1932 BTA LEXIS 1177">*1177 1. Various expenditures incident to incorporation, a bond issue, and erection of a hotel held not deductible in full in the year made.
2. Other expenditures made to hasten the erection of the new building held not deductible in full from income of the period prior to the estimated date for completion of the building without such expenditures.
26 B.T.A. 1192">*1192 The Commissioner determined deficiencies as follows:
| Calendar year | |||
| petitioner | Docket No. | 1922 | 1923 |
| W. P. Brown & Sons Lumber Co | 39970 | $19,594.01 | $1,901.14 |
| Brown Brothers Land & Lumber Co | 39971 | 6,235.07 | 4,369.05 |
26 B.T.A. 1192">*1193 The cases were consolidated. The parties filed a stipulation which will enable them to settle the case at Docket No. 39971 under Rule 50. The stipulation will also enable them to settle under Rule 50 certain issues raised in Docket No. 39970.
There is left for our consideration and decision the following assignments of error in Docket No. 39970:
1. Consolidated net income for 1922 is overstated by the following deductions claimed1932 BTA LEXIS 1177">*1178 by the Brown Realty Company and disallowed by the Commissioner:
| Incorporation expense | $507 |
| Title examination and recording | 341 |
| Attorney's fees | 1,500 |
| 2,348 |
2. Consolidated net income for 1922 is overstated by $1,815 representing the amount paid by the Brown Realty Company as insurance premiums against any liability arising incident to the erection of the Brown Hotel.
3. Consolidated net income for 1923 is overstated by $9,500 representing part of the total expense of $10,000 incurred by the Brown Realty Company in procuring a loan secured by the issuance of 20-year bonds.
4. Consolidated net income for 1923 is overstated by $59,479.18 representing the additional cost of erecting the Brown Hotel at an earlier date than was originally projected, $650 having been expended in 1922 and the balance in 1923, the total being either ordinary expenses or extraordinary depreciation in 1923.
FINDINGS OF FACT.
W. P. Brown & Sons Lumber Company and the Brown Realty Company are affiliated corporations having their principal places of business in Louisville, Kentucky. Their income-tax returns for 1922 and 1923 were filed at Louisville. The former corporation1932 BTA LEXIS 1177">*1179 owned all of the stock of the other except a few qualifying shares.
In November, 1922, the Brown Realty Company began the erection of a fifteen-story building to be known as the Brown Hotel located at Broadway and 4th Street in Louisville. It made no general 26 B.T.A. 1192">*1194 contract for the erection of the building but executed separate contracts with the various builders.
During the year 1922 the Brown Realty Company paid out the following amounts for the purposes indicated and deducted the total as expenses for the year:
| Incorporation expenses: | |
| License tax fee | $500 |
| Recording fee | 7 |
| Title examination and recording | 341 |
| Share of attorney's retainer | 1,500 |
| Total | 2,348 |
The Commissioner disallowed the deduction in determining the deficiency and added it to the cost of the building for depreciation purposes.
A group of corporations, which included the Brown Realty Company, employed an attorney in 1922 at an annual retainer $7of,500. Of this amount $1,500 was charged to the Brown Realty Company as a fair amount based upon the size of that company as compared to the others in the group. During the erection of the Brown Hotel this attorney attended to contracts1932 BTA LEXIS 1177">*1180 with builders, settled accident claims, attended to rental agreements between the owner and the operating company, passed upon papers in connection with a loan, represented the owner in the matter of the proposed widening of 4th Street, and advised and rendered other services to the Brown Realty Company.
In 1922 the Brown Realty Company paid $1,815 as advance premiums on an owner's contingent liability insurance policy expiring in one year. The policy was taken out some time in the latter part of 1922 to protect the owner and the W. P. Brown & Sons Lumber Company from liability growing out of the construction of the hotel. The Commissioner disallowed the deduction of this item as an expense for 1922 in determining the deficiency and added it to the cost of the building for depreciation purposes.
During the year 1923 the Brown Realty Company paid $10,000 as expenses for securing a loan, for which 20-year bonds were issued by that company. The Commissioner allowed a deduction of $500 of this amount and disallowed the deduction of the balance of $9,500, on the theory that the expense should be prorated over the life of the loan.
The $10,000 was paid under an agreement whereby1932 BTA LEXIS 1177">*1181 S. W. Straus & Company purchased $2,350,000 of the construction bonds of Brown Realty Company payable over a period of twenty years and was to cover all reasonable attorney's fees incurred by the purchaser for legal services in examining and passing on the title to the property, 26 B.T.A. 1192">*1195 in preparing the bonds and trust deed, and all other legal services connected with the making of the bond issue, cost of preparing, engraving and lithographing the bonds and printing the trust deed, printing and mailing circulars, procuring a water color picture of the building, guarantee survey, certification of bonds by the trustee and all other expenses connected with the making of the bond issue.
