7 T.C. 717">*717 By these proceedings, consolidated for hearing and consideration, petitioners challenge part of the following deficiencies in income tax, as determined by respondent:

Petitioners having waived an issue raised in the pleadings, the remaining questions are whether rents which were assigned to a trustee pursuant to an agreement of May 1, 1937, constitute income taxable to petitioners when collected during the taxable years in question; 7 T.C. 717">*718 if so, whether petitioners may deduct the payments of such rents made to the stepmother of one of them and, after her death, to 1946 U.S. Tax Ct. LEXIS 83">*84 her estate, as allowances for exhaustion of the stepmother's interest acquired by one of the petitioners or as business expenses.

Some of the facts were orally stipulated.

FINDINGS OF FACT.

The stipulated facts are hereby found accordingly.

Petitioners, who are husband and wife, reside in New Jersey, and filed their tax returns with the collector of internal revenue for the fifth collection district of New Jersey. Louise C. Wolff will be referred to hereinafter as petitioner.

Petitioner was the only child of August Heidritter, who died testate on December 28, 1921, leaving a net estate of an agreed value of $ 786,685.77 at the time of his death.

In the estate tax return the net estate was valued at $ 533,372.68; the total gross estate, at $ 683,506.45, composed of the following:

By his will dated May 8, 1918, and admitted to probate by the Surrogate's Court of Union County, 1946 U.S. Tax Ct. LEXIS 83">*85 New Jersey, decedent made the following provisions, inter alia, for the disposition of his estate:

Second: I give, devise and bequeath to my beloved wife, Eugenie Heidritter, my homestead property 1254 Waverly Place, in the City of Elizabeth, New Jersey, to have and to hold for and during her natural life, with the land adjoining the same, and also all the household furniture in the dwelling on said property for the same period.

* * * *

Seventh: All the rents, interest, issues and profits of my estate shall be paid to my said executors in trust, to be divided by them as follows:

One-half of said rents, interest, issues and profits shall be paid to my said wife, Eugenie Heidritter, and the remaining half to be paid by my daughter, Louisa C. Wolff, wife of Henry E. Wolff, during the lifetime of my said wife.

* * * *

Ninth: All the residue of my estate, after the death of my said wife, I give and bequeath to my daughter, Louisa C. Wolff, wife of Henry E. Wolff, to have and to hold to her and to her heirs and assigns forever.

Eugenie Heidritter was petitioner's stepmother. She was born on August 27, 1864, and died on July 3, 1938.

Following the death of August Heidritter, considerable1946 U.S. Tax Ct. LEXIS 83">*86 litigation ensued between petitioner and her stepmother with reference to the 7 T.C. 717">*719 validity of his will; controversy also existed as to their respective rights under the will of Frederick L. Heidritter, a brother of August, who had died in 1911.

These differences were resolved by an agreement entered into between petitioner and her stepmother on July 9, 1924. Petitioner agreed to pay to her stepmother $ 10,000 per year for a period of two years, $ 12,000 per year for the succeeding two years, and thereafter $ 15,000 per year for and during the remainder of her stepmother's life. Upon the death of the stepmother petitioner was required to pay only the quarterly payment due up to and including the date of the stepmother's death. She also agreed to pay $ 6,450.80 upon the execution of the agreement and an additional sum of $ 1,000 annually in consideration of the stepmother's transfer of her life interest in the homestead. The stepmother, in return, agreed to "sell, assign, transfer and set over" to petitioner "all the right, title and interest of the party of the second part [the stepmother] of every nature and kind whatsoever in the estate of the said August Heidritter, deceased, 1946 U.S. Tax Ct. LEXIS 83">*87 except as above expressly reserved, and also in and to the Estate of Frederick L. Heidritter, deceased, without limitation."

The payments which petitioner was required to make were to be secured by a mortgage of $ 300,000 on certain real estate situate in Elizabeth, New Jersey, occupied by the Heidritter Lumber Co.

Thereafter petitioner defaulted in the payments and the mortgage was foreclosed; a final decree was entered in the New Jersey Court of Chancery on January 8, 1935, directing that the premises be sold.

A new agreement was entered into between petitioner and her stepmother on May 1, 1937, modifying their earlier agreement. At that date petitioner was in arrears in payments under the earlier agreement in an amount of $ 46,650.93.

Petitioner agreed:

(a) To pay her stepmother $ 6,500 upon the execution of the agreement, which sum was actually paid by her husband;

(b) To obtain the cancellation of a second mortgage in the sum of $ 45,000 covering the mortgaged premises;

(c) Upon cancellation of the second mortgage, to hold and retain title to the premises in trust, and to sell and dispose of the property to such persons and upon such terms and conditions and for such consideration1946 U.S. Tax Ct. LEXIS 83">*88 as her stepmother might determine and direct;

(d) Not to sell or encumber the property in any way except with express written consent of her stepmother, and meanwhile to continue existing leases and assign all rents, issues, and profits realized from the property to the trustee designated in the agreement;

(e) Upon sale of the property, to transfer and deliver all net proceeds thereof to the trustee.

