15 T.C. 534">*534 Respondent determined a deficiency in petitioner's income tax liability for the calendar year 1946 in the amount of1950 U.S. Tax Ct. LEXIS 57">*59 $ 11,004.30. 15 T.C. 534">*535 Petitioner claims that it sustained a net operating loss of $ 78,615.14 in the taxable year, entitling it to a net operating loss carryback for the years 1944 and 1945.

Petitioner assigns as error respondent's disallowance of a claimed loss of $ 107,715.62 on the sale of a diesel generator and spare parts previously acquired by petitioner as part of its purchase of a Mexican radio station. If deductible, a further question arises as to whether the loss results from the sale of a capital asset within the meaning of section 117 (a) (1) and 117 (d), I. R. C., or whether it results from the sale of "property used in the trade or business" within section 117 (j), I. R. C.

A second allegation of error concerns the rate of depreciation on the Mexican transmitting equipment removed by petitioner and installed in its station at San Antonio, Texas.

A third issue is presented by respondent's determination that petitioner may not amortize certain leasehold improvements over the original term of the lease but instead must amortize them over the combined primary and optional renewal period or the expected useful life of the improvements, whichever is shorter.

The proceeding1950 U.S. Tax Ct. LEXIS 57">*60 was submitted upon the pleadings, testimony, and a stipulation of facts. The facts so stipulated have been incorporated in material part in our findings of fact.

FINDINGS OF FACT.

Petitioner is a corporation with its principal office in San Antonio, Texas. Its income and excess profits tax returns for 1943, 1944, 1945, and 1946 were filed with the collector of internal revenue for the first district of Texas. The notice of deficiency involved herein was mailed to petitioner on March 8, 1949. Petitioner filed claims for refund of its income and excess profits taxes for the years 1943, 1944, and 1945. These claims were disallowed.

Petitioner is engaged in the radio broadcasting business and operates Radio Station KABC in San Antonio, Texas. During the period involved herein, petitioner was closely connected through common stock ownership with the Texas State Network of Fort Worth, Texas. Gene L. Cagle, an officer and stockholder of petitioner, was also president of the Texas State Network.

In 1944, Station KABC was operating on a power of 250 watts unlimited time. The officers and stockholders of petitioner were anxious to increase the station's power but had been unable to 1950 U.S. Tax Ct. LEXIS 57">*61 do so because of the unavailability of channels and financial problems. In 1943, a channel had become available which was suitable for 50,000 watt daytime operation and 10,000 watt nighttime operation but 15 T.C. 534">*536 50,000 watt transmitters were not then available to petitioner in the United States on account of wartime allocations and restrictions.

To acquire a high-powered transmitter, petitioner conceived the idea of purchasing a Mexican radio station with a view to moving its equipment to San Antonio for use at KABC. Cagle sent Truett Kimzey, a radio engineer, who was then technical director of the Texas State Network, to search along the border for such a high-powered Mexican station. After investigation, Kimzey reported that he had found such a station at Nuevo Laredo, Mexico. Legal title to Station XENT was then in the hands of a Mexican company doing business as Compania Industrial Universal (hereafter abbreviated C. I. A.). Cagle proceeded in January 1944 to obtain on behalf of petitioner, at a cost of $ 1,000, a six months' option to purchase all the property and equipment of Station XENT from Thelma Yount, who, under a power of attorney from C. I. A., was acting head1950 U.S. Tax Ct. LEXIS 57">*62 of the station. The option covered all the property and equipment of XENT, including its radio transmitter capable of operation at 50,000 watts, together with its spare parts, a 300 kilowatt diesel power plant, together with its associated equipment and spare parts, two 300 foot radio towers, miscellaneous studio equipment, and all leasehold improvements.

On April 22, 1944, petitioner filed an application with the F. C. C. for a permit to change its frequency from 1,450 kilocycles to 680 kilocycles and to increase its power from 250 watts unlimited time to 50,000 watts day and 10,000 watts night, unlimited time. In this application, petitioner stated it was planning to purchase the Mexican Station XENT under terms of an option contract and that certain equipment would be removed from Mexico and used in the improvement of petitioner's facilities at San Antonio, Texas. This application was conditionally granted by the F. C. C. on July 12, 1944, subject to compliance with the requirements of the War Production Board. Petitioner then applied to the War Production Board for a permit to build a small transmitter house and received approval of such construction in November 1944, subject1950 U.S. Tax Ct. LEXIS 57">*63 to the requirement that construction be commenced on or before January 13, 1945, and completed by July 13, 1945, these time limits being subsequently extended.

