City Nat'l Bank Bldg. Co. v. Commissioner

*93 The Commissioner determined deficiencies in the petitioner's income tax as follows:

The petitioner assigns as error the action of the Commissioner in failing to allow an annual deduction for depreciation on the City National Bank Building and, in the alternative, his failure to allow an annual deduction of $17,850 representing amortization of the cost of leasehold improvements*757 ($595,000) over the stipulated life of the building (33 1/3 years). The petitioner claims overpayments.

FINDINGS OF FACT.

Rufus E. Lee, president of Rufus E. Lee & Co., investment bankers of Omaha, Nebraska, made some inquiry in 1925 on behalf of himself and Otis & Co., investment bankers of Cleveland, Ohio, *94 in regard to the investment possibilities of a building in Omaha, Nebraska. He learned that the City National Bank Building of that city could be acquired for $1,500,000.

The building was 16 stories high, with a basement. The first floor and part of the second floor were occupied by stores and a theatre entrance. The rest of the building was used for office space. The land and building were owned by City National Bank Building Co., a Nebraska corporation (hereinafter called the Nebraska corporation). The property was encumbered by a mortgage in the amount of $560,000.

Lee and Otis & Co., after investigation, were satisfied with the price. Lee obtained an option to purchase the stock of the Nebraska corporation for $940,000.

He and Otis & Co. then organized the petitioner under the laws of Delaware. Its authorized capital stock (2,000 shares each*758 of $1 par value) was subscribed for by Lee and Otis & Co. Each took one half of the stock and paid for it at par in cash. They had previously decided to finance the transaction by the sale of land trust certificates and bonds, and had agreed upon all details. Land trust certificates were chosen because of the popularity of such form of investment in Ohio, where Otis & Co. was located, and because they were not limited as to tome of redemption.

Lee assigned his option to the petitioner. The petitioner purchased the stock, liquidated the Nebraska corporation, and thus acquired the fee title to the property. The petitioner paid off the mortgage. It also paid a commission of $25,000 to Lee.

It next conveyed the property in fee to the Union Trust Co. of Cleveland, Ohio, by a warranty deed.

Thereupon, it leased the property from the Union Trust Co. for a term of 99 years, renewable forever, at an annual rental, with an exclusive option to purchase at any rent-paying date for $1,050,000. The lease was dated June 1, 1925.

The Union Trust Co. executed a declaration of trust and issued 1,000 shares of equitable ownership in the fee simple title to the property. Otis & Co. *759 sold the certificates to the public and the petitioner received $930,000 from that source.

Otis & Co. also purchased and sold to the public an issue of $600,000 par value 6 1/2 percent first mortgage leasehold sinking fund gold bonds of the petitioner, secured by a first mortgage on the leasehold estate held by the petitioner. The bonds were dated June 1, 1925, and were due June 1, 1940. There was provision for a sinking fund of $58,000 per year, to be used to pay interest and retire bonds before maturity. Otis & Co. paid $540,000 to the petitioner for the bonds.

*95 The petitioner took possession of the building under the lease and paid the annual rental to the Union Trust Co. and the successor trustee. The trustee retained a commission and distributed $55,000 annually to the holders of the land trust certificates.

The deed from the petitioner to the trustee, the lease, the declaration of trust, and the first mortgage trust deed were all recorded at the same time on June 1, 1925.

The lease stated that the Trust Co. was trustee for those who might be or become the owners of land trust certificates. It provided for "a yearly rental of Fifty-five Thousand Dollars*760 ($55,000) for each of the years of said term and any renewal thereof" and for payment by the lessee of an annual commission to the trustee. The lessee was to pay all taxes, assessments, repairs, and insurance. In case of loss by casualty, the lessee was to pay for the restoration or replacement of the buildings after applying the proceeds of insurance. The lessee, while not in default and upon giving proper security, could remove and replace the building by paying all costs of the new building in excess of the salvage on the old building. There was a provision for approval of the plans by the trustee. All buildings and improvements were to become a part of the realty. Where the lessor was not at fault, the lessee was to pay all costs of litigation. In case of default the lessor had the right to declare the term of the lease ended, to reenter the premises, buildings, and improvements and "again to repossess and enjoy as in the lessor's first and former estate, free of any right or claim on the part of the lessee" and the lessee was to "surrender said premises together with the buildings, improvements and fixtures then thereon." The lessor was to have a first lien on the leasehold*761 estate and all rights thereunder for amounts due under the lease. The lessee was given the right to mortgage its estate when not in default.

