*3431 The Commissioner's determination that a hotel leasehold had no value when assigned to the petitioner in exchange for $200,000 par value of its capital stock is approved. The Commissioner's determination was corroborated by a dealing at arm's length between the lessor and the original lessee six weeks before the assignment and the opinion evidence offered by the petitioner to prove value is insufficient to overcome the determination of the Commissioner, strengthened by the corroborating facts.
*844 This is a proceeding for the redetermination of deficiencies in income and profits taxes for the following years in the following amounts:
| Year: | Deficiency |
| 1919 | $1,564.85 |
| 1920 | 2,653.96 |
| 1921 | 7,872.13 |
| 1922 | 14,466.93 |
| Total | 26,557.87 |
It is alleged that the Commissioner erred in refusing to allow any amount representing the cost of a hotel leasehold for the purpose of computing an allowance for exhaustion thereon and the gain or loss on its sale.
FINDINGS OF FACT.
The petitioner during the years for which the deficiencies are*3432 asserted operated the Planters Hotel in the City of St. Louis, Mo. During this time and prior thereto, the property was owned by the Commonwealth Realty & Hotel Co., the stock of the latter corporation being held for the most part by various estates and trusts. The property had been used for hotel purposes under the name "Planters Hotel" for approximately 100 years and during that period the hotel had acquired a national reputation. The building which was on the *845 property during the taxable years in question was constructed in 1894. For some time prior to the year 1918 the hotel had been operated by a company known as the "Planters Hotel Company," which early in the year 1918 had been unsuccessful in its operation and was in default in its rental payments. The Commonwealth Realty & Hotel Co., therefore, in April, 1918, took over the lease and all the stock of the hotel at a valuation of 40 cents on the dollar, and gave to the former operating company certain stock in the Commonwealth Realty & Hotel Co.
For a short time after taking over the lease the Commonwealth Realty & Hotel Co. attempted to operate the hotel but met with little success and through its officers*3433 made attempts to find a new lessee who could operate the hotel satisfactorily. It was considered that the furniture and equipment of the hotel was somewhat out of date and that it would be necessary to invest $100,000 to $150,000 in betterments and improvements in order that the hotel might be operated successfully in competition with other hotels in the city. The Commonwealth Company, therefore, began negotiations with prospective lessees who might be able to operate the hotel successfully and advance the necessary amount for refurnishing. After some time spent in such negotiations it finally, on August 29, 1918, entered into a lease with Theodore B. Baker, a reputable hotel operator whom it considered to be the best man available, both from the standpoint of his ability to manage a hotel and to advance the necessary money.
The lease was for a term of 10 years and provided for an annual rental of 10 per cent of yearly gross receipts, payable by the lessee to the lessor monthly on or before the 15th day of each month with the further provision that if in either of the first two years the gross income should fail to equal $550,000 a year, or if in any subsequent year during the*3434 period of the lease the gross income should fail to amount to $650,000, the lessor should have the right to terminate the lease by giving the lessee six months' notice in writing of its intention so to do. The lessee further covenanted to expend within one year from the date of the lease for betterments and improvements the amount of $50,000 and in addition to advance to the lessor's account no less than $50,000 and no more than $100,000 to be expended for betterments and improvements, the sum so advanced to be repaid to the lessee by the lessor out of those rents received by the lessor under the terms of the lease, which should exceed the fixed charges against the property each year until the whole sum was repaid, the total fixed charges not to exceed the sum of $62,500. This latter sum so advanced by the lessee was not to bear interest within the first two years after the execution of the lease but thereafter was to bear interest at 6 per cent a year. The lease further provided that *846 the lessee should have the right to assign the lease to a corporation to be organized under the laws of the State of Missouri for the purpose of conducting a hotel business, the said corporation*3435 assuming all of the obligations of the lessee, but after such assignment should have been made by the lessee no further assignment should be made without the written consent of the lessor and any assignee should take over the lease subject to all of the conditions and agreements contained in the lease and not otherwise.
On November 12, 1918, Theodore B. Baker, the original lessee, assigned the lease to the petitioner herein and received therefor $200,000 par value of the petitioner's capital stock.
The petitioner was incorporated on September 21, 1918, and had an authorized capital stock of $250,000 par value, of which stock $30,000 was issued for cash, $20,000 for notes, and $200,000 for the lease, as above set forth. A portion of the minutes of a meeting of the board of directors of the petitioner held on October 1, 1918, is as follows:
It was moved, seconded and unanimously carried that the officers of this Company be instructed to carry out the terms of a contract between C. C. Nelson and Theodore B. Baker and Planters Operating Company, which is as follows:
1st: That 2000 Shares of Stock in the Treasury of this corporation procured by C. C. Nelson withdrawing his subscription*3436 for that number of Shares, be issued to C. C. Nelson and Theodore B. Baker in consideration of the following:
2nd: C. C. Nelson and Theodore B. Baker in part consideration of said stock shall assign and transfer to this Company a Lease covering on property located in the City of St. Louis, State of Missouri, to-wit:
All of a certain ten-story brick building, situated on the East Half of Block No. One Hundred One (101) of said City of St. Louis, the same being bounded on the East by Fourth Street, on the North by Pine Street, on the South by Chestnut Street, and on the West by a private alley, said portion of said Block hereby conveyed having a frontage on the West side of Fourth Street of two hundred thirty feet and four inches (230' 4") and a depth from Fourth Street westwardly of one hundred and twenty-five feet six inches (125' 6") more or less to said private alley.