A commercial radio equipment company and Kimzey prepared the necessary engineering data on the F. C. C. application and selected a new transmitter site. The site was obtained through a 10-year lease beginning January 1, 1945, with an option to renew for 15 years at the same rental. The lease provided that the lessee could cancel the lease at the end of the first year if circumstances prevented it from making the transmitter installation upon the property, and 15 T.C. 534">*537 further provided that the lessee would have the right at any time during the period of the lease when the rent was not in default and on termination of the lease to remove from the premises all buildings, fixtures and equipment which it had placed thereon.

In July 1944, petitioner, on the advice of the F. C. C. engineering department, decided not to use the XENT antenna towers, which were not high enough for effective operation on the proposed new transmitter site at KABC. Prior to this time, petitioner had intended to remove from Mexico the antenna towers1950 U.S. Tax Ct. LEXIS 57">*64 as well as the transmitter, diesel power plant, and all spare parts.

When petitioner first undertook negotiations looking toward the purchase of the XENT equipment, it was uncertain that it could obtain from the San Antonio Public Service Co. sufficient electric current for requirements of its projected increase in transmitting power. When it subsequently ascertained that local power would be available, it determined to use the XENT diesel as a source of auxiliary power.

While petitioner's application to increase its power was pending before the F. C. C., Cagle went to Mexico City and obtained the services of a Mexican attorney to help secure the necessary export licenses for the XENT equipment. While there he learned that a Mexican statute forbade export of heavy equipment out of Mexico but that exceptions were made to the statute in certain circumstances.

Petitioner encountered difficulties in obtaining approval of the Mexican Government for exporting the XENT equipment. In July 1944, it obtained a 2 months' extension of the original option for a consideration of $ 100 and in September it obtained an additional extension of the option until November 25, 1944, on paying $ 200, 1950 U.S. Tax Ct. LEXIS 57">*65 plus a payment of $ 500 a week to the controlling stockholder of C. I. A. for every week that the purchase was thereafter delayed. To expedite obtaining the necessary export permits, petitioner paid, on request of its attorneys who handled the negotiations, $ 35,000 to an agent in Mexico City to cover the agent's expenses and disbursements for legal services in Mexico. This payment was made contingent upon the agent's securing the approval of the Mexican Minister of Communications. On October 10, 1944, this approval was obtained, as set forth in the following letter from the Minister of Communications to the Secretary of Foreign Relations:

I refer to the contents of your kind letters above mentioned, to inform you that this Office does not object that the actual proprietors of Radio Station "XENT" of Nuevo Laredo, Tamps., transfer the equipment with which they are actually working, to the Alamo Broadcasting Company of San Antonio, Texas, in the understanding that rights to the use of frequency 1140 Kc. 1-B Class, will not be transferred but will be at the disposal of this Office, for any action that may become necessary.

15 T.C. 534">*538 On being apprised of this letter, petitioner, on1950 U.S. Tax Ct. LEXIS 57">*66 October 31, 1944, purchased Radio Station XENT for $ 100,000 as per the terms of its original option.

Although petitioner had obtained the approval of the Mexican Department of Communications, it had not secured export permits at the time of its purchase of XENT since it had been advised by its attorneys that the Mexican Government would not issue such permits until petitioner owned the equipment. Petitioner, however, engaged a Texas trucking firm from Laredo, Texas, and sent it across to Nuevo Laredo to load the XENT transmitting equipment. The transmitting equipment was loaded on six trucks but no immediate plans were made to remove the diesel at that time owing to the fact that petitioner's technical experts determined that the transmitting equipment would require two or three months' work in repairing and adapting it to meet the standards of the F. C. C. The diesel was not needed until the transmitter was ready for operation and no housing had been obtained for the diesel at that time.

Shortly thereafter the President of Mexico issued a special decree forbidding the export of the XENT equipment, this decree revoking the previous authorization of the Minister of Communications. 1950 U.S. Tax Ct. LEXIS 57">*67 Petitioner thereupon engaged an attorney from Laredo, Texas, who, after several trips to Mexico City, informed the President of Mexico that petitioner had in good faith paid over $ 100,000 for the XENT equipment and that it planned to take the equipment out of Mexico but that the wave length would remain at the disposal of the Department of Communications. The President finally agreed on March 23, 1945, to permit exportation of the transmitter but not the diesel. A directive was issued to that effect and an export permit was obtained from the Secretary of the Treasury of Mexico. On being informed that the export permit had been obtained, petitioner immediately sent the trucks loaded with the transmitting equipment through the Mexican customs.