7 T.C. 717">*720 The stepmother agreed to make application for dismissal of the foreclosure proceedings; to release petitioners of any personal liability under the original agreement; that all liability for the payments provided in the original agreement was to be limited to the property and proceeds thereof; that she would claim no legal or beneficial interest in the property remaining unsold, after full payment to her or her estate of the amounts due; and the remainder was to become the property of petitioner.

It was further provided that if all arrears and future installments should not have been paid in full and the property should not have been fully liquidated upon the stepmother's death, the right of the stepmother to determine the terms and conditions of sale were to pass to her executors, 1946 U.S. Tax Ct. LEXIS 83">*89 administrators, and assigns in order to secure full payment of the required sums.

The trustee agreed to pay over to the stepmother the amounts received, application of the proceeds being first made to cancel out the arrears and thereafter paying future annual installments of $ 16,000 as they should accrue. The trust was to terminate when all amounts due the stepmother were paid in full.

During the taxable years the amounts of rents collected and paid to the stepmother or her estate were as follows:

It is these amounts which respondent seeks to tax to petitioners and which petitioners in the alternative seek to deduct from their income on account of the exhaustion of the life interest or as business expenses. The total amount paid to the stepmother and her estate up to and including the year 1944 was $ 181,377.41.

From the death of her husband up to the date of her first agreement with petitioner, Eugenie Heidritter was entitled to receive from her husband's estate the sum of $ 13,181.48.

On July 9, 1924, petitioners, as landlords, and Heidritter Lumber Co., as tenant, entered into a lease for a period of 20 years1946 U.S. Tax Ct. LEXIS 83">*90 from July 7, 1923, covering certain premises in Elizabeth, New Jersey, including the property in question, at an annual net rental of $ 12,000 for the first 3 years and $ 15,000 per year thereafter. Part of the premises encompassed by the lease was the subject matter of an earlier lease, made January 29, 1918, between August and Eugenie Heidritter, on one hand, and Heidritter Lumber Co., on the other, which lease was for a term of 18 years, commencing June 30, 1915, and providing for a yearly rental of $ 3,500, or, in lieu thereof, at the option of the tenant, payment of municipal taxes.

7 T.C. 717">*721 Improvements were erected on the land sometime after the death of August Heidritter, but prior to 1924, by the tenant at a cost of $ 160,000.

The paid-in capital stock of the Heidritter Lumber Co. was $ 300,000, which had a book value in 1924 of $ 960,000. The net earnings of the company, after taxes, in 1924 were $ 35,709.18; in 1925, $ 48,000.

At all times herein material, petitioner's interests and those of her stepmother were adverse.

The interest of Eugenie Heidritter in the property in question and of her estate after her death under the agreement of May 1, 1937, was not less than1946 U.S. Tax Ct. LEXIS 83">*91 $ 46,650.93.

OPINION.

Had petitioner paid to her stepmother the purchase price of the latter's life estate in a lump sum, the amount represented thereby would have constituted an investment in a capital asset, exhaustible and therefore recoverable through deduction over the life of the asset acquired, that is, the life expectancy of the stepmother. See Caroline T. Kissel, 15 B. T. A. 705; Estate of F. S. Bell, 46 B. T. A. 484; reversed, other grounds (C. C. A., 8th Cir.), 137 Fed. (2d) 454. But the peculiar facts here present lend an almost fantastic complication to this comparatively simple principle.

In the first place, the payments to the life tenant were not made in a single sum, but sporadically and from time to time over a period of years. In the second place, these same payments were the fruits of the property in which the purchased estate inhered and became available to petitioner currently by reason of the purchase. Hence, petitioner now inferentially concedes that they constitute income to her. See Helvering v. Horst, 311 U.S. 112">311 U.S. 112; Douglas v. Willcuts, 296 U.S. 1">296 U.S. 1;1946 U.S. Tax Ct. LEXIS 83">*92 Helvering v. Blumenthal, 296 U.S. 552">296 U.S. 552. But they correspondingly give rise to the present claim that equivalent deductions are necessary to eliminate distortion. See Associated Patentees, Inc., 4 T.C. 979. In the third place, the years before us are subsequent to the end of both the life and life expectancy of the life tenant. But the fourth complication, petitioner's agreement to pay the life tenant an annuity as the purchase price, which would normally eliminate the need for consideration of any period after the annuitant's death, is offset by a fifth -- petitioner's default in the stipulated annual payments when due and her consequent supplemental agreement covering the deferred payments, which, as made in the tax years in issue, all of which follow the life tenant's death, create the present controversy.

