22 T.C. 737">*737 Respondent determined deficiencies in income taxes for the taxable years ended March 31, 1948, and March 31, 1949, of $ 95,851.70 and $ 31,240.17, respectively.

22 T.C. 737">*738 Respondent made adjustments for the year ended March 31, 1948, as follows: ¹

1954 U.S. Tax Ct. LEXIS 153">*156 Respondent also disallowed capital gains treatment in the computation of tax on income derived from petitioner's sale of any of its buildings. Except for the disallowance and for adjustment (d), petitioner assigns error to the foregoing.

For the year ended March 31, 1949, respondent made adjustments as follows:

1954 U.S. Tax Ct. LEXIS 153">*157 Respondent also disallowed capital gains treatment in the computation of tax on income derived from petitioner's sale of any of its buildings. Except for that disallowance, petitioner assigns error to the foregoing.

By amended answer filed at the hearing, respondent asserted that the deficiencies for the 1948 and 1949 fiscal years should be increased by $ 1,258.75 and $ 5,684.16, respectively, giving as his reasons therefor the following:

(a) Respondent alleges that he erred in allowing as a deduction in the income tax return of the petitioner for the year ended March 31, 1948, interest claimed on land notes in the amount of $ 3,312.49.

(b) Respondent alleges that he erred in allowing as a deduction in the income tax return of petitioner for the year ended March 31, 1949, interest claimed on building notes in the amount of $ 14,958.31.

Petitioner filed an appropriate reply denying respondent's allegations.

FINDINGS OF FACT.

Petitioner is a corporation chartered under the laws of Texas and located at Mineral Wells, Texas. The tax returns for the periods in question were filed with the collector for the second district of Texas.

Prior to the outbreak of World War II, as a step 1954 U.S. Tax Ct. LEXIS 153">*158 in the preparedness program then being initiated by the United States, the United States Army became interested in acquiring possession of several thousand acres of land in Palo Pinto County, Texas, in the vicinity of the city of Mineral Wells, Texas, to be used as an induction and training center. It was not desired to purchase such lands, but rather to lease them. The lands in question were owned by a number of different landowners. The War Department wanted to deal with only one lessor and refused to lease the lands piecemeal. In order to obtain the economic benefits of having a large Army camp located nearby, the city of Mineral Wells, sometimes called the city herein, undertook to secure assignable leases to all of the acreage designated by the War Department and to sublease all such lands to the United States under one master lease.

Accordingly, the city proceeded to acquire leases on the desired acreage, under which the city became primarily liable for all of the 22 T.C. 737">*740 burdens imposed on the lessee under such leases. Each lease, among other things, contained the following provisions:

4. The City shall have the right to assign this lease to the United States of America1954 U.S. Tax Ct. LEXIS 153">*159 (hereinafter called Government,) and to sublet the demised premises for a similar purpose, but will not permit the use of said premises by anyone other than the Government.

* * * *

7. The City shall have the right, during the existence of this lease, to permit the Government to make alterations, clear brush, fell trees, attach fixtures, and erect additions, structures, or signs, in or upon the premises hereby leased, which fixtures, additions, or structures so placed in or upon or attached to the said premises shall be and remain the property of the Government and may be removed therefrom by the Government prior to the termination of this lease, and the City shall require the Government, before the expiration of this lease or the expiration of any renewal thereof, to restore the premises to the same condition as that existing at the time of entering upon the same under this lease, reasonable and ordinary wear and tear and damages by the elements or by circumstances over which the Government has no control, excepted. [Emphasis added.]

8. As a part of the consideration herefor, the City is given the option, at any time during the term of this lease or of any renewal thereof, 1954 U.S. Tax Ct. LEXIS 153">*160 to purchase the lands and premises above described at the price of * * *.

