1955 U.S. Tax Ct. LEXIS 247">*247
1. Building constructed on leased ground should have been depreciated over the life of the lease where there was no right to renew the lease and the building could not be moved except by demolition.
2. Amount received by lessee for salvage value did not constitute income.
23 T.C. 836">*836 This proceeding involves a deficiency in income taxes of the petitioner for 1948 in the amount of $ 2,868.02. The deficiency arises because the respondent has determined that the petitioner realized a capital gain in the amount of $ 1,000 on the sale of a building instead of an ordinary loss in the amount of $ 9,780 as claimed by the petitioner on her return.
Most of the facts have been stipulated.
23 T.C. 836">*837 FINDINGS OF FACT.
The petitioner is an individual residing in Riderwood, Maryland. Her return for the calendar year 1948 was filed with the collector of internal revenue for the second district of New York.
On April 16, 1928, a lease of certain land at 126 East 64th Street was entered into between The Beekman Estate (a corporation) and1955 U.S. Tax Ct. LEXIS 247">*248 Edith M. J. Field, for a definite term of 20 years commencing on the 1st day of May 1928 and ending on the 1st day of May 1948. There was no provision in the lease for an option to renew for an additional term.
At some time prior to the time when the aforesaid lease was entered into, a residential building had been erected on the lot known as 126 East 64th Street, New York, New York, and the building was owned by Edith M. J. Field at the time the lease was executed.
The lease between The Beekman Estate, as lessor, and Edith M. J. Field, as lessee, provided, among other things, as follows:
And the said lessor doth hereby covenant, promise and agree to and with the said Lessee that if the said Lessee shall during the whole of said demised term, well and faithfully keep all and every the covenants in this lease contained on her part and behalf, the said Lessee may at the end of said demised term, or within twenty days thereafter, take down, remove and carry away all such building or buildings, and the materials thereof as may then be standing on the said demised premises, fences only excepted.
On March 18, 1929, Edith M. J. Field, with the consent of The Beekman Estate, assigned the1955 U.S. Tax Ct. LEXIS 247">*249 lease to the petitioner. On the same date, Edith M. J. Field sold, transferred, and conveyed to the petitioner the brick residential building, which was situated on the land at 126 East 64th Street, New York, New York. No consideration was paid by petitioner to Edith M. J. Field for the assignment of the lease.
Petitioner paid Edith Field $ 13,000 for the building which was transferred and conveyed to petitioner.
From March 18, 1929, until about October 1, 1931, petitioner used the building as a residence. During this period, petitioner made extensive alterations to the building at a cost of about $ 30,000.
The building is physically located between two adjoining houses having a partial party wall with one of the adjoining houses. At all times material in this proceeding, it has been a substantially built 4-story brick building, with basement, 25 feet wide, 46 feet deep, with a 14-foot extension in depth 2 stories high built by petitioner as part of the alterations made after she acquired the building.
At some time prior to October 1, 1931, petitioner removed from the premises and the premises were then placed on the real estate market for rent. The first rental of the property1955 U.S. Tax Ct. LEXIS 247">*250 was made on October 1, 23 T.C. 836">*838 1931. Subsequent to the first rental, petitioner rented the premises to various other individuals for various terms under various leases. The last rental of the property was made on July 31, 1940, and the term under that rental continued until April 30, 1948, the last day of the term under the lease from The Beekman Estate to Edith M. J. Field assigned to petitioner.
The premises at 126 East 64th Street had not been used by petitioner as a private residence or been removed from the rental market at any time since October 1, 1931, until and including April 30, 1948.
On October 31, 1931, when the building was placed on the rental market, it had a fair market value of $ 22,000 and a useful life expectancy of from 50 to 60 years.
The rental received by petitioner on the building was included by petitioner in her gross income during the years it was received.
During the years prior to 1948 when the building was on the rental market, the petitioner never claimed and has not been allowed any deduction from gross income for depreciation on the building.
For the year 1948, the respondent allowed the petitioner depreciation on the building in the amount of1955 U.S. Tax Ct. LEXIS 247">*251 $ 442.20. This was to allow for depreciation for the period starting January 1, 1948, and ending approximately April 23, 1948, the date of the sale of the building by petitioner to The Beekman Estate. Petitioner had not claimed any deduction for depreciation in her return for 1948.
On or about April 23, 1948, 1 week before the termination of the lease from The Beekman Estate, petitioner sold the building to The Beekman Estate for the sum of $ 1,000.
In her income tax return for the year 1948, petitioner claimed an ordinary loss of $ 9,780 computed as follows:
| (a) Basis | $ 22,000 |
| (b) Less: Depreciation at the rate of 3 per cent per annum | |
| ($ 660) for 17 years | 11,220 |
| (c) Adjusted basis | $ 10,780 |
| (d) Less: Gross sales price | 1,000 |
| (e) Net loss | $ 9,780 |
OPINION.
This case presents an unusual facet of depreciation. Here, we are not concerned with the appropriate rate of depreciation during the life of the asset but, rather, what the appropriate rate should have been during its life, plus the consequences of the failure to take the appropriate deduction during the life of the asset.
