*2720 1. Petitioner corporation entered into an agreement with the owner of real estate to pay her an annuity as the consideration for the conveyance of such real estate. The real estate was conveyed to petitioner corporation, which made the annuity payments. Held that petitioner entered upon an annuity venture upon which gain or loss is to be computed. Held, further, that to the extent that each annual payment is in excess of the present value of such payment at the time when the annuity contract was undertaken, it is deductible in computing income.
2. Where a corporation, without consideration, increases the amount of its obligation under an annuity contract, the additional payment may not be deducted.
*1140 The Commissioner determined deficiencies of $1,937.55 and $1,861.92 in income tax for 1922 and 1923 and notified the petitioner of his action. This proceeding was then instituted for a redetermination of such deficiencies. Three errors were alleged, only two of which are now urged, *2721 stated as follows:
*1141 (1) The disallowance of a payment of $14,000 in each of the years in question as an expense, the amount having been paid to Hattie I. Moore under a contract whereby she conveyed certain real estate to the petitioner, these payments now being in excess of the value of the property at the time it was deeded to this petitioner.
(2) The allowance for depreciation during the years in question should be proportionately increased on account of the increased cost of the building to the petitioner if the amounts of payments to Hattie I. Moore are held to have been capital payments.
The proceeding was submitted upon a stipulation which we have adopted as our findings of fact.
FINDINGS OF FACT.
The taxpayer is a corporation organized under the laws of the State of New York, engaged in the business of manufacturing blank books and bound record keeping devices, and having its principal place of business in the City of Rochester, N.Y.
For some time prior to December, 1912, the taxpayer had occupied, under a lease from one Hattie I. Moore, certain premises located at 69 Stone Street, Rochester, N.Y., on which two buildings were situated, at an annual*2722 rental of $5,000, in addition to the assumption by the taxpayer of the cost of all repairs, taxes and carrying charges. On December 26, 1912, the taxpayer entered into an agreement with the said Hattie I. Moore, the then owner in fee simple of the above mentioned premises, whereby the taxpayer agreed to pay her the sum of $10,000 per annum during her life as the sole consideration for her conveyance of the said premises to the taxpayer. The legal title to the premises was transferred from her to the taxpayer on December 26, 1912, by the delivery of a deed.
Hattie I. Moore was born March 1, 1858, and on the date of the contract and conveyance she was in very poor health. The condition of her health continued to decline and, on or about January 1, 1917, she contended that by reason of her expected early demise the taxpayer should increase the annual payment to $14,000. This alteration was agreed to by the taxpayer.
Pursuant to the original contract made on December 26, 1912, the taxpayer paid annually during the years 1913 to 1916, inclusive, to the said Hattie I. Moore the sum of $10,000. Pursuant to the contract as amended beginning on January 1, 1917, and during each and*2723 every year thereafter, to and including the year 1927, the taxpayer has paid annually to the said Hattie I. Moore the sum of $14,000.
The fair market value of the real property conveyed on December 26, 1912, was $80,000, both on that date and on March 1, 1913. Of this amount $61,968 represented the value of the buildings on those dates and $18,032 represented the value of the land.
*1142 It was the opinion of the officers of the taxpayer corporation in making the contract on December 26, 1912, that the value of the realty received was at least equal to, if not greater than, the value of the annuity, in view of the annuitant's poor health.
It was the opinion of the officers of the taxpayer at the time of making the alteration in the contract on or about January 1, 1917, in view of the decline in the annuitant's health, that the combined value of the original and altered contracts was not in excess of $80,000.
On January 1, 1913, the life expectancy of a person in normal health of the then age of Hattie I. Moore was 17.4 years. The value on January 1, 1913, of an annuity of $10,000 for 17.4 years was $106,173.96, and represents the present worth, with interest at*2724 6 per cent, of a $10,000 annuity for 17.4 years.
On January 1, 1917, the life expectancy of a person in normal health of the then age of Hattie I. Moore was 14.74 years. The value on January 1, 1917, of annuities of $4,000 and $10,000 for 14.74 years would have been $38,415.04 and $96,037.60, respectively. These sums represent respectively the present worth, with interest at 6 per cent, of $4,000 and $10,000 annuities for 14.74 years.
The sum of $58,745.60 was the value on December 26, 1912, of an annuity of $10,000 to one whose life expectancy was 7.466 years, and represents the present worth, with interest at 6 per cent, of a $10,000 annuity for 7.466 years.
The sum of $21,254.40 was the value on January 1, 1917, of a $4,000 annuity to one whose life expectancy was 6.596 years, and represents the present worth, with interest at 6 per cent, of a $4,000 annuity for 6.596 years.
The sum of $80,000 was the value on December 26, 1912, of a $10,000 annuity to one whose life expectancy was 11.208 years, and represents the present worth, with interest at 6 per cent, of a $10,000 annuity contract for 11.208 years.
The sum of $28,944.96 was the value on January 1, 1917, of*2725 a $4,000 annuity contract to one whose life expectancy was 9.78 years, and represents the present worth, with interest at 6 per cent, of a $4,000 annuity for 9.78 years.
Depreciation was sustained on the buildings covered by the conveyance of the real estate in question at the rate of 2 1/2 per cent per annum.
