Martha Realty Co. v. Commissioner , 22 B.T.A. 342 ( 1931 )

MARTHA REALTY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Martha Realty Co. v. Commissioner

Docket No. 10979.

United States Board of Tax Appeals

22 B.T.A. 342; 1931 BTA LEXIS 2142;

February 24, 1931, Promulgated

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1. INVESTED CAPITAL - PROPERTY PAID IN. - Value for invested capital purposes of contributed capital, being a certain leasehold estate, determined upon the evidence.

2. DEPRECIATION. - Value for depreciation purposes of the same leasehold estate as of March 1, 1913, determined upon the evidence.

Chase Morsey, Esq., for the petitioner.

T. M. Mather, Esq., for the respondent.

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TRUSSELL

This is a proceeding for a redetermination of deficiencies in income tax for 1920 and of income and profits taxes for 1921, determined by the respondent in the amounts, respectively, of $118.29 and $334.42.

The petitioner claims (1) with respect to both taxable years it is entitled to allowances for the amortization, or exhaustion, of a leasehold; and (2) with respect to 1921, its statutory invested capital should include the value of the leasehold then turned over to it by its stockholders.

FINDINGS OF FACT.

J. H. Farish, hereinafter referred to for convenience as Farish, has been engaged in the real estate business in St. Louis for about 40 years. In 1898 he sold to Daniel C. Nugent, hereinafter referred to as Nugent, two parcels of real estate located at or near the corner of Grand Avenue and Washington Street, St. Louis; one lot fronting 100 feet on the west line of Grand Avenue by a depth westwardly of 150 feet along the south side of Washington Street; the other lot being contiguous on the west, fronting 50 feet on the south side of Washington Street and the depth of this lot extending south 244 feet to a public alley. Nugent did not improve the lots, so that in 1904 they were still unimproved when Farish and Nugent took dinner together one evening. In the course of the conversation Nugent remarked that he had made a mistake in buying the lots. Farish replied that such was not the case and reminded him of his failure to improve the property as advised to do. Nugent replied that he was engaged in business and was not desirous of putting cash capital into a building and he suggested that Farish take over the property. Farish indicated his willingness to consider taking a 99-year lease on the property, with a rental of $4,500 per annum for the first 10 years and $5,000 per annum for the remaining 89 years, Farish undertaking to cause a building to be erected on the lots at a cost of not less than $50,000. To this Nugent agreed. The next morning Farish sought out one Abeles with whom he had previously discussed the erection of a building on that corner and it was decided by Farish and Abeles to undertake the project. They each contributed $1,000 and Farish called on Nugent, made a deposit of $2,000, and the details of the proposed lease were discussed and agreed upon. An option to purchase the lease was thus acquired by Farish and Abeles in their own right and not as promoters. However, it was determined for convenience to cause a corporation to be organized for the purpose of taking over the lease and erecting and operating the building. The petitioner, a Missouri corporation, was incorporated on February 3, 1905, starting with a cash capital of $50,000 contributed by Farish, J. Abeles, and R. Abeles. Within a few days thereafter at the request of Farish and Abeles the lease agreement was drawn up and executed directly by and between the petitioner and the lessors, Nugent and his wife. The leasehold had a value of $50,000 when acquired by the petitioner. Later in 1905 there was caused to be issued pro rata to the said three stockholders, additional capital stock of the petitioner in an aggregate par value of $50,000 in consideration of the leasehold and a value was set up on the books of the petitioner of $50,000 for the lease. The erection was immediately commenced of a six-story and basement office building of fireproof cement and steel construction. Prior to completion of the building the stockholders sold $50,000 par value of their holdings of the outstanding stock to three individuals named Fischell, Baumgartner, and Mudd, for a cash consideration of $50,000. The remaining outstanding stock, par value $50,000, was retained by Farish and the Abeles. The building was completed early in 1906 at a cost of $165,000. Operation of the building proved successful and yielded good profits save in the World War years.

At the time of the acquisition of the lease by the petitioner the old "Allen" residence was located on the north side of the street which was later remodeled and extended, and used by the University Club; across the street was an old Baptist church; on the east side of Grand Avenue at Washington Street was a grocery store and a residence occupied as a boarding house; immediately south of the corner lot was a stone church, the Grand Avenue Presbyterian Church; across the street from this church was a small Episcopal church; farther south was a fashionable hotel; to the north were St. Vincent's Hospital and School and the residence of Mr. O'Fallon, an old resident.

