23 T.C. 665">*665 The respondent determined a deficiency in the amount of $ 31,710.06 in the income tax of petitioner for its fiscal year ended July 31, 1948. However, the sole question for decision relates to a deduction for an alleged loss sustained during the fiscal year ended July 31, 1950, which is pertinent here only as a result of the carry-back provisions of the law. The deduction is sought by reason of the demolition of a building by petitioner's lessee pursuant to an agreement between them.

FINDINGS OF FACT.

Some of the facts have been stipulated. The stipulation and the exhibits attached thereto are incorporated herein by this reference.

1955 U.S. Tax Ct. LEXIS 264">*266 Petitioner is a California corporation with its principal office in San Francisco. It filed its corporation income tax returns for its fiscal years ended July 31, 1948, 1949, and 1950 with the collector of internal revenue for the first district of California. It keeps its books and files its returns on the accrual basis.

Petitioner owns and operates theatres and other businesses. On or about March 10, 1946, petitioner purchased the fee interest in the so-called Tivoli property in San Francisco, which consisted of two adjacent, but separate, buildings. One of the buildings was known as the Tivoli Theatre Building, and the other as the Tivoli Office Building. The theatre building was constructed in 1911. It had once 23 T.C. 665">*666 been an opera house and a famous theatrical landmark in San Francisco. When petitioner acquired the property in 1946 that building had a remaining useful life of 20 years. During the period from February 10, 1946, to March 2, 1946, the theatre building was used for legitimate stage performances. From March 30, 1946, to June 2, 1947, it was used for the presentation of motion pictures. By 1947, the district in which the theatre was located was no longer1955 U.S. Tax Ct. LEXIS 264">*267 a desirable theatrical district; there were many bars in the area, and it had become a "tenderloin" district. Its location was away from the main theatre and entertainment districts. From June 2, 1947, until October 6, 1949, the theatre was closed except for one 3-day period in 1948 when it was rented for an outside theatrical showing. Petitioner had closed the theatre in 1947 because it was losing money on the operation and found it economically impractical to keep it running. Petitioner thereafter had no intention of using the property as a theatre again.

The Tivoli Office Building from the date of its acquisition by petitioner has been used as an office building, and a portion of the ground floor has been occupied by a cocktail lounge and bar.

Shortly prior to October 6, 1949, petitioner had negotiations with representatives of a prospective lessee of the theatre building, looking toward the conversion of the building for garage and parking purposes. As a result of these negotiations, petitioner, on October 6, 1949, as lessor, and Harry Morofsky, as lessee, executed a lease of the theatre building for a term of 25 years and an aggregate rental of $ 420,000; in addition, the1955 U.S. Tax Ct. LEXIS 264">*268 lessee agreed to pay all real estate taxes and charges levied against the property. Although the term of the lease was to start May 1, 1950, the lessee was allowed to enter immediately for the purpose of beginning the necessary alterations. The specified rental was to be paid at the rate of $ 1,250 per month for the first 10 years, and $ 1,500 per month for the last 15 years. The lease specifically limited the use of the property for the purpose of conducting the following business:

A garage and storage and offices for the use of the Lessee in connection with garage operations, or concessions under-let hereunder to be used with office space, as hereinafter provided.

In the lease Morofsky, the lessee, specifically undertook to remodel the building so as to make it suitable for conducting a garage and car storage business with such offices as might be necessary for the conduct of the business. For this purpose petitioner, as lessor, granted the lessee authority to construct as many floors as the lessee might find necesary but the lessee was obligated as a minimum to construct a basement floor and a first and second floor above that.

Under the lease the lessee was required to submit1955 U.S. Tax Ct. LEXIS 264">*269 to petitioner for its approval plans for the remodeling of the building. In the latter part of 1949, preliminary and final plans for a 5-story garage were 23 T.C. 665">*667 prepared by the lessee at an expense of approximately $ 4,000, and were approved by petitioner. It was anticipated by the lessee that the cost of the remodeling would be between $ 45,000 and $ 50,000.

At the time the lease was entered into on October 6, 1949, neither the petitioner nor the lessee had any intention of demolishing the theatre building.

