*664OPINION.
Morris:The two major issues in this case present questions of fact relative to valuations of assets. At the comparatively late date of January 29, 1918, a valuation is required for the purpose of computing the allowable deductions from income by way of allowances for exhaustion, wear and tear. The dates of valuation effective for invested capital purposes are much earlier, going back to the year 1903 for some of the values, and to 1909 for others. Included in the evidence is a detailed retrospective appraisal of the “ depreciated normal costs ” based upon cost of reproduction new with allowances for depreciation. In connection with this appraisal and with another made upon the basis of a physical inventory in the *665middle of 1917, a few months prior to the transfer of the assets to the petitioner, there has been an ascertainment of additions subsequent to acquisition and the cost thereof. The cost of the additions is acceptable. The situation is similar with reference to the value of the assets in 1918, where the conclusion hereinafter reached is considered amply sustained by the record. Cf. Georgia Manufacturing Co., 5 B. T. A. 893; Donaldson Iron Co., 9 B. T. A. 1081. Relative to the valuations in the earlier years, we do not find the evidence so convincing and wo are not satisfied that the beginning values shown in the appraisal are sufficiently supported to enable a recognition of them. Cf. Rockford Malleable Iron Works, 2 B. T. A. 817; Tibby-Brawner Glass Co., 2 B. T. A. 918. The land values determined are upon the testimony of qualified witnesses. We have included whatever values are allowable upon the record. For the reasons stated they fall a little short of the claims of the petitioner, nevertheless in our opinion any question of abnormality of capital is removed.
The first issue relates to the computation of allowances for exhaustion, wear and tear which are deductible from income in the taxable years as provided in section 234 (a) (7) of the Revenue Act of 1918. The rate of annual depreciation is not in dispute. The amount of the base to which the annual rate is applied is at issue. The petitioner alleges in the amended petition that the proper base for the six-month period following acquisition, and therefore ended June 30,1918, amounts to an average of $3,728,415.56. Since the additions to cost during the period amounted to $112,762.18, one-half thereof is deductible from the claimed base, and the alleged amount of value at acquisition is $3,672,034.47. In support of this value there is in evidence a physical inventory, taken in the middle of 1917, a few months prior to the transfer, which removes all reasonable doubt of the actual existence of the assets claimed to have been acquired; a current professional appraisal of the cost of reproduction new, and of the “ sound value ” of the assets after deducting allowances for depreciation; a retrospective appraisal of later date; in addition, the testimony of witnesses qualified to express opinions of some weight in the determination of the values. Upon a consideration of all of this evidence we are convinced that the fair market value of the depreciable assets amounted to at least the amount claimed, $3,672,-034.47, and that is the proper base, together with due consideration of the cost of subsequent additions, upon which the amounts of the allowances should be computed as affording deductions which will be entirely reasonable.
The second issue relates to the amount of value allowable for invested capital purposes, under the Revenue Act of 1918, for various *666properties turned in for capital stock, par value $5,000,000 issued on January 29, 1918. It is admitted that an interest and control of 50 per cent or more remained in the same persons after the transfer and the value allowable is limited under the provisions of section 331 of the Revenue Act of 1918.
The assets were transferred to the petitioner by three persons, whose interests in the assets were equal and similar. Each owned a one-fourth interest acquired under the will of Alexander M. Byers, and a one-twelfth interest acquired upon the death of a brother, Dallas C. Byers. Subsequent to acquisition there were various additions to the assets originally acquired. With respect to any one of the assets the dates of acquisition by each of the three persons were the same. It is apparent then, that the question requires the determination of the cost of a three-fourths interest and of a one-fourth interest, with due consideration being given to the life interest held by the mother until August, 1912, and to subsequent additions to the properties, and to reasonable allowances for depreciation.
Alexander M. Byers died in 1900, leaving a will conveying all his property to trustees, with authority to continue two businesses, until the date when the youngest child should reach his majority. The youngest child reached the age of twenty-one years in 1902; in 1903 the properties were conveyed by the trustees under the will to the surviving four heirs. Properties which were located at Girard were owned solely by the decedent. Properties located at Pittsburgh were owned by a corporation of a somewhat similar name to that of petitioner; the decedent owned all of the capital stock thereof, and transfer of the Pittsburgh properties was effected in 1903 directly from the corporation to the four heirs as distributions, in liquidation to stockholders.
For the purposes of ascertaining the cost of the three-fourths interest, the petitioner claims that the values of the assets in 1903 are the allowable acquisition costs to the heirs. In this we agree with reference to the Pittsburgh properties which were owned by a corporation and were distributed to the stockholders in 1903, but with reference to the Girard properties the question arises whether under the terms of the will the properties were acquired in 1.900 when the decedent died, or in 1903 when the trustees under the will conveyed the properties to the heirs. However, the record does not establish to our satisfaction the value of the Girard properties in either 1900 or 1903, and we see no reason for increasing the value which the respondent has allowed as of either of those dates. After a careful consideration of the evidence we conclude that the cost of the depreciable assets, after deducting a reasonable allowance for depreciation, amounted for the Girard properties to at least *667$963,649.04, and for the Pittsburgh properties to at least $1,459,-678.83. With respect to the lands at Girard, the respondent has included subsequent acquisitions which cost $119,767.16, and this cost should also be allowed.