In 1906, Farish acquired a 99-year lease on the corner of Grand Avenue and Olive Street, in the near vicinity of the property here under consideration; he organized a corporation, and a large office building, the Metropolitan Building, was erected on that corner. In about 1908 or 1909, employing similar methods, Farish caused the erection of the first theater in that neighborhood. The vicinity grew steadily in importance as a business center. In 1914 the Grand Avenue Presbyterian Church property was sold for a cash consideration of $144,000. The petitioner acquired the fee to the property here under consideration in 1922 for a cash consideration of $125,000, and sold the property in 1925 for $575,000; within six or eight months thereafter, the property was resold for $775,000 to the Fox moving picture theater interests. The vicinity had grown to a business center of importance particularly with respect to office buildings and large moving-picture theaters.

The value of the leasehold as of March 1, 1913, was $175,000.

OPINION.

TRUSSELL: This is purely a fact case in which we are required to determine, from the evidence, the value in 1905 of a leasehold for invested capital purposes, and also the value as of March 1, 1913, of the same leasehold for purposes of computing allowances for the amortization or exhaustion thereof in connection with the determination of net income.

The petitioner is a corporation which was organized in 1905 for the express purpose of taking over the leasehold, erecting an office building on the site, and operating the property. At the outset, the sole assets of the petitioner consisted of the valuable rights acquired under the lease contract and an amount of $50,000 in cash. All of this capital was contributed by the stockholders in 1905 and currently within that year the lease was valued upon the books at $50,000 and, in all, capital stock in an amount of $100,000 par value was issued to the three original stock subscribers.

The leasehold is expressly tangible property with respect to invested capital, see section 325(a) of the Revenue Act of 1921, and its actual cash value when paid in is statutory invested capital, see section 326(a)(2) and (3) of the statute. This is so, whether paid in for stock or as paid-in surplus. The respondent has determined that the leasehold had no actual value when acquired by the petitioner but, after consideration of the evidence adduced, we are unable to agree with this determination. Farish, who was the prime mover from the very beginning, was an experienced real estate operator and, we believe, a well qualified judge of opportunities and of values in the real estate field in St. Louis. He was instrumental in securing the leasehold on what appear to us to be advantageous terms; he was an organizer and stockholder in the petitioner. Farish took the stand in behalf of the petitioner and testified convincingly to a value of $50,000 for the leasehold in 1905 when acquired by the petitioner. He testified that he was of that opinion in 1905 when a value of $50,000 was entered upon the books and that the other stockholders had agreed with him. In the initial year, and prior to the completion of the building, the three original stockholders, then holding all of the outstanding stock, interested other individuals in the enterprise, selling them out of their holdings $50,000 par value of the stock for a cash consideration of $50,000. Since at this time the assets behind the stock had not been increased by profitable operation of the building and the fair market transaction involved a transfer of a 50 per cent interest, we think the consideration definitely expressed a fair market cash value for the stock equal to its par value and for all practical purposes effected an evaluation of the leasehold in the amount of $50,000. We see no reason for assigning any value in excess of cost to the petitioner's equity in the then uncompleted building. All of this leads to the conclusion that the cash value for invested capital purposes of the leasehold when acquired by the petitioner in 1905 was $50,000 and, as contributed capital, that value is properly allowable in the statutory invested capital of the petitioner, subject however to accumulated reductions of earned surplus by way of allowances for amortization or exhaustion, spread pro rata over the life of the leasehold.

The evidence shows that the leasehold increased in value as the neighborhood grew more and more into a business center and the ground rentals provided in the lease contract grew comparatively cheaper and cheaper. The vice president of one of the large St. Louis banks, a man actively in touch with real estate matters for 25 years, and, we believe, well qualified to express an opinion, testified to a value for the leasehold as of March 1, 1913, of $175,000. Farish, also well qualified, testified to a value which corroborates this opinion. There is practically nothing to the contrary. Not only is this evidence convincing, but it may not be disregarded. We therefore conclude that the value amounted to $175,000 of the leasehold as of March 1, 1913, for purposes of computing allowances for the amortization or exhaustion thereof, in determining net income.

The net income, average invested capital, and resulting tax liability will be recomputed in accord with this opinion.

Decision will be entered pursuant to Rule 50.