In November 1949, the lessee submitted to the proper authorities of the City and County of San Francisco his plans for remodeling the Tivoli Theatre Building so as to convert the building to a 5-story parking garage. The city and county authorities declined to approve the plans as submitted and insisted upon costly revisions involving a substantial increase in the thickness of the walls by the addition of concrete, the inclusion of additional supporting members, and changes in the plans for the ramps, all of such a nature as to reduce substantially the amount and convenient usability of floor space for parking purposes and to render it economically unfeasible to use the1955 U.S. Tax Ct. LEXIS 264">*270 theatre building for the purpose of a parking garage.

The estimated cost of the remodeling, if performed in accordance with the plans required by the City and County of San Francisco, was in excess of $ 125,000. It was not economically feasible to incur such cost, and the plan for remodeling the theatre building for purposes of a parking and storage garage therefore had to be abandoned.

After the defeat of plan for remodeling the building, the lessee consulted another engineer who advised that the theatre building be demolished and that the area thus released be used for surface parking.

On April 24, 1950, the lessor and lessee entered into a letter agreement looking toward the purchase of the entire Tivoli property by the lessee, and providing in any event for permission to the lessee to demolish the theatre building. That agreement reads in part as follows:

1. The sale price is to be $ 350,000.00.

2. The sum of $ 25,000.00 is to accompany the sale agreement, in consideration for which the Purchaser shall have an option to conclude the deal within one (1) year.

* * * *

5. In the event the Purchaser does not conclude the purchase of the property within one (1) year, the $ 25,000.001955 U.S. Tax Ct. LEXIS 264">*271 mentioned under #2 above shall remain with the Seller as additional lease deposit under that certain lease dated the 6th day of October 1949, between Blumenfeld Enterprises, Inc., as lessors, and Harry Morofsky, as lessee, and shall be deducted from rentals at the end of the lease term. In consideration of this additional lease deposit, the lessors grant to the lessee permission to demolish the rear portion of the premises [theatre building] for the purposes conforming to said lease and further provided the lessee shall furnish to the lessor modified plans showing the proposed basement and ground floor development and shall secure from the lessors written permission for said development. All of the cost of demolishing and improving shall be at the lessee's sole cost and expense.

23 T.C. 665">*668 6. The Seller, as the lessor, expressly retains all of their rights under the aforementioned lease dated October 6, 1949, and makes no waiver of any of the conditions of said lease. * * *

7. In the event the Purchaser exercises his option to purchase within the one (1) year period, then he shall be given credit by the Seller for the net gross profit from the operation of all of the premises in 1955 U.S. Tax Ct. LEXIS 264">*272 the interim period. The Seller shall deduct from said rentals, taxes, insurance, utility costs and all other legitimate items of expense.

The letter agreement also contained a statement that it sets forth only the "basic agreement" and that both parties would thereafter execute a "formal sales agreement." The $ 25,000 payment, referred to in paragraph 2 above, was in fact made on May 1, 1950. When the letter agreement of April 24, 1950, was entered into, the lessee had not determined whether he would exercise the option to purchase which was given therein.

The "formal" agreement contemplated by the parties was executed on February 23, 1951. By its terms the time for exercise of the lessee's option was extended to expire on October 1, 1951, and the lessee was expressly required, notwithstanding anything in the lease of October 6, 1949, to the contrary, to clear the portion of the property formerly occupied by the theatre. The lessee was also expressly authorized to use the "premises and area for parking lot purposes by erecting a ramp for ingress and egress therefrom through the old entrance to the Tivoli Theatre." Pursuant to permission granted by the lessor in paragraph 5 of the1955 U.S. Tax Ct. LEXIS 264">*273 letter agreement of April 24, 1950, the lessee had already demolished the theatre building on or about May 1, 1950, prior to the end of petitioner's fiscal year ended July 31, 1950.

There was at no time any understanding or plan, either by the petitioner or the lessee, to construct a new building on the theatre property, and no building has ever been constructed thereon.

On September 27, 1951, Harry Morofsky exercised the option granted by the agreements of April 24, 1950, and February 23, 1951, to purchase the Tivoli property, and on November 7, 1951, assigned his rights thereunder to the Hertz Shoe Clinic, Inc., a corporation. That corporation is now the owner of the Tivoli property.

Petitioner has claimed in its returns, and respondent has allowed, depreciation on the Tivoli Theatre and Office Buildings on the basis of a remaining life of 20 years from the date of its acquisition of the fee interest therein (March 10, 1946).