In November, 1922, the Brown Realty Company began wrecking the old buildings at Broadway and 4th Street in Louisville to make way for the erection of the Brown Hotel. It estimated that the building could be completed under normal working conditions in February or March, 1924. The building was actually completed in the early part of October, 1923. In order to hasten the work, the Brown Realty Company paid a bonus to wreckers and the concrete contractor, paid the excess of overtime wages of certain1932 BTA LEXIS 1177">*1182 workers over their normal wage, and paid other amounts which otherwise it would not have paid. It expended the following amounts in connection with the erection of the hotel for the purposes shown:
| 1. Plasters (excess of overtime union wage over regular | |
| union wage) | $24,382.49 |
| 2. Brick masons (excess of overtime union wage over | |
| regular union wage) | 3,919.26 |
| 3. Hod carriers (excess of overtime union wage over | |
| regular union wage) | 922.03 |
| 4. Concrete (bonus for completing work ahead of schedule) | 9,800.00 |
| 5. Wrecking (bonus for completing work ahead of schedule) | 650.00 |
| 6. Drayage (furniture ordered in advance to avoid delay) | 742.09 |
| 7. Storage until hotel was completed (furniture ordered | |
| in advance to avoid delay) | 500.00 |
| 8. Poles for electric light wires while excavating | 89.26 |
| 9. Electric light | 292.89 |
| 10. Light bulbs | 2,244.71 |
| 11. Excess of union over nonunion wages for hod carriers | 5,094.38 |
| 12. One-half cost replacing sidewalk destroyed during | |
| construction (other one-half allowed as deduction) | 952.50 |
| 13. Watchmen's wages | 3,536.20 |
| 14. Power for temporary elevator | 58.15 |
| 15. Workmen's compensation insurance | 365.40 |
| 16. Cost of small tools which disappeared | 679.70 |
| 17. Temporary canopy and walk over sidewalk | 362.20 |
| 18. Repairs to temporary walk | 10.80 |
| 19. Temporary protection to roof of adjoining building | 156.20 |
| 20. Chute to lower debris to street | 56.45 |
| 21. Railroad fares for out of town carpenters | 219.24 |
| 22. Carpenter foreman hotel bill | 347.60 |
| 23. Office supplies, telephones, telegrams, etc | 1,217.09 |
| 24. Hoisting engineer's salary | 300.00 |
| 25. Hoist repairs | 28.96 |
| 26. Temporary cloth covering for elevator doors | 74.80 |
| 27. Drayage | 2.00 |
| 28. Miscellaneous expense | $82.84 |
| 29. Temporary shed for tools | 24.70 |
| 30. Express on test tubes for concrete | 72.50 |
| 31. Water | 619.83 |
| 32. Sewer connection | 191.17 |
| 33. American flag | 3.25 |
| 34. Hardware | 10.19 |
| 35. Paper | 9.80 |
| 36. R. B. Tyler special | 1,090.71 |
| 37. Cost of signs leased for profit | 369.79 |
| Total, deducted on return and disallowed by Commissioner | 59,479.18 |
1932 BTA LEXIS 1177">*1183 26 B.T.A. 1192">*1196 Items 1, 2, and 3 were paid in addition to the contract prices in order to have the contractors work their men overtime. The work was done in 1923.
The contract for concrete work specified bonuses and penalties for completing each floor ahead of or behind schedule. Item 4 is the total bonus earned by the contractor under this contract in 1923.
The contract for wrecking old buildings provided that a daily bonus or penalty should be paid depending upon whether the work was completed before or after November 18, 1922. Item 5 is the total bonus earned by the contractor under this contract and paid to him in 1922.
The record does not disclose the amount, if any, by which item 6 would exceed the cost of drayage had the furniture been put into the hotel directly upon arrival.
During the construction of the hotel, electric lights were used to illuminate the temporary covered walks over the sidewalk, parts of the premises where workmen needed light, advertising signs leased at a profit to the owners, and for other purposes. No segregation of the cost of light and bulbs for these various purposes can be made from the record. The bulbs were used, broken, lost, 1932 BTA LEXIS 1177">*1184 or stolen.
The contract for brickwork provided that if union hodcarriers and mason's tenders were employed, the owner should pay any additional cost of such labor over nonunion wages. Item 11 is the amount paid under this provision when the bricklayers demanded the employment of union men.
At night the temporary elevator was used to carry workmen to and from work.