When the required acreage had been assembled by the city under a number of individual leases, all of said acreage was subleased by it to the United States under a single master lease to take effect November 1, 1940, which, among other things, contained the following provisions:

8. The Government shall have the right, during the existence of this lease, to make alterations, attach fixtures, and erect additions, structures, or signs, in or upon the premises hereby leased (provided such alterations, additions, structures, or signs shall not be detrimental to or inconsistent with the rights granted to other tenants on the property or in the building in which said premises are located); which fixtures, additions, or structures so placed in or upon or attached to the said premises shall be and remain the property of the Government and may be removed therefrom by the Government prior to the termination of this lease, and the Government, if required by the Lessor, shall, before the expiration of this lease or renewal thereof, restore the premises to the same condition as that existing at the time of entering upon 1954 U.S. Tax Ct. LEXIS 153">*161 the same under this lease, reasonable and ordinary wear and tear and damages by the elements or by circumstances over which the Government has no control, excepted: Provided, however, that if the Lessor requires such restoration, the Lessor shall give written notice thereof to the Government sixty days before the termination of the lease.

Provided further that any restoration shall be based on and confined to the structures, fixtures, and appurtenances covered by the condition survey. Provided further that in the event of termination of this lease, the Government shall be allowed four months from and after July 1 of any year in which to remove or otherwise dispose of the improvements, both above ground and underground, that have been placed thereon by the Government. [Emphasis added.]

Under the foregoing lease, the United States took possession of the Camp Wolters premises and built an extensive and expensive induction 22 T.C. 737">*741 and training center thereon, consisting of many barracks, power plant, hospital facilities, etc. The Government further laid extensive concrete paving, installed water and gas pipelines, used portions of the premises for a firing range, and otherwise so1954 U.S. Tax Ct. LEXIS 153">*162 altered the premises that it would have cost a large sum of money to restore the premises to anything like their original condition as required by the lease.

Early in 1946, it became apparent that the Government intended to deactivate Camp Wolters and was contemplating dismantling and disposing of the improvements owned and located on the Camp Wolters premises. At this point, the mayor of Mineral Wells, a lawyer, became concerned about the potentially large liability of the city under the restoration clause of the leases to which it was a party, in the event the United States either was dilatory about settling with the underlying landowners (grantors in the original leases wherein the city of Mineral Wells was lessee), or was unable to come to satisfactory terms with such landowners concerning the restoration of their premises to the original condition, or did not adequately compensate them for failure to effect such restoration. The mayor was also concerned over the financial setback that the city probably would suffer when Camp Wolters was deactivated. He discussed the possible ways of solving these twin difficulties with H. E. Dennis, a director of the Mineral Wells Chamber 1954 U.S. Tax Ct. LEXIS 153">*163 of Commerce and chairman of its Industrial Committee. A plan was formulated by Dennis to prevent the demolition of the Camp Wolters improvements and conserve them for industrial use through the purchase of the Camp Wolters land and facilities by private citizens interested in the welfare of the city.

The essence of the plan was as follows: Dennis agreed to attempt to interest several individuals in putting up the money to purchase the Camp Wolters lands, provided that the city would assign to him and any other individuals he might be able to interest in the venture, the city's option rights to purchase the leased premises from the several original lessors. It was contemplated that, if and when Dennis and his associates acquired the Camp Wolters lands and the restoration rights incident thereto, they would have preferential rights to acquire the Camp Wolters buildings and improvements and be in a position to save them from demolition and use them as a means of attracting light industries to the Mineral Wells Camp Wolters area. As consideration for the assignment of the city's option-to-purchase rights, Dennis and his associates agreed, for their part, to save the city harmless from1954 U.S. Tax Ct. LEXIS 153">*164 any and all restoration claims that might be asserted against it by the original landowners.