In its income tax return for its fiscal year ended July 31, 1950, petitioner claimed as a deduction an abandonment loss on the demolition of the Tivoli Theatre Building in the amount of $ 154,226.34 ¹ representing the undepreciated balance of the cost of 1955 U.S. Tax Ct. LEXIS 264">*274 that building, as shown on petitioner's books, resulting in a net operating loss of 23 T.C. 665">*669 $ 82,818.32 for its fiscal year ended July 31, 1950. Petitioner claimed a net operating loss carry-back of $ 82,818.32 from its fiscal year ended July 31, 1950, to its fiscal year ended July 31, 1948, and made application for a tentative carry-back adjustment under section 3780 of the Internal Revenue Code of 1939. A tentative allowance was made to petitioner under this section in the amount of $ 30,803.55.

In his determination of petitioner's deficiency for the fiscal year ended July 31, 1950, respondent has disallowed the deduction claimed upon the demolition of the Tivoli Theatre Building, and in his notice of deficiency to petitioner for its fiscal year ended July 31, 1948, respondent has not allowed the net operating loss deduction claimed by petitioner.

Respondent1955 U.S. Tax Ct. LEXIS 264">*275 on or about June 27, 1952, mailed to petitioner by registered mail the notice of deficiency covering its fiscal years ended July 31, 1949 and 1950. Petitioner did not file a petition with this Court for a redetermination of the deficiencies set forth in the notice. Petitioner paid the deficiencies and filed claims for refund.

OPINION.

The sole question for decision is whether the demolition of the Tivoli Theatre Building on or about May 1, 1950, resulted in a deductible loss to petitioner. There is no serious dispute between the parties as to the underlying facts.

Petitioner acquired the fee interest in the property in March 1946. The building then had a remaining useful life of 20 years. After an attempt to use the building for the presentation first of legitimate performances and then of motion pictures, petitioner found that it was losing money. The district in which the property was located had deteriorated, and petitioner in 1947 closed the theatre without any intention of reopening it thereafter. On October 6, 1949, petitioner entered into an agreement in which it undertook to lease the property for a 25-year term beginning May 1, 1950, at an aggregate rental of $ 420,000, 1955 U.S. Tax Ct. LEXIS 264">*276 payable in specified monthly installments; in addition, the lessee was to pay real estate taxes and other charges levied against the property. The lease agreement contemplated that the lessee would remodel the building for use as a multi-story parking garage. However, the plans for conversion of the building were thereafter found unacceptable by the city and county authorities who insisted upon modifications that were so costly as to require that the entire project be abandoned. The lessee was then advised by an engineer that the building be demolished and the space thus released be used for surface parking.

Such was the unhappy situation in which the lessee found himself in April 1950, prior to commencement of the term of the lease, and it 23 T.C. 665">*670 was in the light of that situation that the petitioner and the lessee executed the letter agreement of April 24, 1950. That agreement provided for an option, upon payment of $ 25,000, to purchase the entire Tivoli property for $ 350,000, the option to be exercised within a specified time. The agreement also authorized the lessee, upon payment of the $ 25,000 (which could be applied against the lessee's obligation for rent in the 1955 U.S. Tax Ct. LEXIS 264">*277 event that the option were not exercised) to demolish the theatre building. Petitioner expressly retained all rights under the lease agreement of October 6, 1949.

It was pursuant to permission thus granted in the letter agreement of April 24, 1950, that the lessee, on or about May 1, 1950 (at the beginning of the term of his 25-year lease), demolished the building. Thereafter, he exercised the option to purchase the property. We hold that, in the circumstances of this case, petitioner did not suffer any loss by reason of demolition of the building.

