*1098 1. Petitioner Wester acquired an exclusive agency for the sale of a tract of land. He agreed to plat the land and otherwise improve it for sale as subdivisions. The owner of the land was to receive $600,000 net out of sales. Pending the receipt of such amount by the owner, the petitioner was to receive a specified portion of the selling price of each tract to meet his overhead expenses and, when the owner had been paid the whole amount due it, the petitioner was to receive, as additional compensation, all of the unsold land and sums owing under sales contracts previously entered into. Held, that amounts expended by the petitioner to improve the land for sale are deductible as ordinary and necessary business expenses.
2. The petitioner constructed several poultry houses on unsold land in the tract at his own expense. The action of the respondent in allowing deductions for exhaustion of the property at the rate of 7 1/2 percent per annum is approved in the absence of proof that his determination does not rest upon a correct determination of the facts.
*30 These proceedings were consolidated for hearing and report and involve the redetermination of the following deficiencies in income taxes:
| Docket No. | Year | Amount | |
| W. L. Wester | 67036 | 1930 | $3,138.89 |
| W. L. Wester, executor, estate of Marjorie E. Wester | 67037 | 1930 | 3,138.89 |
| W. L. Wester | 67145 | 1929 | 10,383.15 |
| W. L Wester, executor, estate of Marjorie E. Wester | 67146 | 1929 | 10,383.15 |
The issue is whether expenditures made by petitioner Wester for improvements on land of another which was being sold by Wester, under an exclusive agency contract, are deductible as ordinary and necessary business expenses or represent capital costs recoverable as parcels of the land are sold.
FINDINGS OF FACT.
Petitioner W. L. Wester is a resident and citizen of the State of Washington and executor of the estate of his deceased wife, Marjorie E. Wester, who died after March 3, 1931. Petitioner has been in the subdivision real estate business for twenty-eight years.
On May 23, 1921, petitioner Wester entered into a written contract with the South Seattle Land Co., a Washington corporation, for the sale of about 1,830*1100 acres of land owned by the corporation in King County, Washington. The contract and the amendment made thereto in 1921 provided, among other things not important here:
(1) That Wester was to be the exclusive agent for the handling and sale of the land;
(2) That the land, when subdivided, was to be sold for certain fixed minimum prices and on specified terms, unless otherwise agreed to by the parties;
(3) That Wester should pay the cost of platting the lands, constructing and opening roads or streets, advertising, his own office expenses, any commissions to outside real estate brokers for selling the lands, abstracts of title or title insurance, "and that the company shall be at no expense in reference to the handling and sale of said property under this agreement." The cost of revenue stamps to deeds was to be apportioned between the parties according to their rights to receive a portion of the payments made under each contract of sale;
(4) That the corporation would execute such plats as might be from time to time prepared by Wester for the purpose of subdividing the lands and execute such money receipts, contracts of sale, and deeds as complied with the terms of the contract;
*1101 (5) That the corporation would receive out of the proceeds of sale of the lands the net sum of $600,000 (less a credit for a certain portion of the lands) plus interest on deferred payments. As partial compensation for his services in handling the lands, Wester was to receive all sums derived from sales of land in excess of the amount due the corporation with the provision, however, that pending the receipt by the corporation of its proportionate share of the selling *31 price of the whole tract, and to carry overhead expenses of Wester in conducting the sales, payments received from purchasers were to be apportioned between the parties in the following manner:
(a) Wester should receive all payments up to 25 per cent of the selling price, plus, during such period, interest on the unpaid purchase price.
(b) Thereafter principal and interest should be divided equally between the parties until either received in payments on principal "the excess over the Settlement Schedule price," fixed at $600,000.
(c) When one of the parties received in payments on principal "the excess over the Settlement Schedule price," the remaining payments were payable to the other party.
*1102 (d) In the event of sales for cash, Wester was to receive the entire amount above the settlement schedule price, which for cash sales was fixed to give the corporation the net sum of $700,000 for the entire tract.
(6) That Wester would prepare all papers and make all collections under the contracts of sale and make a monthly accounting to the corporation.
(7) That the agreement could not be assigned by Wester without the written consent of the corporation.