The agreement and declaration of trust between the trustee and the holders of land trust certificates of equitable ownership in the real estate declares that the trustee holds the title to the premises for the benefit of the holders of certificates of equitable ownership issued under the agreement. It briefly describes the lease and the payments to be made by the lessee. Article II states that "The equitable ownership and beneficial interest in the Trust Estate is divided into One Thousand indivisible equal shares" represented by certificates known as "Land Trust Certificates." The trustee is to pay quarterly to the certificate holders their pro rata share of the net proceeds of the rental. The agreement also provides that no beneficiary shall have as such any legal title to the trust property but his interest shall be equitable only and shall not entitle him to partition during the continuance of the trust. The trustee is not to be personally liable. *96 The trustee is to have the exclusive right to manage and control the trust*762 estate. The compensation of the trustee for the first year and for each year thereafter is fixed but if it is required to perform extraordinary services, it is to be paid extra therefor by the lessee.

The first mortgage trust deed from the petitioner to the trustee for the bondholders secured by the leasehold describes the security for the mortgages as "all the right, title, and interest which the Company [the petitioner] has or may hereafter acquire" in the property whether by virtue of the lease or otherwise.

The Commissioner, in determining the deficiencies, has not allowed the petitioner any deduction representing depreciation of the building. The petitioner on its return for 1929 claimed a deduction of $5,950 representing amortization of the cost of its leasehold at the rate of 1 percent. The Commissioner, in determining the deficiency for each year, allowed a deduction of $5,950. The petitioner claimed and was allowed for each year a deduction of $55,000 for rent.

The parties have stipulated:

If it should be judicially, finally determined in these proceedings that the petitioner's title or interest in the subject property is not that of alessee as alleged in*763 the deficiency notice and/or that the written agreements in evidence created a relationship in petitioner of mortgagor as alleged in the petitions and that by reason thereof petitioner has a depreciable interest as owner in the premises, then and in that event only, a fair allocation of the cost price of $1,525,000.00 is $750,000 to the building and improvements and $775,000 to land and other assets; that this is without prejudice to the effect to be given agreements and acts, a part of or contemporaneous with or subsequent to the acquisition of the property under the option to purchase from the stockholders of the former City National Bank Building Company. The building had an expected life of 33 1/3 years from June 1, 1925.

OPINION.

MURDOCK: The principal claim made by the petitioner in these proceedings is that it has never ceased to be the owner in fee simple of the City National Bank Building property and, as such, it is entitled to deduct in each year 3 percent of $750,000, or $22,500, as depreciation on the building. It has already been allowed a deduction for the exhaustion of its leasehold and for the rent which it paid as lessee. The question of discount is not*764 raised, and the Board must assume that the petitioner has been allowed such amortization of discount (for example, discount on its bond) as it is entitled to deduct in computing its net income for each year. The Revenue Act of 1928 provides for the deduction of "a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business." Sec. 23(k). The basis for depreciation is the cost of the property. Secs. 23(m), 114(a), 113(a). This means the cost of the property to the owner who is using the property in *97 his trade or business. "The amount of the allowance for depreciation is the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage value) suffice to provide an amount equal to the original cost." . Deductions for depreciation are allowed for the purpose of restoring to the owner his capital investment in exhausting property over the period of its use from untaxed earnings derived from its use. ¹ When the owner of depreciating property sells his*765 property, he thereby recovers all or a part of his capital investment in the property, and the difference is made up in gain or loss. He is not entitled thereafter to deductions for depreciation based upon the cost of the property, even though he may immediately lease it. .