The day after the transmitting equipment had been taken across the border, an injunction in a proceeding instituted by the controlling stockholder of C. I. A. was served upon the Mexican customs officials prohibiting the removal of the XENT equipment on the allegation that its sale had been accomplished by fraud. The petition for injunction was dismissed by the Mexican District Court on April 23, 1945, but the decision was appealed and two1950 U.S. Tax Ct. LEXIS 57">*68 other lawsuits were instituted involving the XENT property which petitioner had been unable to remove from Mexico. Petitioner engaged Texas and Mexican lawyers to defend it in these suits and also incurred caretaking expenses in connection with this property. For some time thereafter, petitioner believed that it might still prove possible to secure permission 15 T.C. 534">*539 to remove the diesel from Mexico and use it as a source of auxiliary power. In view of the mounting legal and caretaking expenses, however, it determined to dispose of the equipment for whatever price it could realize. In July 1946 petitioner's attorney sold on behalf of petitioner all of the XENT equipment remaining in Mexico, consisting of the diesel power plant and its related equipment, to the Mexican attorneys who had been handling the above lawsuits for $ 4,125 and an assumption by the purchasers of any liabilities which might be imposed on petitioner as a result of appeal of the injunction which was then pending in the Mexican Supreme Court.

Petitioner subsequently purchased a second-hand 200 kilowatt diesel power unit in 1948 as a source of auxiliary power. In 1949, it sold the former XENT transmitter as1950 U.S. Tax Ct. LEXIS 57">*69 junk for $ 2,000, replacing it with a new transmitter which cost about $ 95,000 at the factory and approximately $ 150,000 when installed.

The total cost to petitioner of all the equipment of Radio Station XENT which it purchased from C. I. A. was $ 196,501.15. Of this total cost, $ 45,240 was allocable to the cost of the diesel power unit and associated equipment which petitioner was unable to remove from Mexico and which it sold in July 1946.

The leasehold improvements which petitioner erected on its new transmitter site had a total cost to petitioner as of May 1, 1946, in the following amounts:

In the deficiency notice, respondent adjusted the rate of depreciation claimed on the leasehold improvements and gave the following explanation of such adjustment:

Leasehold amortization on the building, towers and other antenna equipment was claimed on a basis of 9 months for the year of a remaining primary lease term of 120 months beginning January 1, 1945. However, there is a renewal period of 15 years, that is, an option to renew, in the lease agreement and that period1950 U.S. Tax Ct. LEXIS 57">*70 has been added to the life of the building. The antenna is depreciated over its expected physical life, which is less than the combined periods of the lease. This treatment, inclusion of the renewal period for purposes of amortization, is accorded under section 29.23(a)-10 of Regulations 111.

The proper period of depreciation for the brick building involved herein is 285 months from May 1, 1946. The proper period of depreciation for the following assets of petitioner set forth in the deficiency notice is their economic useful life which is found to be as follows: 15 T.C. 534">*540

OPINION.

The principal question here involves the loss claimed by petitioner on its sale of the diesel power unit. On its 1946 return, petitioner claimed a loss of $ 111,515.62. Its petition reduced the claimed loss to $ 107,715.62 and the brief further reduced it to $ 82,171.26.

Respondent's theory for denying petitioner any loss is that the cost basis of the diesel was not in excess of the amount received for it since, according to respondent, petitioner intended1950 U.S. Tax Ct. LEXIS 57">*71 the diesel for salvage at the time it purchased the total property, including the diesel, of Mexican radio station XENT. Respondent would require petitioner to apply the amount received for the diesel in reduction of the cost basis of the XENT transmitting equipment which was removed from Mexico and placed in operation in petitioner's enlarged station at San Antonio. Alternatively, respondent asserts that if petitioner did sustain a loss, it must be held a capital loss on property which was never used in its trade or business.