Pursuant to this understanding, the option rights were assigned by the city in a resolution dated April 17, 1946, to Ernest Mims, as nominee for Dennis and any others he might interest in the venture. 22 T.C. 737">*742 On June 18, 1946, the city officials passed a resolution relating to the purchase of the buildings and improvements on Camp Wolters, which provided in part as follows:

WHEREAS, certain valuable improvements have been constructed on the leased lands by the Government and negotiations are now in progress for the sale of such improvements and the City desires to authorize Mr. Ernest Mims, a citizen of Mineral Wells, Texas, to represent the City in such negotiations. NOW, THEREFORE, be it resolved by the Board of Commissioners of the City of Mineral Wells, Texas, that Mr. ERNEST MIMS is hereby authorized and empowered to negotiate with representatives of the United States for the transfer of improvements that have been constructed on lands covered by Lease No. W. 58-qm-540 to himself, or his nominee, in lieu of restoration, upon such terms as may be agreed upon by him and the representative1954 U.S. Tax Ct. LEXIS 153">*165 of the United States, provided that no obligation is incurred by the City and provided further that there is procured from the owner or owners of the tract of land covered by said lease a full and complete release to the City and the Government of any and all damages resulting from the use of such lands by the Government and a release from the payment of future RENTALS, and the City hereby ratifies the actions of Mr. Ernest Mims that may be taken in this connection.

Dennis succeeded in inducing some 18 or 19 other individuals to each put up the sum of $ 10,000 in cash and join him in his attempt to purchase the Camp Wolters land and improvements. (Later additional persons were permitted to participate in the venture and the number of participants, including Dennis, eventually numbered 89 from whom approximately $ 356,000 was raised. They will hereinafter be referred to as the Dennis Group.) With a portion of the funds thus raised, Ernest Mims, acting as agent for the Dennis Group, exercised the options to buy some 3,000 or more acres of land on which the principal improvements made by the Government at Camp Wolters were located, for an aggregate consideration of approximately $ 1954 U.S. Tax Ct. LEXIS 153">*166 151,000 (the total of the prices set in the options). In each instance, deeds were taken in the name of Mims. Each deed included the following provision relating to the landowners' restoration claims:

Including in this conveyance all claims or demands which I * * * [grantor] * * * may have or be entitled to against the United States Government or the City of Mineral Wells by reason of the construction and maintenance of army facilities on the property here conveyed, for damages, restoration or otherwise.

Of the approximately $ 151,000 paid, $ 50,000 was paid for the transfer of the restoration rights, which sum constituted the Dennis Group's basis for those rights.

Through Mims, the group also concluded an agreement (referred to by them as a contract) on March 21, 1947, with the United States, represented in the transaction by General Henry Hutchins, then Colonel Hutchins of the United States Army Corps of Engineers. The contract gave them the right to acquire all of the physical assets 22 T.C. 737">*743 owned by the United States and located on or affixed to the Camp Wolters premises for an agreed consideration of $ 412,500 in cash plus the relinquishment to the United States of all 1954 U.S. Tax Ct. LEXIS 153">*167 restoration claims then held in Mims' name.

All of the Dennis Group's assets, rights, and privileges were held in common, each member's share thereof being in proportion to the member's cash contribution to the $ 356,000 fund raised from the group.

Petitioner corporation was chartered on April 3, 1947, with authorized capital stock consisting of 1,424 shares of common stock of the face or par value of $ 10 per share, all of which was subscribed for and fully paid in in cash ($ 14,240) by the Dennis Group. At the same time, there was paid into the treasury of the corporation by the Dennis Group, as paid-in surplus, the further sum of approximately $ 190,000 in cash, so that petitioner corporation, when first organized, began business with a cash capital of $ 204,240. This $ 204,240 was the balance remaining of the $ 356,000 contributed by the 89 members of the Dennis Group after approximately $ 151,000 thereof was paid for the land and the restoration rights bought by their agent, Mims.

On April 7, 1947, the Camp Wolters lands (but no restoration rights) were conveyed to petitioner by Mims, as nominee for the Dennis Group, in consideration of a series of 89 nonnegotiable unsecured1954 U.S. Tax Ct. LEXIS 153">*168 installment notes (hereinafter referred to as land notes) totaling $ 151,336.88. On the same day, namely April 7, 1947, Mims, as nominee for the Dennis Group, also executed an assignment to petitioner of (a) the contract for the purchase of the Camp Wolters improvements and (b) the restoration rights above referred to. As consideration for the assignment, petitioner paid nominee Mims $ 1,424 in cash and executed a series of 89 nonnegotiable unsecured installment notes (hereinafter referred to as building notes) in the total face amount of $ 411,080.20. The gain realized by the Dennis Group on the transaction was at least equal to the $ 1,424 paid to Mims. The assignment reads, in pertinent part, as follows:

WHEREAS, on or about the 21st day of March, 1947, the undersigned, Ernest M. Mims, made and entered into a contract with the Government of the U. S. acting through the duly authorized officers of the Corps of Engineers U. S. Army for the purchase of certain buildings, improvements, fixtures, attachments and personal property located on and within the Camp Wolters Military Reservation; in connection with which agreement the said Ernest M. Mims agreed to pay the sum of $ 412,500.001954 U.S. Tax Ct. LEXIS 153">*169 in cash to said Government and also agreed to waive all claims for restoration or other damages considered to be due him as the owner of the fee title to the lands upon which said military reservation was situated; said preliminary contract being evidenced by telegram dated March 18, 1947, to the undersigned from the Division Engineer, Southwestern Division Corps 22 T.C. 737">*744 of Engineers, Dallas, Texas, and by proposal letter of the undersigned to said Division Engineer dated March 20, 1947, and by letter from said Division Engineer to the undersigned dated March 21st, 1947, reference being made to said instruments for full description.

WHEREAS, Camp Wolters Enterprises, Inc., a Texas Corporation, is desirous of acquiring the aforementioned contract and the contract rights of the said Ernest M. Mims with reference to said purchase.

NOW, THEREFORE, I, Ernest M. Mims, of Palo Pinto County, Texas, in consideration of the sum of Ten ($ 10.00) Dollars to me in hand paid by said Corporation, and other considerations as hereinafter set out do hereby sell, transfer, assign and set over to the said Camp Wolters Enterprises, Inc., a Corporation, the above mentioned contract and all of my claims1954 U.S. Tax Ct. LEXIS 153">*170 and rights thereunder; and I hereby authorize the said Corporation to proceed either in the name of said Corporation or in my name to final consummation of said purchase and to acquire title either in my name or in the name of the Corporation from the U. S. Government the title to said properties; and it is hereby understood and agreed that in the event the representatives of the United States Government require that the bill of sale or other form of conveyance executed by them be made to me in my name, that I will take such title for the benefit of the Corporation and will forthwith execute such instrument or instruments as may be necessary or appropriate to vest record title to any asset or assets so conveyed to me in the Corporation.

In consideration of this assignment of my contract rights, the Corporation agrees to pay me the sum of $ 1424.00 in cash and to execute and deliver to me, or to my nominees, its nonnegotiable, unsecured promissory notes in the number and principal amounts as follows: 26 notes in the principal sum of $ 11,547.56 each; 6 notes in the principal sum of $ 5,774.28 each; 7 notes in the principal sum of $ 2,886.79 each; 6 notes in the principal sum of $ 2,309.191954 U.S. Tax Ct. LEXIS 153">*171 each; 1 note in the principal sum of $ 1732.01; 18 notes in the principal sum of $ 1154.37; 9 notes in the principal sum of $ 1154.38 each; 16 notes in the principal sum of $ 578.20 ² each; all of said notes dated April 7, 1947, payable to the undersigned, or his nominees, in five equal annual installments, the first installment due five years after date and additional installments six, seven, eight and nine years after date respectively, and bearing interest at the rate of four (4%) per cent per annum after maturity only, the interest payable annually, and all past due principal and interest to bear interest at the rate of six (6%) percent per annum. Said notes shall contain the usual provision for accelerated maturity and attorneys fees and the privilege of payment of any amount of principal at any time after date; and shall contain the further provision that each is one of a series of 89 notes of the same date and that no payment can be required on any one note except on a pro-rata basis out of property or funds of the Corporation available for payment on the entire series of notes.