It is of course true that the destruction of a building may result in a deductible loss (cf. Parma Co., 18 B. T. A. 429; Dayton Co. v. Commissioner, 90 F.2d 767 (C. A. 8)), and Treasury regulations have long recognized that such deduction may be available. Petitioner relies upon such regulations. ² However, it has been firmly established that not every destruction of a building results in a deduction, since none is available where the taxpayer has not in fact sustained a loss by reason of the demolition. An example is furnished in the regulations, where one purchases1955 U.S. Tax Ct. LEXIS 264">*278 real estate intending to raze an existing structure for the purpose of erecting another building on the site. In such circumstances the purchaser is not regarded as having in fact sustained any loss, and no deduction is allowable. But the situation thus described is not the only one in which the deduction is unavailable. See Commissioner v. Appleby's Estate, 123 F.2d 700, 702 (C. A. 2). And it has been disallowed in a variety of other circumstances, where no actual loss was suffered as a result of the demolition. Charles N. Manning, 7 B. T. A. 286; William Ward, 7 B. T. A. 1107; Oscar K. Eysenbach, 10 B. T. A. 716; Anahma Realty Corporation, 16 B. T. A. 749, affirmed, 42 F.2d 128 (C. A. 2), certiorari denied, 282 U.S. 854">282 U.S. 854; Mary C. Young, 20 B. T. A. 692, affirmed, 59 F.2d 691 (C. A. 9), certiorari denied, 287 U.S. 652">287 U.S. 652; Spinks Realty Co., 21 B. T. A. 674,1955 U.S. Tax Ct. LEXIS 264">*279 23 T.C. 665">*671 affirmed, 62 F.2d 860 (App. D. C.); Laurene Walker Berger, 7 T.C. 1339.

1955 U.S. Tax Ct. LEXIS 264">*280 We turn then to the facts of this case to inquire whether petitioner in fact sustained a loss by reason of the demolition. It must be kept in mind that when petitioner purchased the property in March 1946, the building had a remaining useful life of 20 years. By May 1, 1950, when the building was demolished, less than 16 years of useful life remained. Yet, at that time, when the building and improvements had an unrecovered cost of $ 132,284.42, the property was subject to a 25-year lease at an aggregate rental of $ 420,000. And in the agreement of April 24, 1950, authorizing the lessee to demolish the building, petitioner expressly retained all its rights as lessor. The term of the lease extended substantially beyond the remaining useful life of the building, and since the lessee's obligations under the lease were in no way curtailed upon removal of the building, we cannot conclude that petitioner in fact sustained any loss by reason of the demolition. Cf. Albert L. Rowan, 22 T.C. 865.

Moreover, there are other factors in this case that preclude the allowance of the claimed deduction. Permission to demolish the theatre building was given to the1955 U.S. Tax Ct. LEXIS 264">*281 lessee in the letter agreement of April 24, 1950. That agreement was one that looked primarily toward the sale of the property. Of course, there was no assurance at that time that the sale would go through, but the option was in fact exercised and the sale did in fact take place, as contemplated, although there were modifications in some of the details. In such circumstances the only loss allowable would be one at the time of sale equal to the excess, if any, of the adjusted basis over the sales price. See Oscar K. Eysenbach, 10 B. T. A. 716, 722.

Finally, the deduction must be disallowed for the further reason that the removal of a building in connection with obtaining a lease on the property is regarded as part of the cost of obtaining the lease. Charles N. Manning, supra;Mary C. Young, supra;Spinks Realty Co., supra;Laurene Walker Berger, supra. To be sure, the demolition of the theatre building was not contemplated at the time of execution of the agreement of October 6, 1949, but, prior to the commencement of the lease (May 1, 1950), 1955 U.S. Tax Ct. LEXIS 264">*282 it had become abundantly clear that the entire purpose of the lease would be defeated unless the building were demolished. And it was in recognition of this plain fact that the permission to remove the building was granted on April 24, 1950. The provision granting that permission was a modification of the original agreement, and the lease must be regarded as founded on both the October 6, 1949, and April 24, 1950, agreements. Indeed, the razing of the building may well have constituted a benefit rather than a detriment to petitioner. The evidence suggests that the building was obsolete or obsolescent, and the rather substantial cost of 23 T.C. 665">*672 demolition was borne by the lessee. Here then was a situation where such a building was removed at the expense of the lessee who was about to begin a long-term lease under terms and conditions that appear to have been highly favorable to the lessor. From the lessor's point of view the building was being replaced by an advantageous lease and therefore no deductible loss is allowable in accordance with the holdings in the cited cases that the unrecovered cost of the razed building is to be treated as part of the cost of the lease.

The 1955 U.S. Tax Ct. LEXIS 264">*283 facts in this case are unusual, but from whatever point of view the problem is studied, we are led inevitably to the conclusion that petitioner did not in fact sustain a loss as a result of the destruction of the theatre building, and that to allow the claimed deduction here would be to give petitioner a windfall that Congress never intended.

Decision will be entered under Rule 50.