The evidence does not sustain respondent's determination that petitioner had no intention of making use of the diesel at the time of purchase. We have no doubt that petitioner was primarily interested in acquiring XENT's high-powered transmitter when it negotiated for the Mexican station. But whatever the principal motivation may have been, the testimony clearly establishes that up to and beyond the date of acquisition petitioner planned to employ the XENT diesel as a source of either primary or auxiliary power at its proposed new site. Even after petitioner learned that permission had been obtained to export the XENT transmitter from Mexico but not the1950 U.S. Tax Ct. LEXIS 57">*72 diesel, it continued to entertain the hope that it would later prove possible to bring out the power unit. It was only in view of the mounting caretaking and legal expenses incurred in connection with it that petitioner eventually decided in 1946 to dispose of the diesel for whatever price it could realize on an immediate sale. This proved to be a total consideration of $ 4,125 paid by the purchasers.

In determining the cost basis of the diesel unit and its spare parts, which were included in the sale price, we have given full weight to the relevant testimony bearing both on petitioner's expenditures for the total XENT equipment and to its method of allocation in attributing a portion of this cost to the diesel power plant. In purchasing the XENT equipment, petitioner paid a lump sum for the station as a whole, no values being assigned to the individual items of equipment 15 T.C. 534">*541 included therein. To arrive at a cost basis for the individual components, petitioner has employed percentages based on its estimates of the fair market values of the various items and has applied these percentages to the total costs incurred for the equipment as a whole. We regard this as an acceptable1950 U.S. Tax Ct. LEXIS 57">*73 method of allocation, but we have made certain adjustments to petitioner's estimates of fair market values in the light of the testimony of the witnesses for both parties.

In regard to the total cost incurred by petitioner in purchasing the XENT equipment, respondent originally contested only an item of $ 35,000. The evidence adduced convinces us that the disputed $ 35,000 was actually expended by petitioner as a part of its costs incident to the acquisition of the Mexican equipment. As a result of the testimony of petitioner's witnesses, however, we have made necessary adjustments in determining the cost basis of the XENT equipment as a whole. Also, in arriving at the proper cost basis for the diesel here in issue, we have made further adjustments in segregating from the total cost those costs which were shown to be related only to the equipment removed from Mexico and similarly have segregated those costs wholly concerned with the diesel and spare parts left in Mexico. Making the requisite changes in the computation of total expenditures and in the percentages used in allocation, we have found that petitioner had a total cost basis of $ 196,501.15 for the XENT equipment, of 1950 U.S. Tax Ct. LEXIS 57">*74 which $ 45,240 is allocable to the cost of the diesel power unit and related spare parts. Upon the sale of this property in Mexico in July 1946, petitioner incurred a loss in the amount of $ 41,115.

The nature of petitioner's loss is governed by our determination that petitioner purchased the diesel with the intent of using it in its new facility. The loss properly falls within the provisions of section 117 (j)¹ as a loss incurred on the sale of property "used in the trade or business". We have previously held that "used in the trade or business" means "devoted to the trade or business" and includes property purchased with a view to its future use in the business even though this purpose is later thwarted by circumstances beyond the taxpayer's control. Carter-Colton Cigar Co., 9 T.C. 219. See also Wilson Line, Inc., 8 T.C. 394; Kittredge v. Commissioner, 88 Fed. (2d) 632; Yellow Cab Co. of Pittsburgh v. Driscoll, 24 F. Supp. 993">24 F. Supp. 993; Independent Brick Co., 11 B. T. A. 862.

1950 U.S. Tax Ct. LEXIS 57">*75 15 T.C. 534">*542 Petitioner here had no control over the decree of the President of Mexico which permitted it to bring out the XENT transmitter but not the diesel. It fully intended to use the diesel as a source of either primary or auxiliary power until it became evident that the costs of keeping a caretaker with the equipment in Mexico and of defending the lawsuits that occurred in respect to the property were rapidly consuming its investment in the property. Since petitioner could not determine when, if ever, permission might be obtained to export the diesel, it decided to dispose of it rather than incur additional expense. Although no depreciation was taken or allowed on the diesel, it nevertheless falls within the classification of property "of a character which is subject to the allowance for depreciation" within the meaning of section 117 (j). See The P. Dougherty Co., 5 T.C. 791, affd., 159 Fed. (2d) 269.

On the issue presented by respondent's determination that petitioner should depreciate the XENT transmitting equipment over a 6-year period instead of the 4-year period claimed by petitioner, we hold that petitioner 1950 U.S. Tax Ct. LEXIS 57">*76 has fully met its burden of proof and has shown to our satisfaction that the economic useful life of this equipment was not in excess of 4 years. ² One of petitioner's radio engineers testified that the XENT transmitter was already obsolete at the date petitioner acquired it. The transmitter required 3 months of overhauling to meet F. C. C. standards and even after such a re-working was still deemed by petitioner so obsolete as to justify its replacement with a new factory built transmitter when wartime restrictions were lifted. Such a replacement was actually made in 1949 and the XENT transmitter was then disposed of for its salvage value as junk.