For the purpose of ascertaining the cost of the one-fourth interest which Was acquired from Dallas C. Byers, the petitioner claims an amount of appreciated value for all of the assets, including the de-preciable assets and the Girard lands, due to a general increase in values. Petitioner admits that the Girard properties were acquired by the three surviving heirs immediately upon the death of Dallas 0. Byers in 1909, but it is claimed that the mother was left a life interest in the Pittsburgh properties and the year of her death, 1912, was the proper date of valuation of the Pittsburgh properties. It is true that the three surviving heirs did not acquire the personal property at Pittsburgh until it Avas distributed to them in 1912. As to the real estate at Pittsburgh, there is nothing before us to show that the property did not vest in the heirs in 1909. Manderson v. Lukens, 23 Pa. 31; 62 Am. Dec. 312; In re Long Estate, 77 Atl. 924; Schofield v. Olcott, 11 N. E. 352; Armstrong v. Barber, 88 N. E. 246; Flanner v. Fellows, 68 N. E. 1057; Pengery v. Rulom et al., 92 N. E. 592; Smith Estate, 75 Atl. 425.
As will presently appear, for the Pittsburgh lands, we have determined from the evidence the values of the lands in 1903 and in 1909, thus disposing of the issue in part, but with regard to the depreciable assets at both Girard and Pittsburgh, and also the lands at Girard, the record does not afford a basis upon which we can allow any increase in value. The cost of the depreciable assets and of the Girard lands remains the same for the purpose of determining the cost of the one-fourth interest as was determined for the purpose of computing the three-fourths interest.
With respect to the Pittsburgh lands, we are well satisfied that the prices per square foot in 1903 and again in 1909, together with the subsequent additions at cost, all as set out in detail in the findings, are properly allowable as the costs of the respective interests. In the absence of evidence of the value of the Water Street land in 1909, we find no greater allowable value at any time than $10 per square foot as shown in the findings.
The third issue was abandoned by the petitioner. See Russel Wheel & Foundry Co., 3 B. T. A. 1168.
The fourth issue raises the question of the proper adjustment of earned surplus, for invested capital purposes, on account of depreciation of prior years in respect of properties acquired after March 3, 1917, when the basis for computing the depreciation is greater than *668the limited value at which such properties may be included in invested capital under section 331 of the Revenue Act of 1918.
The allowances which respondent has made for depreciation of the properties acquired by petitioner on January 29,1918, are based upon a fair market value, as of the date of acquisition, of $2,816,002.17. In computing invested capital, respondent, acting in accordance with the provisions of section 331, included such properties at a value alleged to equal cost to the previous owners, which is less than $2,816,002.17. The earned surplus of each year was reduced for invested capital purposes by the entire amount of depreciation allowed.
We have found that the fair market value of the deprec3able properties acquired on January 29, 1918, was, at that date, $3,672,034.47. That value is the basis for computing the annual deductions for depreciation of the properties. We have found that the cost of the properties to the previous owners was $2,423,326.87. That amount represents the value at which these properties may be included in invested capital under the limitations of section 331.
There is no dispute between the parties as to the remaining life from date of acquisition of the depreciable properties acquired on January 29, 1918. It was fixed at 15 years by respondent, and the petitioner agrees. The annual deduction for depreciation of these properties which petitioner is entitled to make in computing net income, assuming that no unforeseen events may occur during the 15-year period to materially affect the life of the properties, is one-fifteenth, or 6% per cent, of $3,672,034.47, or $244,802.30. If the provisions of section 331 were applicable for depreciation purposes, so as to restrict the basis to the limited value at which the properties may be included in invested capital, the annual deduction for depreciation would be one-fifteenth, or 6% per cent, of $2,423,326.87, or $161,555.12.
It is the contention of the petitioner that, while it is entitled to make an annual deduction for depreciation in computing net income, of $244,802.30, its earned surplus, for invested capital purposes, should be reduced by only $161,555.12, the difference between these amounts representing realized appreciation. Neither the pleadings nor the brief present the reasoning behind this contention. The petitioner merely asserts that its contention accords with “ the recognized rule,” and relies upon article 844 of Regulations 45 as authority for its position.