The Commissioner of Internal Revenue, in his deficiency notice of May 29, 1926, determined a net income for the year 1922 of $134,524.41 and for the year 1923 of $122,758.16. In arriving at these amounts, no portions of the annuity payments were allowed as deductions from gross income. The Commissioner allowed a deduction of $2,400 in each of these years as depreciation on the buildings in question in determining the net income shown above.
*1143 OPINION.
PHILLIPS: This proceeding raises the interesting question of the proper treatment, for the purposes of the income tax, of a transaction by which one acquires property in exchange for an agreement to pay an annuity over an indefinite period. Do the annual payments represent cost of the property? If so, how is the cost to be determined if the property is sold before the annuity contract has been performed, *2726 or, which is a variant of this inquiry, what cost does the property have for the purpose of depreciation? If the annuitant dies before payments have been made which equal the value of the property, has the purchaser realized a gain or, conversely, if the payments exceed the value of the property, has there been a loss? Some of these questions are within the framed issues in this case; the others must be in mind in reaching our conclusion.
Taxing statutes must be such that they are practical of administration. The administration of the income-tax law requires that the income of each year be susceptible of determination. So far as possible, business transactions must be treated in a manner which will permit a practical application of the statute, which requires that taxable income be ascertained for each year, except in those cases where the statute provides for a different treatment of income from specific transactions. This does not differ from the ordinary requirements of business that capital and liabilities, income and losses, be ascertainable.
If we regard the annuity payments here in question as deferred payments of the purchase price, there is no fixed cost until the*2727 annuitant dies, and insoluble difficulties appear in the application of the tax law to any transaction which necessitates the fixing of such cost prior to such death. On the other hand, if we may treat the transaction as in its nature divisible into an acquisition of real estate and the assumption of an annuity contract, we have a situation which fits into the tax law. Such a treatment does no violence to the transaction; it is in precise accord with it. The petitioner has acquired real property and has parted with its obligation to perform the terms of an annuity contract. The seller has disposed of her property and has received an annuity contract. Where property has been sold for notes or for other property, gain or loss is measured by the value of such notes or other property. Similarly, when property was purchased abroad, the price being payable in foreign currency, we held that the cost was the value of the foreign currency at the date of the purchase, that if payment was not made at that time there was a venture in foreign exchange and that gain or loss on such venture was to be reported as from a sale of foreign currency and did not affect the purchase price of the goods. *2728 ; *1144 . The principle here is the same. Petitioner in effect sold an annuity and received real estate worth $80,000. It sold an annuity of $10,000 per year for $80,000. Having thus entered upon an annuity venture, it must look to that venture to determine whether any gain or loss has resulted.
Moreover, such a solution is in accord with good accounting, which the statute recognizes as one of the matters to be considered in determining the income. Section 212, Revenue Act of 1921. It would obviously be improper for the petitioner, immediately after securing the deed, to have included the real estate in a balance sheet at a cost equal to the first payment made. It would have been equally improper to have failed to include in its liabilities its obligation under the annuity contract, or to continue to include annuity payments as cost long after the actual value of the property has been paid the annuitant. On the other hand, it would be sound accounting to list the real estate as an asset at its value and the annuity contract as a liability. *2729 .
The computation of the value of an annuity involves the reduction of future payments to their present worth by discounting such payments at some agreed rate of interest. In the instant case the present value on December 26, 1912, of these future payments has been fixed at $80,000. According to the stipulation, this represents the present value of a $10,000 annuity to one whose expectancy was 11.208 years. This would represent total payments of $112,080 during these years, but a part of those payments would represent interest for the use of money. Since the present value of the annuity is arrived at by means of adding together the discounted value of the future payments, it is proper that only such discounted value of each payment should be treated as a payment upon the principal of the obligation and the discount should be treated as a payment of interest. If the whole of each payment is treated as a payment upon the principal of the obligation, the obligation would be written off in eight years, whereas it is evident from the stipulation that the normal life of the obligation is 11.208 years. Since this period would not expire until*2730 after the years here in controversy, we are of the opinion that there has been no loss except to the extent that the payments made during the years in question represented the excess over the present value of such payments on February 26, 1912.
So far as the increase in payments made under the amendment of 1917 is concerned, we are of the opinion that such payments may not be deducted. The petitioner received nothing for its agreement to increase the annual payments. The act was purely voluntary, without consideration and in the nature of a gift. Such payments do not represent cost of the real estate, payments under the annuity *1145 venture or expenses of the petitioner. No basis exists for their deduction.
It follows from what we have said above that the cost of the real estate to the petitioner was $80,000 and that depreciation is properly to be computed on that basis.
Reviewed by the Board.
Decision will be entered under Rule 50.
STERNHAGEN, dissenting: Upon the two issues submitted, I am of opinion that no part of the amounts paid by the corporation to the seller of the building can be deducted, because all payments are the purchase*2731 price or cost of the building and such an investment of capital is not deductible. The depreciation deduction must be based on actual cost. United States v. Ludey,274 U.S. 295">274 U.S. 295. Although the base varies each year by the addition of a new payment and the rate varies as to each payment because of the progressively shortening life, this is clear and can be easily computed by arithmetic.
MARQUETTE, SMITH, TRAMMELL, ARUNDELL, VAN FOSSAN, and MURDOCK agree with this dissent.