The owner erected temporary signboards on the premises and leased them for profit during the construction period. Item 37 represents the cost of erecting these signs.
The items shown in the above list were all charged on the books of the corporation to expense except items 4 and 5, which were charged to capital account.
26 B.T.A. 1192">*1197 The gross income of the hotel was, for the last three months of 1923, $200,596.41; for January, 1924, $101,271.94; and for February, 1924, $112,685.37.
The expenditures made to hasten the erection of the building did not serve to produce a better building than would have been secured without such expenditures had a longer time been taken to erect it.
OPINION.
MURDOCK: No evidence was offered in explanation of the incorporation expenses, amounting $507to, or the title1932 BTA LEXIS 1177">*1185 examination and recording, amounting to $341. Apparently the Brown Realth Company was incorporated in the fall of 1922. Expenses incident to incorporation are not deductible as ordinary and necessary expenses of carrying on a business in any one year, but are capital expenditures relating to the entire period of corporate life. The cost of title examination and recording of a deed to the hotel property, if that is what the other item represents, is a part of the cost of the property and is not deductible as an ordinary expense of the year paid.
In 1922, the year for which the attorney was paid $1,500 by the Brown Realty Company, the company was carrying on no business That we know of in which it used the services of this attorney. Instead, it was building a hotel so that later it could carry on a business. All of the services of the attorney related to the construction of this building and perhaps to the organization of the corporation. He may also have had something to do with the loan secured by a bond issue maturing over 20 years, although the testimony is not clear on this point. The cost of legal services incident to the erection of the building is properly a part of1932 BTA LEXIS 1177">*1186 the cost of the building. Those incident to organization should likewise be capitalized. Expenses of a loan should be spread over the life of the loan. So under no circumstances appearing in the record would this fee be deductible in its entirety in 1922. In fact, we can not say that any part of it should be deducted for that year. The Commissioner did not err in this respect.
The insurance premium mentioned in the second assignment of error, of course, added nothing to the value of the building, but such insurance is certainly not unusual in the construction of a building of the size of this hotel. If the petitioner were claiming it as part of the cost of the hotel, what defense would there be to the claim? It had no relation to any business carried on by the petitioner during the year 1922. It was properly treated by the Commissioner as a part of the cost. Cf. Columbia Theatre Co.,3 B.T.A. 622">3 B.T.A. 622.
The $10,000 expense of the bond issue was a part of the cost of securing the loan, a continuing benefit, and not an ordinary and 26 B.T.A. 1192">*1198 necessary expense attributable to carrying on the business in any one year. The Commissioner spread this expense ratably1932 BTA LEXIS 1177">*1187 over the life of the loan. No greater amount was deductible in the year before us than the Commissioner has allowed. Julia Stow Lovejoy,18 B.T.A. 1179">18 B.T.A. 1179; Sigmund Spitzer,23 B.T.A. 776">23 B.T.A. 776.
In our findings of fact we have listed the various items totaling $59,479.18 which the petitioner claims were incident to speeding the completion of the building. We have also explained the nature of each item as fully as the evidence permitted. For some items the record contains no explanation. In many instances the explanation fails to identify the item with the speeding-up process. While in others the expenditure is shown to have had no connection with this process. On any theory of the case such items may not be deducted from income of one year but must be left where the Commissioner placed them, as part of the cost of the building.
Decision of the question of whether or not an expenditure should be classified as capital or expense depends upon the exercise of judgment in the light of circumstances and good accounting principles. Cf. 1932 BTA LEXIS 1177">*1188 Rankin v. Commissioner, 60 Fed.(2d) 76. There are in the list before us a number of relatively small items which under other circumstances might form the basis of a deduction as ordinary expenses or losses. But where, as here, they were incurred in the ordinary course of erecting a building which was to become the principal business asset of the corporation, they should be included in the cost of the building. Liability insurance, loss of small tools, wages of watchmen necessary during the construction period, and telephone and telegram expense incident to construction, are some of the items we have in mind.
There are some items in the list, however, which were definitely and solely related to expedition in the completion of the building. This group would include the first three items representing the "overtime" paid by the Brown Realty Company. The company had contracted for the performance of certain work at a certain price based upon an 8-hour working day. In order to hasten this work the Brown Realty Company agreed to pay the contractor the difference between the amount charged by the workmen for working overtime and the amount they would have charged1932 BTA LEXIS 1177">*1189 had the same hours been spent during a normal working day. Obviously, the amounts thus paid benefited the owner in only one way, i.e., they permitted the building to be occupied and used at an earlier date than otherwise. Likewise, items 4 and 5 fall within this group. The contracts there fixed certain times for the completion of certain work, with penalties for delay and bonuses for days saved. In both instances bonuses were earned, so that the owner paid something 26 B.T.A. 1192">*1199 for speed over what it would have paid had the work progressed only as rapidly as the parties had agreed was a normal rate. The only difference is that here the normal depends upon the agreement of the parties, whereas the union wage scale fixed the normal and overtime wages from which the first three items were determined. The furniture storage charge and at least a part of the drayage would also come within this group.