The petitioner does not hold the legal title to the building in question, but is only a lessee. The Union Trust Co. holds the legal title, and the holders of the land trust certificates are the beneficial owners of the land and building. . The holders of the land trust certificates paid about $1,000,000 for their interest. It is a real interest. The petitioner sold the property to the Union Trust Co. of Cleveland, Ohio, by a warranty deed, and received therefor $930,000 in cash and a valuable leasehold. The $930,000 in cash which it received was obviously a return to it of so much of its capital investment in the property and, *766 since it thus recovered that portion of its capital investment, the same amount should not be again recovered by it through deductions for depreciation on the property of others. The remainder of its original cost was recovered through the receipt of a valuable leasehold, and that part of its original capital investment in the property should not be again recovered by it through deductions for depreciation on the property of others. The value of this leasehold is demonstrated by the fact that the petitioner was able immediately to mortgage the leasehold interest for $600,000. The petitioner received $540,000 in cash for the bonds secured by this mortgage. The petitioner is entitled to and has received the benefit of proper deductions for the exhaustion of the leasehold. It may also be entitled to deductions for amortization of discount on its bonds secured by the mortgage on the leasehold. It has claimed and has been allowed deductions for the rent which it pays under the lease. Not only is there no statutory authority for allowing the petitioner a deduction on account of depreciation of the building, but on principle the petitioner is not entitled to such a deduction since, *767 as has been demonstrated, it does not need such deductions to return its capital outlay. *98 ;; certiorari denied, ; affirming . Cf. .

The fact that the petitioner is not entitled to depreciation on the building may be further demonstrated. If a new building is ever to replace the present building during the term of the lease, the petitioner will probably have to pay for its erection. That cost will represent additional cost of the leasehold, since the building will not belong to the petitioner. That additional cost, if paid, will be recoverable through annual depreciation charges. ;; . The petitioner may not anticipate such future additional costs of its leasehold. *768 A present deduction in anticipation of future additional cost would not be a "reasonable" deduction. If the petitioner decides to forfeit the lease when the present building wears out, its loss will be no more than the unexhausted cost of the leasehold. It can not lose the entire original cost to it of the building, because it sold the building in 1925 and most, if not all, of its original cost was restored to it at that time. If it were allowed annual deductions of $22,500, and then were to default on the lease when the present building wears out, it would have received a substantial amount of income tax free. Congress did not so intend. The question of depreciation allowance to the trustee and the land trust certificate holders is not before the Board. ² They may, perhaps, sustain no loss from depreciation, due to the provisions of the lease. Cf. ; ; affirmed on this point, *769 ; . But that question need not confuse the present issue, for the mere fact that the lessors may not be entitled to deductions for depreciation is not a sufficient reason for allowing deductions for depreciation to the lessee. A taxpayer, in order to be entitled to a deduction, must show that it comes within some provision of the statute allowing a deduction. ; ; . This the present petitioner has failed to do.

The petitioner argues that the sale of the property to the Union Trust Co., the declaration of trust, *770 and the sale of the land trust certificates, must be treated as a mortgage and not as a sale by the *99 petitioner. The decision of the Board in , now on appeal to the Court of Appeals for the Sixth Circuit, and the decision of the Sixth Circuit in , affirming an unpublished opinion of the Board, are cited as authorities in support of this argument. The opinions of the Board in the above mentioned cases were promulgated prior to the decision of the Supreme Court in The appellate court in the Neighbors case considered Senior v. Braden, but was of the opinion that that decision did not reach the issue in the Neighbors case. It allowed the taxpayer a deduction for depreciation on the building on the ground that it still owned the building. The court stated:

Neither are we required for purpose of decision to hold with the Board that the deed, declaration of trust and lease together constituted a mortgage. * * * We see nothing in the Senior v. Braden holding inconsistent with the existence*771 of a relationship of borrower and lender between the taxpayer and the certificate holders or their trustee, or that compels a holding that the taxpayer's financing plan resulted in a sale rather than a loan, even when applying the doctrine there announced in the full import claimed for it by the Commissioner to the estate held by the trustee or the certificate holders in the present case.