On the question of whether petitioner may depreciate the building and antenna and ground system which it erected on its leased transmitter site over the primary term of the lease or the shorter of either the total lease period including renewal or the useful life1950 U.S. Tax Ct. LEXIS 57">*77 of the improvements, we uphold respondent's determination. Respondent's Regulations 111, section 29.23 (a)-10, provide in pertinent part as follows:

Sec. 29.23 (a)-10. Rentals. -- * * * The cost borne by a lessee in erecting buildings or making permanent improvements on ground of which he is lessee is 15 T.C. 534">*543 held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment of capital, an annual deduction may be made from gross income of an amount equal to the total cost of such improvements divided by the number of years remaining of the term of lease, and such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term of lease is greater than the probable life of the buildings erected, or of the improvements made, this deduction shall take the form of an allowance for depreciation.

In cases in which the lease contains an unexercised option of renewal, the matter of spreading such depreciation or amortization over the term of the original lease, together with the renewal period or periods, depends upon the facts in the particular case. As a general rule, unless the lease has been renewed1950 U.S. Tax Ct. LEXIS 57">*78 or the facts show with reasonable certainty that the lease will be renewed, the cost or other basis of the lease or the cost of improvements shall be spread only over the number of years the lease has to run, without taking into account any right of renewal. * * * If, in any case, the life of the improvements is less than the number of years the lease has to run, including the renewal period if properly to be considered, the deduction for depreciation with respect to such improvements shall be spread only over such life.

We have previously recognized the validity of the above Regulations. Morris Nachman, 12 T.C. 1204; Standard Tube Co., 6 T.C. 950.. Mertens, in his Law of Federal Income Taxation, has stated the rule as follows:

§ 23.93 -- Where the Lease Provides for Renewal. Where the lease has a definite fixed life, the property reverting to the lessor at its expiration or losing its usefulness at that time, exhaustion will be prorated over the life of the lease. Where, however, the lessee has an option to renew on the same terms, the exhaustion should be spread over the combined period named in the lease and the1950 U.S. Tax Ct. LEXIS 57">*79 renewal period, or the life of the property, whichever is shorter.

This rule is said to be subject to two exceptions: (1) where the renewal option provides that the rental for the renewal period is to be based upon a reappraisal of the property, and (2) where it is apparent that the parties will not exercise the right to renew or where it is apparent that the right to renew will be worthless. In such cases the period of exhaustion is limited to the original term of the lease. Here, the lease provides that petitioner as lessee has the right at any time to remove from the premises all buildings and fixtures which it has placed thereon, provided the rent is not then in default. It also provides that at the termination of the lease petitioner has a similar right to remove all buildings and fixtures from the property. It is thus apparent that the property will not revert to the lessor at the expiration of the original term as was the case in 1620 Broadway Corp., 36 B. T. A. 149.

The lease also provides for renewal at the same rental so that no question arises of the renewal option requiring a reappraisal of the property as in Bonwit-Teller & Co., 53 Fed. (2d) 381,1950 U.S. Tax Ct. LEXIS 57">*80 cert. denied, 284 U.S. 690">284 U.S. 690. There is no evidence that the parties to the lease had 15 T.C. 534">*544 definitely determined not to renew the lease in the taxable year or that the renewal option would be worthless to petitioner at the expiration of the original term. When petitioner expended on improvements on the leasehold property an aggregate of $ 119,858.29 as of the taxable year here in issue, it appears unlikely that it would abandon this investment at the expiration of the original term of the lease, especially since the lease can be renewed without increase in rent. We have taken into account the testimony of petitioner's officers who said that they were uncertain at the time of the execution of the lease whether they would renew it in the light of possible future competition from FM and television stations. We regard this testimony, however, as an expression only of the threat of competition, which is present to a greater or lesser extent in all business activity and do not regard it as an expression by petitioner that it had decided not to renew the lease at the expiration of its present term.

Under the facts here present, we hold that the leasehold improvements1950 U.S. Tax Ct. LEXIS 57">*81 should be depreciated over the combined period of the original term of the lease plus the renewal period or the useful life of the improvements, whichever is shorter. See East Kauai Water Co., Ltd., 11 T.C. 1014. Respondent's determination in this respect is therefore approved.

Decision will be entered under Rule 50.