As further consideration the said Corporation agrees that it will comply with the terms of the1954 U.S. Tax Ct. LEXIS 153">*172 contract first above referred to sand [sic] will pay to the U. S. Government the sum of $ 412,500.00 in cash upon execution of the assignment and sales contract by the Government by which the title to the buildings and other properties above described pass to the Corporation, or to me, which shall be for its benefit, and the Corporation assumes the obligation of the undersigned to pay said sum of money to the Government for such transfer and delivery of the properties.

22 T.C. 737">*745 Each of the aforementioned 89 land notes and 89 building notes bore interest at the rate of 4 per cent per annum and included the following provisions:

The principal of this note is payable in five equal annual installments, the first due and payable five years after date, and a like installment six, seven, eight and nine years after date, respectively; the maker having the privilege of paying all or any part hereof at any time after date. It is understood1954 U.S. Tax Ct. LEXIS 153">*173 that this note is one of a series of 89 notes this day executed by the corporation; and no payment hereon shall be required except on a pro-rata basis out of property or funds available for payment on the entire series of notes.

* * * *

It is understood and agreed that the undersigned Corporation will probably hereafter become indebted to the Republic National Bank of Dallas, or other parties; such loans to be secured by liens on physical properties of the corporation; and no payment shall be made on this note unless and until the corporation has completely liquidated said loans, and any renewals, extensions, or refinancing thereof.

At petitioner's first stockholders' meeting, which was held on July 18, 1947, each of the 89 members of the Dennis Group was given a part of the following, such part determined on the basis of the member's pro rata cash contribution to the $ 356,000 raised by the Dennis Group:

(a) The 1,424 shares of common stock issued by petitioner.

(b) The $ 1,424 in cash paid by petitioner to Mims (as nominee for the Dennis Group) for the assignment of the "contract" with the United States and the restoration rights.

(c) The 89 serial building notes (totaling $ 411,080.20) 1954 U.S. Tax Ct. LEXIS 153">*174 issued as additional consideration for the "contract" and restoration rights.

(d) The 89 serial land notes (totaling $ 151,336.88). Each of the 89 notes in the two series was dated April 8, 1947, and made out to a member of the Dennis Group in an amount determined by applying the same percentage to the total face value of the series as the percentage of that member's contribution to the aforementioned $ 356,000. During the 1948 fiscal year petitioner paid, and took a deduction on its return for, $ 3,312.49 in interest on the land notes; during the 1949 fiscal year it paid, and took a deduction for, $ 14,958.31 in interest on the building notes. By June 1948, the petitioner had fully redeemed the series of building notes.

In connection with the purchase of the buildings from the Government, petitioner borrowed from the Republic National Bank in Dallas, Texas, $ 325,000. The formal application for the loan was made on April 14, 1947. The initial discussion between the bank and the individuals representing petitioner was held 2 or 3 weeks before the date of the application to the bank for the loan. The 22 T.C. 737">*746 application stated the purpose for which petitioner, Camp Wolters 1954 U.S. Tax Ct. LEXIS 153">*175 Enterprises, Inc., was formed in the following language:

Camp Wolters Enterprises, Inc., of Mineral Wells, Texas, a Texas corporation, with a paid in capital and surplus of $ 356,000, was formed for the express purpose of acquiring Camp Wolters with a view of establishing new industries in Mineral Wells, Texas, in the buildings at Camp Wolters suitable for such purposes, and for the wrecking and sale and salvage of those properties purchased. The corporation has ninety-two stockholders, twenty directors and an executive committee of nine.

The transfer of the physical improvements located at Camp Wolters took the form of a "Supplemental Agreement for Cancellation of Lease, and Transfer of Improvements" executed April 15, 1947. Under this agreement Mims was substituted for the city of Mineral Wells as lessor, and the Government relinquished, transferred, and delivered to Mims title to the improvements in consideration of the payment to the Government of the sum of $ 412,500 in cash (part of which was the money borrowed from the Republic National Bank) and waiver of all restoration rights. The city of Mineral Wells was required to join in the execution of the agreement because it was1954 U.S. Tax Ct. LEXIS 153">*176 the original lessor under the original leasing agreement.

