building sites have increased. Within a few blocks of the petitioner's building many modern buildings in heights of from 50 to 70 stories have been erected and they are well filled with tenants. The assessed value of the site upon which the petitioner caused a building to be erected has doubled over the assessed value in 1923.

The return filed by the petitioner for 1922 reported as follows:

*1967 The return filed by the petitioner for 1923 reported a net income of $4,706.11 after the deduction of a "net loss" for 1922 in the amount of $366.88.

A deduction of depreciation on the new building was claimed in the return filed by the petitioner for 1923 in the amount of $50,386.36, computed on a cost of $1,511,590.83 and a useful life of 20 years, the effective period in 1923 being taken as eight months.

*40 In determining the deficiency the respondent has computed the net income for 1923 as follows:

OPINION.

TRUSSELL: Taking up the several issues in the order in which they are stated above, we find in the first issue the petitioner claiming recognition of economic obsolescence of the building it caused to be erected. *1968 The petitioner contends that the building is entirely too small and the value of the building site has grown entirely too large to permit of the successful operation of the building for many years in the face of the competition of the surrounding buildings of 50 to 70 stories. Furthermore, the present structure is not adapted to be extended so that long before the end of its natural physical life or of even the term of years considered by the respondent to be the useful life, it will be necessary to refinance the project, tear down the present building, and erect in its place a more modern structure. But these are subsequent developments. We have under consideration here but one taxable year witnessing the completion of the construction of the building and its operation for a brief eight months. The evidence is thoroughly satisfying of present conditions, but it does not show definitely or even approximately when it became known that the building would have but a short useful life. On the contrary, the petitioners are shown during the taxable year as pioneers in this field, venturing into an undeveloped neighborhood; seeking out tenants at terms which are now grown to be exceedingly*1969 low; offering inducements to especially desirable tenants; engaging the services of agents upon a commission basis to secure tenants. To allow the claim of the petitioner we must find that before, or at least as soon as completed, the building was known to be one of an exceedingly short useful life. We think that the evidence is all to the effect that the startling development of the vicinity was not determinable or perhaps even foreseen during the taxable year. This means that the deduction allowable for depreciation *41 in the taxable year must be based upon either the physical life to be expected or upon the useful life as determined by the provisions of the lease agreement, if such useful life is the shorter. After a careful consideration of the lease agreement the intention is clear, we think, to provide for a tenancy of 41 years and 11 months unless both parties desired to terminate the agreement after a term of 20 years and 11 months. Either party had the option to continue the agreement. We do not regard it is significant that the continuation was to be effected through a new lease agreement; that was merely a device to facilitate the intended readjustment of the*1970 amount of the ground rentals. The petitioner attempts to argue that, since its capital stock was only $10,000, it was financially irresponsible and could afford to break its agreement; we prefer to entertain the assumption that the petitioner would have done what it had agreed to do if called upon by the lessor to do so. We are satisfied that the physical life of the building was not less than the term of 41 years under the lease (after completion) and we, therefore, conclude that the allowance of the respondent, upon a basis of 41 years, is reasonable in this regard and the annual rate used for this taxable year should not be revised. Revisions of the base upon which to apply this rate are considered elsewhere in this opinion.

The second and third are issues no longer since the respondent now concedes the claims of the petitioner and this conclusion is amply supported by the facts in the case. The items incurred in 1922 of alterations for tenants, $22,765.10; interest on borrowed money, $2,700; real estate taxes, $9,902.49; and ground rentals, $26,041.67, were all improperly capitalized and should be deleted from the cost returnable to the petitioner through depreciation allowances, *1971 as should also the ground rentals incurred in 1923 in the amount of $20,833.33. All of these items, with the exception of alterations for tenants, are properly allowable as deductions in the respective years in which incurred. The allowance for depreciation in the taxable year should be reduced accordingly.

In the fourth issue, the aprties are not in agreement relative to an amount of $1,000,000 of cost of construction of the building. It is not disputed that the amount was actually expended in the erection of the building. The point to be decided is whether, as contended by the respondent, the money was loaned to the petitioner and by it invested in the building, in which event it would properly be included in the cost to the petitioner, or, as contended by the petitioner, the money was contributed by the lessor in an assumption of a part of the cost of the building, and since the petitioner was *42 not liable to repay the investment, it had no depreciable interest in the amount. Upon a careful consideration of the building agreement and of the lease agreement we do not find any undertaking on the part of the petitioner to purchaser the lessor's interest in the building*1972 or to assume any liability as a borrower of the $1,000,000. Certain of the rental provisions may have some resemblance to transactions of borrowing and repayment, but it is only superficial, for the liability of the petitioner to make the payments is that of a lessee and such is its only liability. The petitioner acquired no more than its beneficial interest as lessee and it was liable for no more than the various rental payments due from it as lessee. We attach no importance to the early bookkeeping entries which are now shown to have been so contrary to the facts. In our opinion the cost of $1,000,000 was not borne by the petitioner, and it should not be considered in computing the deductions allowable to the petitioner for depreciation of the building.