(8) That Wester should conduct the sales so that upon the termination of the agreement there would not be an undue proportion of the undesirable tracts.
(9) That in the event sales by Wester did not produce $75,000 per year for the account of the corporation "* * * this contract may be canceled by the company and thereupon an adjustment and settlement shall be made between the parties hereto based on their respective rights under the terms of this agreement."
(10) Article Twelfth of the contract read as follows:
"The company is to advance the 1921 taxes which are to be made a charge against the interest of the said Wester and carry interest at the rate of six per cent per annum and are to be repaid to the company*1103 by the said Wester within the period of two years from such advance. All taxes and assessments thereafter are to be paid by the said Wester before delinquency. The understanding and agreement of the parties contemplates the sole handling by the said Wester of all of said lands and the producing for the company in money and contracts of Six Hundred Thousand Dollars ($600,000.00) net and interest on deferred payments on contracts as above set forth, within a period not exceeding eight years from this date; and that any lands remaining unsold and any excess cash and real estate contracts over and above that amount, shall belong to and go to the said Wester as additional compensation for handling said property under the terms of this agreement, and that the said Wester will devote his best efforts to the carrying out of this contract until he has produced for the company the amount above mentioned as coming to it out of the sale of said lands."
All sales of land under the agreement were made on a form of contract in which the South Seattle Land Co. was named as the seller.
The contract of May 23, 1921, as amended, was in effect continuously until August 1931, when it was terminated*1104 by the South Seattle Land Co. on account of alleged default of petitioner Wester.
During the taxable years petitioner Wester received amounts from the South Seattle Land Co. for selling land pursuant to the terms of the contract. In returns filed on the comunity property basis, each petitioner included one-half of the amounts received as commissions *32 earned for selling real estate. In his computation of the deficiencies the respondent determined that in 1929 and 1930 petitioner Wester expended the following amounts, all of which the petitioners claimed as ordinary and necessary business expenses incurred in improving the property being sold by Wester:
| 1929 | 1930 | ||
| Monticello poultry house No. 1 | $55,036.92 | Monticello poultry house No. 1 | $2,030.42 |
| Monticello poultry house No. 2 | 33.59 | Monticello poultry house No. 2 | 20,377.16 |
| Monticello poultry colony house | 112.46 | Monticello warehouse | 445.18 |
| Industrial Insurance on labor pay roll | 1,065.25 | Monticello clearing | 6,252.68 |
| Monticello clearing | 12,525.87 | Development work, Beverly Park | 1,220.52 |
| Reservoir | 6,123.94 | Development work, Cedarhurst | 30.00 |
| Development work, Beverly Park | 921.25 | Development work, Monticello | 269.32 |
| Development work, McMicken Heights | 3,826.13 | Development work, Stimson Park | 111.55 |
| Development work, Stimson Park | 108.00 | Reservoir construction | 41.75 |
| Water system, Beverly Park | 127.29 | Water system, Beverly Park | 206.35 |
| Jensen well water system | 1,542.73 | Water system, McMicken Heights | 5,173.58 |
| Water system, McMicken Heights | 14,837.02 | Well No. 2 | 1,336.46 |
| Water system, Shields | 1,881.08 | Well No. 3 | 13.00 |
| Water system, Stimson Park | 1,585.30 | Development work, McMicken Heights | 3,774.20 |
| Total | 99,726.83 | Total | 41,282.17 |
*1105 The first three items in each tabulation represent the cost of poultry houses constructed by petitioner Wester on unsold land in the tract.
In his audit of the returns the respondent eliminated from gross income the amounts reported as commissions earned from selling real estate and, after increasing the expenditures for 1930 to $41,711.50 by the addition of an item of $429.33 for clearing land, disallowed the items as ordinary and necessary business expenses and determined that they were capital expenditures. He allowed recovery of the investment in the poultry houses by deductions for depreciation at the rate of 7 1/2 percent per annum. The respondent prorated the remaining items, plus amounts which petitioner Wester estimated he would expend on the land in the future for a like purpose, over the unsold tracts and treated the result as cost of the land to petitioner Wester. This alleged cost figure and, in addition thereto, the amount payable to the South Seattle Land Co. out of erach sale, he deducted from the selling price to determine the gain realized or loss sustained by petitioner Wester from sales made in the taxable yeats.