On its books and records, petitioner entered as the cost to it of the Camp Wolters lands the sum of $ 151,340.80, ³ and recorded as the cost to it of the buildings and improvements acquired from the Government the sum of $ 827,354.20, which it apportioned ratably over such assets. This $ 827,354.20 includes $ 412,500 paid in cash to the Government, the $ 1,424 paid to nominee Mims, the $ 411,080.20 issue of building notes and an unidentified $ 2,350 not here in issue. In the notice of deficiency from which this appeal was taken, respondent reduced the aggregate basis for the buildings and improvements by $ 411,080.20 (the amount of the building notes) to $ 416,274. There is no controversy between the parties as to the manner in which the total consideration paid for the buildings and improvements is to be apportioned as between specific assets. The dispute between them is confined solely to the contention of petitioner on the one hand that such aggregate basis totals $ 827,354.20, and the contention of the respondent on the other hand, that such aggregate basis does not exceed the sum of $ 416,274.

1954 U.S. Tax Ct. LEXIS 153">*177 Petitioner's amended return for the fiscal year ended March 31, 1948, shows the following sources of gross income: 22 T.C. 737">*747

Petitioner's return for the fiscal year ended March 31, 1949, shows the following sources of gross income:

1954 U.S. Tax Ct. LEXIS 153">*178 22 T.C. 737">*748 Petitioner held the improved areas of Camp Wolters until 1951, when condemnation proceedings were instituted and it was taken over by the United States Air Force. During the period petitioner held the property it rented about 35 to 40 per cent of the square footage of the buildings. Of approximately 200 barracks buildings, petitioner sold about 130 or 140 and rented 60 or 70. A number of other buildings were also sold, some as a fire prevention measure. The buildings acquired from Camp Wolters, except those actually rented by the petitioner at one time or another, were held by petitioner for sale.

The Government began organizing and building the Camp Wolters Training Camp in 1940. Petitioner purchased the used property in 1947. The remaining useful life of the Camp Wolters buildings from and after the date acquired by petitioner was 10 years. The remaining useful life of all other depreciable Camp Wolters improvements and equipment from and after the date acquired by petitioner was as determined by respondent in his deficiency notice. Petitioner has introduced no evidence to the contrary.

OPINION.

1. The major issue involves determining the correct basis of the buildings1954 U.S. Tax Ct. LEXIS 153">*179 and improvements acquired from the Government by the petitioner. Respondent argues that their basis is composed only of the following:

Petitioner, on the other hand, contends that included in that basis is an additional $ 411,080.20 given the Dennis Group (through Mims) in building notes as further consideration for the assignment of the contract and restoration rights and that the correct total basis is, therefore, $ 827,354.20.

The Government had leased land for Camp Wolters with a clause requiring it to restore the land to its prior condition. It would have cost the Government an undetermined sum to have restored that land. The Dennis Group, composed of 89 members and acting through nominee Mims, first acquired the leased land along with the restoration rights from the original owners for approximately $ 151,000. On March 21, 1947, again acting through Mims, they concluded a contract with the Government under which they were to1954 U.S. Tax Ct. LEXIS 153">*180 acquire the Camp Wolters buildings and improvements, constructed by the Government, 22 T.C. 737">*749 in return for $ 412,500 in cash and the release of all restoration rights. The interest of each member of the group in the assets, rights, and privileges of the group was in proportion to that member's cash contribution to the group fund. Petitioner was chartered on April 3, 1947, with 1,424 shares of fully paid common stock, plus paid-in capital surplus -- the money for both the stock and surplus coming from the group fund. All of petitioner's stock was issued to members of the Dennis Group in proportion to each member's cash contribution to the aforementioned fund. On April 7, 1947, Mims (acting for the Dennis Group) conveyed the Camp Wolters land to petitioner and assigned the contract for the buildings and improvements, plus the restoration rights, to petitioner. In return therefor petitioner gave the following consideration:

A. For the land:

89 nonnegotiable, unsecured installment notes (land notes) in the total face amount of $ 151,336.88 -- each note made out to a member of the Dennis group in proportion to that member's contribution to the group fund.