The fifth issue relates to transactions between the petitioner and certain of its tenants. In securing two very desirable tenants the petitioner followed, as a special inducement to them, a custom prevalent in the vicinity, and assumed the liabilities of the tenants for rental payments over the remaining terms of two leases for the old quarters of the tenants, although knowing well at the time that because of the short terms*1973 remaining on the old leases it would probably be impossible to avoid losses due to the difficulty in finding subtenants for the short periods at rents which would anywhere near approach the liabilities assumed. The results of the operations of these leases by the petitioner are set out in the findings and there were not only ultimate losses on them, but for each of the years there were annual losses. The amounts of the losses are not in dispute. The petitioner readily admits that they were incurred as allowances in the nature of special reductions to the desirable tenants during the first three or four years, and contends that it must follow that the net amount of the loss in each year should be reflected in the results for that year. The rentals paid in 1923 by the petitioner were claimed as deductions in the return and were not disallowed in computing the deficiency. The respondent, however, now proposes to treat the ultimate losses as allowances in the nature of bonuses to the tenants to be capitalized as cost to the petitioner of these tenancies, returning the cost to the petitioner in pro rata annual deductions spread over the terms of the tenants' leases in the new building*1974 of the petitioner.

We have had several occasions to consider questions with respect to commissions paid to agents for personal services in obtaining tenants and we uniformly decided that the commissions represented *43 capital costs of securing the tenants, rather than ordinary expense of the year, and a clear reflection of the income from the leases required capitalization of the costs and deduction pro rata over the periods of the tenancies. ; ; . We think that the situation presented in the instant case is similar. The losses were intentionally incurred by the petitioner not in consideration of the first few years of operation, but rather of the terms and advantages of the entire rental periods in the new building. The petitioner argues that proration not be allowed since section 234(a)(1) of the Revenue Act of 1921 specifically provides for the deduction of "rental or other payments required to be made as a condition of the continued use and possession of property" etc., etc. The answer to this is that the*1975 true nature of the transaction must govern and if it is, as we find here, capital in its true significance, being the cost of securing a valuable asset, then it should be capitalized. The commissions for securing tenants considered in the cases cited above were similarly situated in that compensation paid for personal services is specifically deductible under the statute, yet we capitalize them.

There remains the question of the amount which is properly to be capitalized and returned through pro rata deductions spread over the tenancies. The question is presented in retrospect and we know exactly what was the actual cost to the petitioner as represented in the ultimate net losses incurred. There are no facts conflicting or upon which different valuations should be based. For the purposes of this case it is unnecessary for us to look further, and we accept the ultimate net losses in evidence as the bases to be assigned as capital expenditures. The collections during the taxable year from the old leases as well as the rental payments under the old leases should, therefore, be excluded from the return and the pro rata deductions we have authorized should be allowed in recomputing*1976 the deficiency.

The remaining issue, the sixth, brings into consideration, with reference to the taxable year, the operations of the year 1922, due to the claim of the petitioner for the allowance of a credit against net income for the taxable year of a so-called "net loss" for 1922. Such a credit, or rather deduction, has actually been allowed by the respondent in computing the deficiency having been claimed in the original return and left unadjusted by the respondent. The amount originally claimed was $366.88. The respondent now comes forward to contend that there was no statutory net loss and the deficiency should be accordingly redetermined and increased. On the *44 other hand, the petitioner contends that the net loss already allowed should be increased in the amount of the additional deductions for 1922 for ground rentals, interest and taxes which were improperly capitalized as costs of construction and so escaped inclusion in the deductions originally claimed.

The point to be decided is whether the petitioner was regularly carrying on a business in 1922 as it must have been to comply with section 204(a) of the Revenue Act of 1921 which provides that as used*1977 in that section the term "net loss" means "only losses resulting from the operation of any trade or business regularly carried on by the taxpayer." The charter of the petitioner authorized a great variety of activities, but during the two years here under consideration the petitioner engaged in but one project - first, the erection, and then the operation of an office building. What might have been done is immaterial; we must confine our consideration to what was actually done. In detail then, the petitioner in 1922 leased a suitable building site, caused to be started and to be continued the erection of an office building, with intention to operate the building for profit by renting the offices to suitable tenants and providing the usual building services; also, it secured several tenants for the new building, the tenancies to begin if and when the building was ready for occupancy. In this connection it collected advance payments from the tenants and incurred liabilities for commissions to agents for personal services in securing tenants. The building was not ready for occupancy until the following year. The petitioner contends that the business was carried on from the moment*1978 that it acquired the leasehold and proceeded to start erection thereon of its building, for the reason that it was doing the things authorized by its charter. We have had occasion previously to consider this point in , wherein that petitioner was engaged during the taxable years in the erection of a building with intention to operate a hospital therein when ready for occupancy, and we decided a preliminary period of preparation - of getting ready to carry on business - was not one in which a net loss resulting from operation could be recognized. We think the instant case is comparable in that all of the activities of the petitioner were prospective - it was getting ready to operate its business. Consequently, we are of opinion that we should be controlled by our previous decision cited above. A statutory net loss to the petitioner for 1922 is unallowable.

Judgment will be entered pursuant to Rule 50.