OPINION.
DISNEY: At the outset we are*1106 met with the contention of the respondent that the record is devoid of proof of any expenditure for any purpose. We can not so agree. The deficiencies involved herein were determined upon the basis of the Internal Revenue agent's reports, which reports set forth that petitioner Wester, as claimed by the petitioners in their returns, expended $99,726.83 in 1929 and $41,711.50 in 1930 in developing the real estate, and are made a part *33 of the deficiency notices by reference. The figures used by the respondent in the determination of the deficiencies are not only consistent with the returns of the petitioners, but in his answer to the petition filed in Docket No. 67036 he denies only such facts as are inconsistent with and contrary to his determination as stated in his notice of deficiency. Moreover, upon trial it was agreed by counsel that there was only one issue, the language being: "There is no issue with respect to the amount of income if it was in fact earned by Mr. Wester." This can only fairly mean that there was no controversy as to the amount of the expenditures.
The determination of the respondent is presumed to rest upon a correct determination of the facts. *1107 . There is no suggestion in the record before us that the figures used in arriving at the deficiencies in question are incorrect in any respect. Under the circumstances, it would be error for us to accept the correctness of the respondent's determination without recognizing the basis for the result he reached. .
The petitioners contend that the expenditures are deductible as ordinary and necessary business expenses, citing . In contending that we should sustain his determination, the respondent argues that the petitioners had an interest in the realty being sold and that, irrespective of the question of title, the expenditures were not ordinary and necessary.
In support of his view that Wester had sufficient title in the realty to require the expenditures in question to be capitalized as part of cost of the land on which the improvements were made, and to treat sales of parcels thereof as giving use to taxable gain to petitioner, the respondent cites *1108 , a case involving the identical contract before us. Our understanding of the court's ruling does not agree with the respondent's interpretation.
After the termination of the contract in August 1931, Wester filed a complaint in the Superior Court of King County for an order restraining straining the South Seattle Land Co. from canceling any of the sale contracts or options, from applying any of the moneys received thereunder other than in payment of delinquent taxes, from selling any lands upon which the permanent improvements were located, from interfering with his possession and operation of the poultry plant, and for an accounting for his equity in the contracts of sale, options, and permanent improvements made on the land. The pleading contained no allegation of interest in the realty other than the improvements made at the plaintiff's expense. Wester appealed from the court's decision that the complaint did not state a cause of action.
*34 The ultimate ruling of the appellate court was that the complaint, as amended, stated a cause of action for an accounting. In reaching its conclusion the court*1109 did not expressly or inferentially hold that the South Seattle Land Co. and Wester were joint owners of the property so as to require a severance of title in connection with the proceeding. It remarked that "The enterprise had in it something of the nature of a joint adventure or of a special and limited partnership", and that the interest of Wester in the "subject-matter" of the contract was such as to give him a right to an accounting. The premise for the decision was the well settled rule that equity will assume jurisdiction in cases where there is a complexity of mutual accounts and justice can not be done without an accounting. The plaintiff was entitled to receive a proportionate part of the money paid by purchasers of subdivisions prior to the termination of the agency contract, and, because of the complicated method adopted for apportioning receipts from sales, he would have been entitled to an accounting in equity irrespective of the fact that part of his compensation was contingently payable in real estate.
The lower court did not interpret the appellate court's decision as holding that the petitioner had a property interest in the realty. In its decree entered in*1110 1934 after trial it decreed the South Seattle Land Co. to be the sole owner of the contracts (for sales made by Wester), lands, and improvements existing on August 15, 1931, free from any claim which the plaintiffs may have had therein, without directing the plaintiffs to convey any interest in the property to the South Seattle Land Co.
