*28 Decisions will be entered under Rule 50.
Petitioner inherited an interest in an income-producing building erected prior to the decedent's death by a lessee. The building was erected at the lessee's expense and was occupied under a lease which extended beyond the useful life of the building, and the lessee was obligated, upon expiration of the lease, to yield up the building, wear and tear excepted, in a good tenantable condition. Held, the petitioner had a basis for depreciation based on the fair market value of the building at the time she acquired her interest in it by inheritance from her mother. See section 113 (a) (5), I. R. C.Charles Bertram Currier, 7 T. C. 980, followed. Milton H. Friend et al., Trustees, 40 B. T. A. 768; affd., 119 Fed. (2d) 959, distinguished.
*851 These proceedings, which were consolidated, involve deficiencies*29 in income tax for the taxable years 1943, 1944, and 1945, as follows:
| Docket | ||||
| Petitioner | No. | 1943 | 1944 | 1945 |
| J. Charles Pearson, Jr | 20413 | $ 239.08 | $ 397.54 | $ 210.98 |
| Helen Blesi Pearson | 20414 | 1,498.00 | 533.37 | 576.94 |
The deficiencies in each of the above dockets are primarily due to the disallowance of a deduction for depreciation for each of the years involved on certain property known as the Gulf States Building, Dallas, Texas. The respondent explained this adjustment in a statement attached to the deficiency notices, as follows:
No deduction for depreciation is allowable in respect of the Gulf States Building for the reason that your interest in the building at date of inheritance is *852 limited to the present worth of the right to acquire beneficial possession of the building in 1985 after the expiration of its estimated useful life.
The petitioners contest this adjustment by appropriate assignments of error.
The petitioners in each of the above dockets also contested by appropriate assignments of error the disallowance of medical expenses and contributions for each of the years 1944 and 1945. No evidence was introduced with regard thereto and*30 these assignments of error have apparently been abandoned. Effect will be given thereto in the recomputation under Rule 50.
Petitioner in Docket No. 20414 also alleged that in the year 1945 the respondent erred in failing to allow an additional credit for exemption. At the hearing this assignment of error was waived.
The sole issue, therefore, is whether respondent erred in denying a deduction for depreciation to petitioners on the Gulf States Building, in which one of the petitioners had an undivided one-third interest, where the building was built by the tenant under a lease for a term of years ending beyond the agreed useful life of the building.
FINDINGS OF FACT.
The stipulated facts are found as stipulated.
Petitioners, husband and wife, during the tax years 1942 to 1945, inclusive, were residents of Dallas, Texas. They filed separate income tax returns for these years with the collector of internal revenue, Dallas, Texas. Helen Blesi Pearson will hereinafter be referred to as the petitioner. The rentals for the property here involved and the depreciation deductions which the respondent has disallowed were returned by the Pearsons on a community property basis.
Under date*31 of March 1, 1919, petitioner's grandparents, Charles T. Rowan and Ellen Rowan, executed a lease on their community property described as lot 8 in block 69 1/2 according to the official map of the city of Dallas, Texas, fronting 50 feet on the north line of Main Street and 100 feet on the west line of North Akard Street, more or less, being in the very center of downtown Dallas, the property now being known as the Gulf States Building. The lease was for a term of 66 years and 10 months beginning March 1, 1919, and ending December 31, 1985. For convenience, the lessors and lessees involved herein, in whom there were some changes, are referred to hereinafter as the lessor and the lessee.
On July 14, 1919, Charles T. Rowan executed a warranty deed conveying his entire interest in the property to his wife, Ellen Rowan. Charles T. Rowan died July 30, 1924.
On August 10, 1924, Ellen Rowan, then a widow, executed a warranty deed conveying her interest in this property in equal shares to *853 her three children, Albert L. Rowan, Roberta L. Freenor, and Mae Lee Blesi, mother of petitioner, for a recited consideration of $ 10, love and affection, and other considerations paid. This *32 warranty deed was filed for record July 16, 1940, and was recorded in the deed records of Dallas County, Texas. Ellen Rowan died June 20, 1940.