The facts in the present case are different in some respects from the facts in the Lazarus and Neighbors cases. It may be that these differences serve to distinguish the cases. The transactions in the Lazarus and Neighbors cases were initiated by existing corporations in order to refinance their indebtedness. Here the transactions were initiated by bankers who desired some business. The petitioner was given the right to mortgage its leasehold estate. No such right was given under the Lazarus and Neighbors leases. The petitioner actually mortgaged its leasehold estate, bonds secured by the mortgage were sold to the public, and the petitioner received $540,000 of the proceeds. In the present case and in the Lazarus case the land trust certificates were not delivered*772 to the taxpayer but were sold by either the trustee or the bankers, while in the Neighbors case the trustee delivered the land trust certificates to the former owner, which then sold them to bankers. The lease in the Neighbors case contained provisions relating to separate property owned by the lessee. No such provisions are found in the Lazarus leases or in the lease involved in the present case. The question of gain or loss which was involved in the Lazarus and Neighbors cases is not involved in the present case.

The Supreme Court in , considered the same land trust certificates issued on the City National Bank Building of Omaha which are involved in this present proceeding. Although the court had a very different question before it, nevertheless, *100 we think that its decision points the way for our decision of the present question. The Court there concluded that the trustee held legal title to the real estate, and the owners of the trust certificates had abn interest in the land. The Court, including the dissenting members, was obviously of the opinion that the sale was a real sale and not merely a*773 loan or a mortgage. Had the Court been of the opinion that the owners of the trust certificates were merely owners of an equitable interest in a mortgage or in something which amounted to no more than security for a loan, it would have either reached a different conclusion or have based its decision upon some other ground than that upon which it did base it. Thus the transactions in the present case were in law and in fact exactly what they purported to be. The petitioner sold its property, benefited from the method which it used, and now can not deny the fact of sale in order to claim tax benefits which would have resulted from the use of a mortgage or some other form of loan. The test is what was done, not what might have been done. . The above discussion also disposes of the petitioner's alternative contention.

Reviewed by the Board.

Decision will be entered for the respondent.

BLACK, dissenting: I do not think that the facts in the instant case are sufficiently different to justify a distinction in this case from what we held in F. and R. Lazarus & Co.,32 B.T.A. 633,*774 now on appeal to the Sixth Circuit, and in a memorandum opinion in H. F. Neighbors Realty Co., affirmed by the Court of Appeals for the Sixth Circuit, 81 Fed.(2d) 173.

I think that the court in the Neighbors case rightly held that the Supreme Court's decision in , does not control the decision of the question which we have here to decide. As to the effect of the Supreme Court's decision in Senior v. Braden, the court said in part:

We see nothing in the Senior v. Braden holding inconsistent with the existence of a relationship of borrower and lender between the taxpayer and the certificate holders or their trustee, or that compels a holding that the taxpayer's financing plan resulted in a sale rather than a loan, even when applying the doctrine there announced in the full import claimed for it by the Commissioner to the estate held by the trustee or the certificate holders in the present case.

A collateral issue is involved with respect to depreciation taken by the taxpayer upon the buildings located upon the leased property, on the theory that the taxpayer still had the beneficial interest*775 in the property, and on the theory that the investment in the buildings was of its capital as owner. The Board allowed the depreciation. We think it was right, and that the case of Weiss v. Wiener, 27. U.S. 333, does not here apply. See also (C.C.A. 6).

The decision of the Board of Tax Appeals is affirmed.

*101 Of course it seems clear that petitioner would not be entitled to a deduction for both amortization of its so-called leasehold and a deduction for depreciation. If petitioner is entitled to a deduction for depreciation, and I think it is, then its so-called leasehold should simply be regarded as a part of its plan for securing the certificate owners in the loans which were made to petitioner and petitioner should not be allowed any deduction for exhaustion of leasehold.

A deduction for depreciation would take care of its return of capital invested in wasting assets. Therefore I think an opinion in this proceeding should hold that petitioner is entitled to the deduction for depreciation which it claims and should be disallowed the deduction for amortization of leasehold*776 which it claimed on its income tax return and was allowed by the Commissioner.

ARUNDELL, MCMAHON, and LEECH agree with this dissent.