In , the petitioner and others, as agents, agreed to pay part of the cost of preparing a tract of land for sale as lots and thereafter sell the land for the account of the owner. When the owner received the sum of $400,000 from sales as the purchase price of the land, they were to receive, as compensation for their services, the unsold lots in the tract and all contracts, notes and mortgages, and other proceeds of the venture. In 1923 Fletcher paid the sum of $7,921.62 as his share of expenditures made by the agents "in connection with platting, surveying and preparing the real estate involved for sale as lots." In holding that Fletcher was not required to capitalize the amount but was entitled to deduct it as an ordinary and necessary business expense, we said:
* * * The excess over the $400,000 was*1111 in fact compensation for services rendered as truly as if the owners had agreed to pay petitioner a straight salary or set commission. The expenditures made by petitioner in producing such income were in substance no different in principle from expenditures made by a lawyer in prosecuting his client's case on a contingent basis, which in the case of the lawyer are admittedly deductible. A taxpayer on the cash basis deducts his expenses when paid and reports his income when received. If, after petitioner receives his share of the property remaining unsold after the owners have *35 been paid their $400,000, he makes further expenditures of the same nature as the ones in question, such further expenditures must be capitalized and considered a part of the cost of the property received. But this is because he is then acting on his own account and not as the agent for others. The same rule applies in the case of the lessee of property. If the lessee makes improvements having a life in excess of the term of the lease, the lessee is entitled to deduct as additional rental the cost of such improvements spread over the remaining term of the lease, *1112 ; whereas, if such improvements were made by the owner of the property, a deduction to the owner would be based on the life of the improvements. * * *
A like situation prevailed here respecting all of the items in controversy excepting those relating to the Monticello poultry houses and warehouse. Petitioner Wester, as agent for the South Seattle Land Co. and in consideration of the payment to him of certain commissions for effecting sales of parcels of land for the owner, agreed to put the tract in condition for sale at his own expense. The nature of the undertaking required the facilities for which the outlay was made. The expenditures merely enhanced the value of another's property and did not result in the creation of a capital asset of Wester. The deductibility of an amount as an ordinary and necessary expense is ordinarily determined by the nature of the expense and not by the amount involved. In , we said, in disussing the question of capital expenditures as against business expenses, "this determination should not be made to depend alone upon whether*1113 they are major or minor items." Generally speaking, the fact that expenses are unusual in amount can not deprive them of their inherent character as expense items. . The amount of the expense in the Fletcher case was probably as large as the amount in controversy here, since Fletcher had only a one-sixth interest in the agency contract.
The petitioner received the moneys reported as income by him, from the owner of the land, as compensation for his services in handling the property. His contract was specifically one of agency. He never acquired ownership of any part of the land. If petitioner Wester had become entitled to a conveyance of unsold tracts upon the receipt by the owner of its share of the selling price, the fair market value of the land received would have been taxable to him as compensation for services rendered. ; affd., . Such amount would then constitute petitioner Wester's cost basis for the computation of gain or loss upon a subsequent sale. The amounts received by petitioner Wester in the taxable years were not paid to*1114 him on account of a property interest he had in the realty, but as partial compensation for services rendered in order to enable him to meet overhead operating expenses.
Following the reasoning of the Fletcher case, we hold that all of the expenditures in question, except the expenditures of $55,182.97 *36 and $22,852.76 made in 1929 and 1930, respectively, in connection with the construction of the Monticello poultry houses, are deductible as ordinary and necessary business expenses.
From the meager facts before us we are not warranted in concluding that the cost of the poultry houses should receive like treatment. Aside from the proof made by the petitioners that the plants were located on unsold land in the tract owned by the South Seattle Land Co., we have no competent evidence as to the circumstances surrounding the investment to overcome the presumption that the respondent's determination rests upon a correct finding of the facts. Nothing appeared in the contract of May 23, 1921, as amended, obligating petitioner to make the investment and such poultry houses are not of the character of improvements, such as grading, etc., which are ordinarily associated with*1115 the sale of lots such as here involved. For aught we know there may have been an agreement between the owner of the land and petitioner Wester giving the latter title to the improvements at least during the effective period of the agency contract.
In computing the deficiencies the respondent allowed deductions for exhaustion at the rate of 7 1/2 percent per annum on cost. Such action has not been shown to be error and will not be disturbed.
Reviewed by the Board.
Decision will be entered under Rule 50.
STERNHAGEN and MELLOTT dissent.