And Theodore B. Baker shall assume the management of the hotel property covered by said Lease and manage same to the best of his ability in the interest of this Company for a reasonable compensation to be agreed upon.
3d: Said C. C. Nelson and Theodore B. Baker personally guarantee this Company a net profit*3437 from the operation of said Hotel sufficient to comply with Paragraphs Seventeen and Eighteen of said Lease and agree personally to make up any deficit and supply this Company with sufficient funds out of said net profits, or from their own funds if necessary, to enable this corporation to fully comply with said Paragraphs Seventeen and Eighteen in said Lease and prevent a forfeiture of said Lease for non-compliance with said Paragraphs.
Paragraphs 17 and 18 of the lease referred to the amounts to be expended and advanced by the lessee for betterments and improvements. At the time the lease was assigned, C. C. Nelson and Theodore B. Baker owned nearly all of the stock of the petitioner.
*847 On November 24, 1922, the Commonwealth Realty & Hotel Co. and the petitioner entered into the following agreement in accordance with which the petitioner canceled its lease and received from the Commonwealth Realty & Hotel Co. the sum of $200,000:
NOVEMBER 24, 1922.
The PLANTERS OPERATING COMPANY,
Saint Louis, Missouri.
GENTLEMEN: We hereby exercise the option extended to us under date of December 13, 1921, in paragraph seven of our letter of said date addressed to you*3438 which said option was thereafter approved in writing at end of our letter of December 13, 1921, to you by you and by the stockholders of your company. The terms of said option have been further modified by the writer to you on November 16, 1922, and modified by your memorandum of acceptance on said letter of November 16, 1922.
It is understood that you are to deliver to us the real estate known as The Planters Hotel building and property together with the window screens and window shades and all electric fixtures above the second floor, also all toilets, washstands and bath tubs located in halls of said building above the second floor and other items not listed as furniture and fixtures in the appraisal made by the American Appraisal Company of Milwaukee, under date of May 3, 1919, (excepting such furniture and fixtures as have heretofore been junked or sold) and excepting such items as have been purchased and installed by you as replacements or as additional furniture and fixtures.
You are to retain the items purchased and installed by you and the furniture and fixtures as listed in said American Appraisal Company's list, (less those heretofore junked or sold), also all bath*3439 tubs, all toilets, all washstands and fixtures (less those in the halls retained by you) also all electric light fixtures below the third floor, as your own property, and remove same at your own expense not later than January 7, 1923.
Upon your acceptance of this proposition we are to pay you the sum of $100,000.00 and pay you an additional sum of $100,000.00 on the day you deliver possession of said Planters Hotel and property herein referred to in accordance with the above terms, but not later than January 7, 1923.
For said $200,000.00 you are to vacate to us and give possession of said Planters Hotel property, cancel the lease now held by you and made by us and also cancel all claims of all kinds held by you against us.
You are to have and retain possession of the property, rent free, to January 7th, 1923, from Nov. 24, 1922, both dates inclusive. In the event the building is not vacated and possession of same and said property delivered to us in accordance with the foregoing terms, then and in that event we shall be entitled to retain from the said sum of One Hundred Thousand ($100,000.00) Dollars (constituting the second payment to you) One Thousand ($1,000.00) Dollars*3440 for each day of delay thereafter; this sum of One Thousand Dollars per day to be liquidated damages, but not to limit our recovery in excess of this in case that we can prove greater damages on account of said building not being completely evacuated by January 7, 1923, in accordance with the terms of this agreement. This agreement runs to ourselves and our assigns.
The foregoing provision with reference to damages is included herein in view of the fact that we have contracted as owners to sell the Planters Hotel building and real estate and personal property hereinbefore mentioned to John M. Robertson or his assigns, and have agreed to deliver complete and unencumbered *848 possession thereof to said Robertson or his assigns not later than January 7, 1923, and to pay him or his assigns as liquidated damages, the sum of One Thousand ($1,000.00) Dollars for each day's delay thereafter, said sum of One Thousand ($1,000.00) Dollars not being intended as a limit to his damages in case he can prove greater damages for failure to deliver complete and unencumbered possession as aforesaid by said date.
Respectfully yours,
COMMONWEALTH REALTY & HOTEL COMPANY,
(Signed) By W. *3441 S. THOMPSON, President.
The above proposition was duly accepted by the petitioner.
The Commissioner in computing the petitioner's tax liability for 1922 considered the whole amount of $200,000 as income and also allowed the petitioner no deduction for exhaustion of the leasehold during the taxable years 1919, 1920, 1921, and 1922.