The cost of electric light (poles, current, and bulbs) incident to overtime work would be a similar expenditure. But the amount thus spent can not be determined from this record. The poles were for excavation, not for wrecking. We do not know that the excavating was rushed on an1932 BTA LEXIS 1177">*1190 overtime basis, nor that it cost in all more than a normal amount. The items for light and bulbs included light for the temporary sidewalk and canopy, light for the advertising signs, and perhaps some normal charges for light in the building. These items can not be charged entirely to overtime work. Nor is there any basis in the record for a segregation. We can not see that the excess of union over nonunion wages for hodcarriers bears any relation to the speeding-up process. Originally, the cheaper non-union labor was employed and the owner and contractor thought they could continue to use it. The other workmen insisted later upon the employment of union labor to perform these functions. This entailed additional cost which the owner had to pay, but it did not hasten completion of the work. The building cost just that much more than it would have cost had they been able to use non-union labor. Suppose all wages had increased, would the increase be other than cost of the building or have any relation to time of completion? Item 37, the cost of erecting temporary signs leased for profit, is no part of the cost of the building, but an expense incident to earning some income in1932 BTA LEXIS 1177">*1191 1923. It was a proper deduction in that year. The other items are so clearly unrelated to the time element or are so inadequately explained as to require no particular discussion.
The petitioner contends that the overtime, bonus and storage items, which were expended solely for the purpose of advancing the day when the hotel could be used to produce income, should be offset as deductions against the earnings from the hotel for the initial period of use made possible by those expenditures, i.e., the last three months of 1923 and the first two months of 1924. The latter months are not before us and our question is whether any portion of these expenditures should be offset against the earnings of the last three months of 1923 as ordinary and necessary expenses of carrying on the business during these months or as a measure of extraordinary depreciation during this period. It does not appear, however, 26 B.T.A. 1192">*1200 that any extraordinary depreciation or exhaustion of the property took place during this period and there is no basis for a deduction under section 234(a)(7), unless a rule should be applied such as is used to justify spreading the cost of a loan over the period that the1932 BTA LEXIS 1177">*1192 borrower has the use of the money.
In O.D. 664, 3 C.B. 131, a bonus paid for early delivery of a steamship was held to be an ordinary and necessary expense deductible from income received between the date of delivery and the date it would have been delivered had no bonus been paid. The Commissioner has taken a different view, however, in the present case, which involves a new building instead of a vessel. Cf. Tonningsen v. Commissioner, 60 Fed.(2d) 199. The petitioner also cites two decisions of the Circuit Court of Appeals for the Third Circuit. Atwater Kent Mfg. Co. v. Commissioner, 43 Fed.(2d) 331, and Frank & Seder Co. v. Commissioner, 44 Fed.(2d) 147. These two cases reversed Board decisions reported at 15 B.T.A. 881">15 B.T.A. 881, and 13 B.T.A. 1">13 B.T.A. 1, respectively.
Arguments advanced in support of the petitioner's contention are not without persuasive force. But we must interpret the law as we find it and can not make exceptions, no matter how reasonable they may appear to be. The general rule is that the cost of capital assets is to be recovered through depreciation during use. Section1932 BTA LEXIS 1177">*1193 215(a)(2) of the Revenue Act of 1921 provides that no deduction shall be allowed in any case in respect of "any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate." Section 235 makes this provision applicable in computing the net income of corporations. The amounts in question were paid out for new buildings. It is immaterial that they did not increase the value of the property in the sense of making the building a better building than it would have been otherwise. The phrase "made to increase the value of any property or estate" modifies "permanent improvements or better-ments" and can not modify "new buildings" without violence to grammatical construction and without giving to the words other than their ordinary meaning. It would be both unusual and awkward to speak of "new buildings made to increase the value of any property or estate," but quite proper to speak of "permanent improvements or betterments made to increase the value of any property or estate." The words "or for" after "new buildings" indicate clearly that the latter only was intended. Thus the statute specifically and clearly provides1932 BTA LEXIS 1177">*1194 that the income may not be reduced by the amount in question. Cf. Robert Buedingen,6 B.T.A. 335">6 B.T.A. 335.
Judgment will be entered under Rule 50.