Article 844 of Regulations 45 reads as follows:
Surplus and undivided profits: reserve [or depreciation or depletion. — If any reserves for depreciation or for depletion are included in the surplus account it should be analyzed so as to separate such reserves and leave only real sur*669plus. Reserves for depreciation or depletion can not be included in tlie computation of invested capital, except to the following extent:
(1) Excessive depletion or depreciation included therein and which if charged off could be restored under article 840 may be included in the computation of invested capital; and
(2) Where depreciation or depletion is computed on the value as of March 1, 1013, or as of any subsequent date, the proportion of depreciation or depletion representing the realization of appreciation of value at March 1, 1013, or such subsequent date, may if undistributed and used or employed in the business be treated as surplus and included in the computation of invested capital.
Eor the purpose of computing invested capital depreciation or depletion computed on the value as of March 1, 1013, or as of any subsequent date shall, if such value exceeded cost, be deemed a pro rata realization of cost and appreciation and be apportioned accordingly. Except as above provided value appreciation (even though evidenced by an appraisal) which has not been actually realized and in respect of amounts accrued since March 1, 1013, reported as income for the purpose of the income tax, can not be included in the computation of invested capital, and if already reflected in the surplus account it must be deducted therefrom.
Apparently the petitioner sees in the circumstances of its case a situation bearing such a close analogy to those to which paragraph (2) of the above quoted article relates, as to bring it within the provisions of the article. But in that it is mistaken. It seems entirely clear that the regulation applies only when the statute recognizes a value for computing the deduction for depreciation or depletion in excess of the cost of the property. Two such instances which are readily called to mind are when the March 1, 1913, value of depre-ciable property exceeds cost, and when the discovery value of natural deposits is materially disproportionate to cost. In those instances the statute allows a deduction for depreciation or depletion based upon the higher value, so that the deduction allowable is greater than that necessary to return to the taxpayer its capital investment in the property consumed in the business. The purpose of the statute in allowing the higher values as the bases for depreciation and depletion is, of course, to enable the taxpayer to recover the March 1, 1913, value of its property or the discovery value of natural deposits, free from tax. To the extent that the deduction is greater than that necessary to recover the cost of the property consumed, it includes the nontaxable increment in value of the property, and this is what is known as “ realized appreciation.”
When property is used up in the business, earned surplus and undivided profits are affected only to the extent that capital has been consumed or lost. So, if the annual deductions for depreciation and depletion which include the nontaxable increment in value of the property have been charged against earned surplus and undivided profits account, in their entirety, that account has been reduced to a point where it is less than the true earnings of the business. That *670is the situation which article 844 of Regulations 45 was intended to rectify.
In the instant case the annual deduction for depreciation of the properties acquired on January 20, 1918, for shares of capital stock, will be based upon the fair market value of the properties at the date of acquisition, said value representing cost to the petitioner. In that situation, the annual deduction for depreciation will not be greater than that necessary to return to the petitioner its capital investment in the property used up in the business, and, therefore, will include no element of nontaxable increment in value. In that very material respect does the petitioner’s case differ from those contemplated by article 844.
Furthermore, only true earned surplus and undivided profits can be included in the computation of invested capital. Milton Dairy Co. v. Willcuts, 8 Fed. (2d) 178; and Willcuts v. Milton Dairy Co., 275 U. S. 215. A true earned surplus can not exist unless provision has been made for all of the expenses and losses of the business. The rule is well stated in article 838 of Regulations 45, which, so far as material here, reads as follows:
Surplus and undwided profits; earned surplus. Only true earned surplus and undivided profits can be included in the computation of invested capital, and if for any reason the books do not properly reflect the true surplus such adjustments must be made as are necessary in order to arrive at the correct amount. In the computation of earned surplus and undivided profits full recognition must first be given to all expenses incurred and losses sustained from the original organization of the corporation down to the taxable year, including among such expenses and losses reasonable allowances for depreciation, obsolescence, or depletion of property (irrespective of the manner in which such property was originally acquired), and for the amortization of any discount on its bonds.
In Willcuts v. Milton Dairy Co., supra, the Supreme Court expressed the opinion that the above quoted article correctly interpreted section 326 of the Act as it related to the inclusion in invested capital of earned surplus and undivided profits.
Here, the properties acquired on January 20, 1918, cost the petitioner $3,672,034.47. The parties agree that the life of these properties from date of acquisition is 15 years. Based upon those facts, the petitioner’s capital investment in the properties is being consumed or used up at the rate of $244,802.30 per annum. The petitioner can not have any true earned surplus without adequate provision being made for this consumption of capital. The issue must be decided adversely to the petitioner.
The fifth issue is disposed of by our decision on the second issue.
The sixth issue is a question of the application of the special relief provisions of the Revenue Act of 1918 to the computation of the *671taxes for the fiscal year 1918. It does not appear from the record that it is impossible to compute the invested capital of the petitioner, or to determine the respective values of the several classes of properties, or that there are present in this case any abnormal conditions which work upon the petitioner an exceptional hardship. The respondent is therefore sustained.
Reviewed by the Board.
Decidan will be entered under Rule 50.
Love concurs in the result only.