The petitioner owned a house built on leased land. She bought the house and acquired the1955 U.S. Tax Ct. LEXIS 247">*252 lease when it still had 19 years to run. She 23 T.C. 836">*839 used the premises for residential purposes for a while and, with approximately 17 years left to run on the lease, she converted the building to rental property and subleased. There was no provision for renewal in the lease. The petitioner did have the right to remove the building within 20 days following the end of the term. However, the building was a 4-story brick row house, with basement. As a practical matter, it was impossible to remove the building without literally demolishing it.
About a week before the termination of the lease, in consideration of $ 1,000, the petitioner sold her right to remove the building to the lessor-owner of the land.
The petitioner did not take any depreciation on the building on her returns for the years when the house was used as rental property. Instead, on her return for the year in which the lease terminated, she reported a loss on the building by determining that she would not have fully depreciated the building if she had been depreciating at the rate allowable for the useful life of the building. Her loss was computed by subtracting from her basis in the building the aggregate annual1955 U.S. Tax Ct. LEXIS 247">*253 depreciation she would have been allowed had she been depreciating the building at a rate determined by its useful life. The loss was then reduced by the $ 1,000 which she received for surrendering her right of removal.
The respondent disallowed the loss. He contends that, in view of the fact that petitioner's lease was not renewable, she should have been depreciating the building over the period of the lease. Consequently, at the end of the term, her basis in the building was zero, according to the respondent's theory. Thus, she did not have any loss but actually realized a long-term capital gain in the amount of the $ 1,000 which she received for her right to remove the building.
It is now established that where a lease on ground provides a definite and fixed term, with no option to renew, the cost borne by the lessee in erecting buildings or making other capital improvements, which revert to the lessor at the end of the lease or lose their usefulness at that time, is to be prorated over the life of the lease, or the life of the property, whichever is shorter. The same rule obtains, even though the lease provides a renewal option, where the rental in the renewal period is to1955 U.S. Tax Ct. LEXIS 247">*254 be based on a reappraisal of the property at the end of the term of the lease or where it is apparent that the right to renew will be worthless. Where, however, there is an option to renew on the same terms, the cost of the capital additions made by the lessee should be spread over the combined period named in the lease and the renewal period, or the life of the property, whichever is shorter. ; ; ; , certiorari denied ; .
If there were nothing more to petitioner's case than a lease without right to renew, then we should be obliged, on the authority of the foregoing cases, to hold that she should have depreciated her building over the term of the lease.
However, the petitioner insists that, because she had the right to remove the building within 20 days from the end of the term, the building had1955 U.S. Tax Ct. LEXIS 247">*255 a useful life beyond the end of the term and, therefore, the cost of the building should have been depreciated over its full useful life. She also claims she had a reasonable expectancy that the lease would be renewed at the end of its term. By these arguments she attempts to bring herself within the rule of those cases that hold that where capital improvements on leasehold property do not revert to the lessor automatically, or where the lessor or other successor in possession is required to purchase the improvements at the end of the term, then the capital items are to be depreciated over their useful life. ; .
Petitioner argues that the rental that she was paying to the lessor was reasonable for the location. The inference is that her landlord could not get a higher rental for the ground than that she was paying and, therefore, there was reason to believe that the lease would be renewed at the end of her term. But we do not believe that the petitioner has established her point in this regard and we do not think that on this record it 1955 U.S. Tax Ct. LEXIS 247">*256 can be found that there was a reasonable expectancy that the petitioner's lease would be renewed.
Furthermore, we think that it would have been impossible for the petitioner to remove her building. As we have observed above, it was a 4-story brick row house with a partial party wall with an adjoining building. Petitioner offered no proof that the building could have been moved intact, or that it could have been moved in any manner, and still retain its value and usefulness as a habitable building. The witness called by petitioner testified that the building could not be moved. Consequently, the right to remove the building, realistically appraised, was virtually valueless. The most that this right gave petitioner was the right to demolish the building for whatever salvage value it might have. This case is not like , where the taxpayer owned a floating drydock which could be moved at the end of the lease term or, like , where a successor licensee in possession of the taxpayer's dam would be required to reimburse the taxpayer for the value of the property. 1955 U.S. Tax Ct. LEXIS 247">*257 Therefore, petitioner should have depreciated her basis in the building at the time it was converted to rental property over the remaining term of her lease.
23 T.C. 836">*841 There is another question in the case. On the hypothesis that the petitioner's adjusted basis in the building was zero at the time of its sale because she should have been depreciating it over the period of the lease, the respondent claims that the $ 1,000 which petitioner received for relinquishing her right to remove the building represents a long-term capital gain in that amount from the sale of a capital asset.
We do not agree with respondent's claim. Respondent's regulations state that "The proper allowance for * * * depreciation is that amount which should be set aside for the taxable year in accordance with a reasonably consistent plan * * * whereby the aggregate of the amounts so set aside,