Mae Lee Blesi died intestate June 4, 1941. Her only child and heir was this petitioner, Helen Blesi Pearson, who inherited from her mother her undivided one-third interest in the property here under consideration. Petitioner has since held the property for business use and production of income.
The lease dated March 1, 1919, provided that the lessee agree to pay to the lessor the sum of $ 15,000 as yearly rental for the premises for each year from March 1, 1919, to and including December 31, 1925, and the sum of $ 16,500 as yearly rental for the premises for each and every year from January 1, 1926, to and including December 31, 1985.
At the time the lease was entered into on March 1, 1919, there stood on the property two three-story buildings. It was provided that the lessee would cause to be constructed upon the leased premises a building of steel and fireproof construction, the building to cost not less than $ 100,000 and to be not less than four stories in height and built sufficiently strong to support a total of ten stories. It was*33 provided that all improvements erected upon the leased premises should become and remain the property of the lessor. The lessee further covenanted:
Upon the termination or forfeiture of this lease peaceable possession of the premises in question shall be delivered over to the Lessors or their representatives, wear and tear excepted, in a good tenantable condition.
The lessee was authorized to remove the existing improvements on the property and in accordance therewith the lessee, in order to construct the new building, removed the two existing buildings which had been on the premises at the inception of the lease, without any additional payment to lessor. When these buildings were demolished in 1926 Ellen Rowan had an adjusted basis therein of $ 35,000, amortization deductions for which she claimed and was allowed in her subsequent income tax returns in the annual sum of $ 583.33 based on the remaining sixty-year period of the lease.
The lessee in 1928 constructed a building on said property to a height of ten stories, at a cost of approximately $ 500,000, which is known as the Gulf States Building. Its estimated useful life is fifty years from its completion in 1928. In 1935*34 an additional six floors and penthouse were completed at a cost, including air-conditioning and other necessary alterations, of $ 485,205.91. The entire building is of brick, concrete, and steel construction with a full basement.
On the Federal estate tax return filed for the estate of Ellen Rowan, reference was made in schedule "A" thereof to the "Property at Main *854 and Akard * * * not part of estate by reason of Deed from Ellen Rowan to Albert L. Rowan et al.," and in schedule "G," entitled "Transfers During Decedent's Life," of the return appears the same property, that is, "50 feet North side Main 100 feet West side Akard Block 69 1/2 City of Dallas." However, no value for the property was included in the gross estate because of the deed dated August 10, 1924, referred to above, whereby Ellen Rowan conveyed her interest in the property to her three children, Albert L. Rowan, Roberta L. Freenor, and Mae Lee Blesi, mother of petitioner.
On the grounds that there was no delivery of the deed to the children, and other grounds, respondent adjusted the return to include in the gross estate of Ellen Rowan the total value of $ 412,500 for her interest in the Gulf States Building*35 property, giving the following explanation:
This property was under a 66-year lease at $ 16,500.00 per year net rental payable monthly, is centrally located and improved with an excellent office building of about fourteen stories and any improvements on the lot will revert to the lessors at the expiration of the lease in 1985. Recommended value based upon allowance to the Estate of four per cent return on their investment.
This was agreed to and an additional estate tax was paid accordingly.
Upon the death of Mae Lee Blesi on June 4, 1941, a value of $ 137,500 was included (as property previously taxed) in the estate tax return, that sum representing her one-third interest in the property at her death, which was based on the total valuation used by respondent in the return of Ellen Rowan. Respondent made no adjustment in respect to this inclusion.
The city of Dallas assessed values for the Gulf States Building and land for the years 1940 and 1941, as follows:
| 1940 | 1941 | |
| Land value | $ 348,753 | $ 348,753 |
| Building value | 488,647 | 493,507 |
| Total value | 837,400 | 842,260 |
No outstanding mortgage existed against the Gulf States Building in either 1940 or 1941. It has*36 been stipulated that the fair market value of the Gulf States Building in both 1940 and 1941 was at least $ 450,000. A reasonable return on an investment in property similar to that under consideration in downtown Dallas, Texas, was 8 per cent.