OPINION.
MURDOCK: The petitioner and the respondent agree that the only issue in the case is the cost to the petitioner of the leasehold when acquired on November 12, 1918, since the cost must be the basis for computing the gain or loss on its cancellation in 1922 and for exhaustion purposes during the four taxable years in question. In order to prove the cost of the leasehold for which it exchanged $200,000 par value of its capital stock, the petitioner has attempted to show that the leasehold had a value of at least $200,000 at the time of the transfer while the Commissioner has determined that "no value should be assigned to the leasehold for depreciation purposes or as a basis for the computation of the profits realized upon its sale in 1922."
It appears from the testimony that prior to the execution of the lease in question the hotel*3442 had been unsuccessfully operated by the owner and the prior lessee. Before entering into the lease the owner had negotiated with several prospective lessees, none of whom would agree to pay the amount of rent and to pay out and advance for betterments and improvements the amounts which were finally agreed to be paid by Baker. These facts would seem to show that the lessor had made every attempt to procure and did procure all that the property was worth when it made the lease, and that the lease so made had no bonus value at the time over and above the amounts agreed to be paid. It is further shown by the testimony that there was no market for hotel leases in the city at that time and that the value of the lease, if any, did not increase between the date it was made and the date when it was acquired by the petitioner some six weeks later.
All these facts corroborate the Commissioner's determination that the lease had no bonus value when assigned. The petitioner therefore had the task of convincing us by its evidence that the Commissioner's determination, strengthened by the facts indicated above, is incorrect *849 and that when assigned to the petitioner the lease had*3443 some cash value.
In order to meet the burden of proving value, the petitioner offered the opinion testimony of three witnesses, all of whom had been engaged in the hotel business as managers or owners during the year 1918 and prior thereto. Even if it be assumed that as managers they were qualified to give an opinion as to the cash value of a hotel lease, the weight to be attached to their opinions also depends upon whether or not they were familiar with the property in question and the conditions at the time and on whether or not they have used proper bases or factors in arriving at their valuations.
In the opinion of all three witnesses the lease had a cash value of $200,000 or more at the time of its assignment. However, an examination of their testimony will show that one witness, Clancy, based his opinion upon the belief that the Planters Hotel property was worth $2,000,000, and that a fair return thereon was 7 per cent or $140,000 a year which he compares with a rental of $65,000 a year, an amount which he seems to assume was the rental the lessee would be required to pay. He has also testified that he himself would not have paid $200,000 for the lease unless he was*3444 assured the hotel would do $2,000,000 worth of business yearly. It is apparent that if the hotel did a business of this amount the lessee would be required to pay $200,000 as rental under the terms of the lease, which would exceed by $60,000 the amount which the witness considered a fair rental. In addition there is no satisfactory basis for a $2,000,000 valuation of the hotel property, and this valuation is merely an assumption on the part of the witness.
The remaining two witnesses have set a fair rental value for the property based upon an amount varying from $20 to $30 for each room-month, and, by substracting from a total yearly rental so computed a minimum yearly rental of $65,000, have found an estimated profit to the lessee for each year and thus have formed their opinions as to the cash value of the lease. The lease provides for no definite amount as rental, but only for a certain percentage of gross receipts. The witnesses may possibly have had the nature of this rental in mind when they gave their opinions as to values but it is difficult to see any connection between a rental of this kind and a rental of 7 per cent of an estimated valuation of the physical property*3445 or a yearly rental based upon a monthly value of each room in the hotel, and when the witnesses use for their comparison a rental of $65,000 a year it is seen that they have clearly misunderstood the requirements of the lease as to the rentals which were to be paid. A careful consideration of the testimony of these three witnesses forces us to hold that regardless of their qualifications their opinions depend *850 upon an erroneous understanding of the real terms of the lease and that their comparisons between the rentals set forth therein and the rentals which they consider to be fair are so confusing that their opinions can not serve to overcome a value set by parties dealing at arm's length within such a short period of time before the assignment. See ; ; and .
The petitioner in its brief points out that the lease was canceled in 1922 by the lessee upon the receipt of the sum of $200,000, and that this fact establishes the value as of that date which value would not be more than the value in November, 1918. However, *3446 we can not see that the amount paid by the lessor in 1922 was any indication of the value of the lease in 1918. New circumstances and new considerations were present in 1922 which were not present in 1918. Indeed, the testimony shows that this amount was paid so that the lessor could deliver possession upon the sale of the premises at that time to a prospective purchaser unhampered by a lease thereon.
The Commissioner has indicated in his deficiency letter that if the petitioner were able to prove the amount which it spent in betterments and improvements in accordance with the lease, he would allow exhaustion thereon and a deduction of its unextinguished value for the purpose of computing gain or loss upon the cancellation in 1922. This would seem to be a proper allowance. See ; ; . However, the petitioner has not seen fit either to allege or to prove the amount of any such expenditure and in the absence of such allegation or proof no amount can be allowed.
Judgment will be entered for the respondent.