Some of these difficulties diminish upon further analysis. An agreed annuity payable in consideration of the transfer of an estate 7 T.C. 717">*722 for the annuitant's life would represent the consideration paid, and hence the basis. See United States v. Ludey, 274 U.S. 295">274 U.S. 295; D. Bruce Forrester, 4 T.C. 907.1946 U.S. Tax Ct. LEXIS 83">*93 It would also be coterminous with the period of exhaustion.¹ The installment of purchase price paid in any year and the deduction for depreciation would consequently be interchangeable. Both total cost and anticipated life would be estimates, but, being based upon the same assumed condition, the life tenant's life, any inaccuracy in the one would offset the other. Thus, in Floyd M. Shoemaker, 16 B. T. A. 1145, the amount of the annuity paid in the tax year was allowed as a deduction for exhaustion. So here, if the payments in question had been made as they came due under the original agreement, there would be no problem. See D. Bruce Forrester, supra.Petitioner's cost would already have been recovered by deduction of the amounts currently disbursed.

1946 U.S. Tax Ct. LEXIS 83">*94 It is accordingly the factor of default which serves to make the present case troublesome. Petitioner was apparently on the cash basis, and we see no reason to assume that she would have been permitted to deduct in prior years any amount for the purchase price of the stepmother's life estate which was not actually paid in each year. Cf. Eckert v. Burnet, 283 U.S. 140">283 U.S. 140; see Elizabethtown Water Co. Consolidated, 7 T.C. 406; Detroit Edison Co. v. Commissioner, 319 U.S. 98">319 U.S. 98. Unless the payments due but remaining unpaid are allowed as deductions when made, the investment will hence not be recoverable at any time.

It was apparently on this theory that the closely analogous case of Associated Patentees, Inc., supra, was decided. It was there held, 4 T.C. 979, as outlined in the headnote:

Four individuals transferred to petitioner certain patents which they jointly owned in equal proportions under a contract obligating petitioner to pay them 80 percent of its income from licenses granted for their use. Under this contract petitioner1946 U.S. Tax Ct. LEXIS 83">*95 paid them $ 42,209.76 in the taxable year and in its return deducted that amount as royalties paid. Held:

(1) This payment was a capital expenditure in acquisition of the patents.

(2) Petitioner is entitled to recover by depreciation its total cost of the patents over their lives and, since such cost is not determinable until the close of the term when all of the value of the patents passes and since the yearly payments are attributable to income of the year in which made, the "reasonable allowance" for depreciation provided by section 23 (l), I. R. C., requires the allowance of a deduction in each year equivalent to the payment made in that year. Such allowance will give petitioner over the term no more than its cost and no distortion of income will result.

7 T.C. 717">*723 The opinion states (page 986):

* * * Respondent's regulations recognize the fact that there is no fixed rule, but that the cost should be apportioned over the useful life in such ratable amount as may reasonably be considered necessary to recover during the remaining useful life of the property the unrecovered cost or other basis. The situation here is unusual. But we think that the method for computing depreciation1946 U.S. Tax Ct. LEXIS 83">*96 for which petitioner argues gives it a reasonable, and not more than a reasonable, allowance, whereas the method urged by respondent might deny petitioner the recovery of its cost and would unquestionably result in a distortion of income.

It is, of course, at once apparent that deductions for the exhaustion of a life estate, as such, seem at least questionable when we know the life tenant has already died. See Citizens National Bank of Kirksville, 42 B. T. A. 539; affd. (C. C. A., 8th Cir.), 122 Fed. (2d) 1011; certiorari denied, 315 U.S. 822">315 U.S. 822. But what was a pure life estate when the original agreement took place has now been converted into something more complex. For the very reason that there had been defaults, petitioner undertook, by the supplemental agreement of 1937, to continue payments out of the avails of the property until all arrears had been made good. This was coupled with an extension of the adverse interest beyond the life of the stepmother, if necessary. It follows that both the period of payment and the exhaustion process must go on for some time into the future, even after the1946 U.S. Tax Ct. LEXIS 83">*97 latter's death. While that period is necessarily indefinite, the payments and the estate will end together. We see no violation of the theory of the Shoemaker and Associated Patentees cases to assume here that the amount of each annual payment represents an adequate approximation of the corresponding exhaustion of the capital assets purchased thereby, and hence that, as in these cases, the periodic payments during the tax years in question are deductible "for exhaustion of the terminable estate acquired * * *."

We may add that only the peculiar circumstances of the present situation lead us to that consequence, which may not necessarily follow on other facts. But for the reasons stated, we view respondent's action in this respect as unwarranted by the present record.

Decisions will be entered under Rule 50.