During the taxable years 1942, 1943, 1944, and 1945 the lessee, under the terms of the lease, claimed depreciation on the cost of the Gulf States Building on the basis of a fifty-year life, which depreciation was allowed by the respondent.
*855 OPINION.
It is well settled that a prerequisite for a depreciation deduction from taxable net income under section 23 (l) of the Internal Revenue Code is an investment or depreciable interest in the property sought to be depreciated. Detroit Edison Co. v. Commissioner, 131 Fed. (2d) 619; affd., 319 U.S. 98">319 U.S. 98. It is generally true that a lessor may not deduct depreciation if the lessee has furnished improvements upon which depreciation is claimed. See Reisinger v. Commissioner, 144 Fed. (2d) 475. In those cases the lessor had no investment represented by the cost of such improvements and, therefore, *37 the lessor had nothing to depreciate. See Detroit Edison Co. v. Commissioner, supra.
In the instant case respondent disallowed the claimed depreciation deduction because he contends petitioner has no depreciable interest in the property. He argues in his brief that the lessee erected the building without any cost to the lessor and, therefore, the lessee is the only one entitled to depreciation thereon.
Petitioner contends, however, that, inasmuch as she inherited the property from her mother, she is entitled to the basis provided in section 113 (a) (5) of the code. 1 In support of her contention she relies upon Charles Bertram Currier, 7 T.C. 980">7 T. C. 980. In that case the taxpayer was the life beneficiary in a testamentary trust created by his father's will. The decedent leased the premises for a term of 75 years and the lessee, at its own cost, erected on the premises a building with a useful life less than the term of the lease. The lease obligated the tenant to keep the buildings and improvements in good and tenantable condition and repair and upon the expiration of the lease to yield up the premises and buildings *38 and improvements in first-class condition and repair. By devise, upon the death of the lessor, an interest in the leased property came to the taxpayer. The taxpayer claimed a deduction for depreciation, which respondent disallowed on the ground that the building was erected by the lessee with no cost to the lessor which would constitute a basis for the allowance of depreciation. We pointed out that in the case of inherited property the function of the owner's investment which the depreciation deductions are required to replace is performed by the intervention of the estate tax upon the improvements transmitted by the decedent. The basis of the inherited property was, therefore, not cost, but was fixed *856 by section 113 (a) (5) of the Internal Revenue Code as the fair market value of the property at the date of decedent's death. We held that, since the obligation of the lessee was to return the same building, not a new one, and the leased premises would in fact depreciate even though maintained with scrupulous care, the taxpayer was entitled to depreciation on the improvements. We said:
* * * The basis of inherited property is accordingly not cost, as it was in the Detroit*39 Edison and Reisinger cases, and to say that a property cost the taxpayer nothing makes no contribution to the solution of the present question. As opposed to cost, the basis of property acquired by devise is categorically fixed by statute as fair market value on the date of acquisition. Internal Revenue Code, sec. 113 (a) (5). Hence, if we can discover the fair market value of the property in question at the date of decedent's death, Augustus v. Commissioner (C. C. A., 6th Cir.), 118 Fed. (2d) 88, (or the figure at which it was returned for estate tax purposes, which is recognized as the equivalent, Regulations 103, sec. 19.113 (a) (5)) the upshot would ordinarily be its basis for depreciation in petitioner's hands, without any reference to its "cost." Having acquired a basis by the incidence of the estate tax, the gradually disappearing value of a wasting asset can not be replaced except by periodic depreciation adjustments.
*40 We see no distinction in substance in the facts of the Currier case, supra, and those which are present here. In the Currier case, under the facts which were there present, we had to make a finding of fact as to the fair market value of the building which had been erected by the lessee on the leased premises. This fair market value was found to be $ 250,000 on the date of the lessor's death, that being the basic date. This latter value was the basis of the deduction of the taxpayer, who had acquired it by devise, for depreciation in that case. In the instant case it has been stipulated that the fair market value of the Gulf States Building on the date of the death of Mae Lee Blesi, from whom petitioner acquired her interest in the building by inheritance, was at least $ 450,000. Petitioners have claimed depreciation on the basis of a total value of only $ 412,500, their interest being figured as one-third of $ 412,500 or $ 137,500. Therefore, it seems clear that petitioners are entitled to at least as much depreciation as they have claimed in their returns, the depreciable property having a fair market value on the basic date of at least $ 450,000. We do not understand*41 that there is any controversy between the parties as to the amount of depreciation to which petitioners are entitled, if they are entitled to any at all. Respondent strongly contends that petitioners are not entitled to any depreciation at all. But for the reasons we have already discussed, we hold against that contention. Respondent's disallowance of the depreciation deductions claimed by petitioners on their returns is not sustained.
Respondent relies strongly in his brief upon Friend v. Commissioner, 119 Fed. (2d) 659; certiorari denied, 314 U.S. 673">314 U.S. 673, which *857 affirmed 40 B. T. A. 768. We think the question as urged by the taxpayers in Milton H. Friend et al., Trustees, 40 B. T. A. 768, was different from the question which is here urged. In that case we stated that the taxpayers claimed the right to deduct from the gross rentals which they had received amortization of the capitalized values of the rents to be received under the lease. We held they were not entitled to deduct such amortization and our decision was affirmed by the Seventh Circuit. *42 In that case, among other things, we said: "The petitioners do not even claim that they are entitled to an allowance for depreciation in respect of the buildings." In the instant case petitioners do claim and did claim on their returns a deduction for depreciation of $ 3,197 based on a value of their interest in the buildings of one-third of $ 412,500. We have already pointed out that it has been stipulated that the fair market value of the Gulf States Building at the date of Mrs. Blesi's death was at least $ 450,000.
We think that the issue as presented by the taxpayers in the Friend case was not the same as here presented and, therefore, that case is distinguishable from the case at bar. As already stated, we think our decision in Charles Bertram Currier, supra, is not distinguishable from the case at bar. We, therefore, follow it and decide the only issue presented for our decision in petitioners' favor.
Decisions will be entered under Rule 50.
Opper, J., concurring: The factor which I fear complicates and renders unnecessarily difficult the apparent problem posed here is the parties' stipulation as to the fair market value of *43 the Gulf States Building. While we are not at liberty to disregard it, it seems obviously unrealistic and without it the situation would be the comparatively simple one exemplified by Charles Bertram Currier, 7 T.C. 980">7 T. C. 980. The estate acquired and transmitted to petitioner the land and building subject to a long term lease. Because of that lease the value of land and building combined was apparently less than would have been the case under a more favorable agreement. It is this property, however, with all its attributes, which is being valued and the respondent may have been correct in his appraisal for estate tax purposes under all the circumstances. Bueltermann v. United States (C. C. A., 8th Cir.), 155 Fed. (2d) 597.
What we should then be able to do is divide that over-all fair market value into an amount representing land on the one hand and building on the other. The depreciation allowed would then be a realistic figure. This is what we could and did do in the Currier case but are foreclosed from doing here by the parties' stipulation. It is an unfortunate *858 result but should not obscure the fundamental*44 soundness of the underlying theory that "the taxpayer's basis under section 113 (a) (5) was * * * the value of the interest in the land and the building [emphasis added] which he acquired by devise on the death of the decedent." Bueltermann v. United States, supra, p. 601.
Arundell, J., dissenting: The majority opinion holds that the basis for depreciation of the building in the hands of the legatees is its fair market value at the date of decedent's death, unaffected by the existence of the leasehold. Such an approach would require the inclusion in a decedent's estate of the entire value of land and building, no matter how nominal the rental to be received under the lease might be. What we are concerned with is petitioner's economic interest in the property inherited by her and not the value of the property as such. It seems to me the majority holding is entirely unrealistic and I am unable to agree with it.
Footnotes
1. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --
* * * *
(5) Property transmitted at death. -- If the property was acquired by bequest, devise, or inheritance, or by the decedent's estate from the decedent, the basis shall be the fair market value of such property at the time of such acquisition. * * *↩