*2911 1. The cost of goods sold by petitioner in its first taxable year should be computed by using as an opening inventory the cost of merchandise to individuals who transferred it to petitioner in exchange for stock. Sections 203(b)(4) and 204(a)(8) of the Revenue Act of 1924.
2. The basis for computing depreciation on property paid in for stock in a corporation is the cost to the transferor. Section 204(c) of the Revenue Act of 1924.
3. Expenses of organization and refinancing are not deductible as ordinary and necessary operating expenses.
*793 The respondent has asserted deficiencies in income taxes for the years 1924 and 1925 in the respective amounts of $6,408.24 and $1,691.59. The petitioner assigns as error, (1) the respondent's action in reducing the opening inventory for the year 1924 by the amount of $74,622; (2) the disallowance by the respondent of deductions for depreciation in the amounts of $2,853.04 and $2,622.13 for the years 1924 and 1925, respectively; and (3) the disallowance by the respondent*2912 of a deduction as ordinary and necessary business expenses in the amount of $604, which is the expense of petitioner's incorporation.
FINDINGS OF FACT.
The petitioner is a Minnesota corporation, organized in January, 1924, under the name of the Anderson Implement Co. At some later date its name was changed to the Grain King Manufacturing Co. Its principal office is located at Midway Station, St. Paul. The petitioner is successor to the business of the Anderson Company, which *794 was in the hands of a receiver from early in 1923 until January 16, 1924, when the receiver sold at auction all the assets of the Anderson Company. The purchasers at the auction sale were certain individuals known as the Kohler group. The purchase price was $118,000, cash, and the assumption of a mortgage of $110,000.
The Kohler group paid in the assets purchased to the Anderson Implement Co. and received in exchange stock of a par value of $300,000. The assets were set up on the books of the new company as follows:
| Merchandise | $140,000.00 |
| Real estate | 100,000.00 |
| Buildings | 75,000.00 |
| Machinery and equipment | 85,000.00 |
| Furniture and fixtures | 2,000.00 |
| Patterns | $5,000.00 |
| Bonds | 350.00 |
| Accounts receivable | 37,586.81 |
| Total | 444,936.81 |
*2913 The mortgage assumed by petitioner in the amount of $110,000 was carried as a liability. The remaining $334,936.81 was divided into capital $300,000 and surplus $34,936.81.
On its income-tax returns petitioner computed cost of goods sold by using as its opening inventory for the year 1924, the amount of $140,000. Depreciation for each of the years was computed upon the book value of its property. Petitioner deducted its organization expenses, which were $604, as ordinary and necessary business expenses.
On audit of the above returns the respondent determined that the proper basis to be used in computing depreciation and cost of goods sold was cost to the group of individuals who paid to assets in to petitioner for stock. Included in the assets were accounts receivable in the amount of $37,586.81 and bonds in the amount of $350. Reducing both the purchase price and the book value of the assets by the amounts of accounts receivable and bonds which were supposedly worth face value, the respondent determined that $190,063.19 had been paid for property set up on the books at $407,000. He found that this purchase price was 46.69857 per cent of the set-up value. Using this*2914 percentage he reduced inventory value to $65,378; value of buildings to $35,023.93; machinery and equipment to $39,693.78; furniture and fixtures to $933.97; and patterns to $2,334.53. He allowed a depreciation rate of 7 1/2 per cent on the buildings; 13 per cent on the machinery and equipment; 15 per cent on the furniture anf fixtures; and 25 per cent on the patterns.
OPINION.
LANSDON: There are three issues to the determined in this proceeding - (1) the correct opening inventory for the taxable year 1924; (2) the proper deductions for depreciation in each of the years, and; *795 (3) whether organization expenses should be deducted in computing net income.
On January 24, 1924, petitioner received from a group of individuals in exchange for all of its capital stock of a par value of $300,000, certain assets which it set up on its books at a value of $444,936.81. Standing as a liability against this amount was a mortgage assumed in the amount of $110,000. The respondent has held that the proper basis for computing the cost of goods sold in the first taxable year and deductions for depreciation in each of the years herein involved is the cost to the group of individuals*2915 who paid the property in to petitioner for stock.
The Revenue Act of 1924 provides, in part, as follows:
SEC. 203. (b) (4) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.
SEC. 204. (a) The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property except that -
* * *
(8) If the property (other than stock or securities in a corporation a party to a reorganization) was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in paragraph (4) of subdivision (b) of section 203 (including also, cases where part of the consideration for the transfer of such property to*2916 the corporation was property or money in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made;
* * *
(c) The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as is provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale or other disposition of such property, except that in the case of mines, oil and gas wells, discovered by the taxpayer after February 28, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the basis for depletion shall be the fair market value of the property at the date of discovery or within thirty days thereafter; but such depletion allowance based on discobery value shall not exceed 50 per centum of the net income (computed without allowance for depletion) from the property upon*2917 which the discovery was made, except that in no case shall the depletion allowance be less than it would be if computed without reference to discovery value.
*796 From the above sections of the statute it is clear that the opening merchandise inventory to be used by petitioner in computing cost of goods sold during its first taxable year should be the cost to individuals who transferred the property to petitioner in exchange for stock, and that depreciation for each of the taxable years should be computed on the cost of the assets to such individuals.
We have held that expenses of organization and refinancing are not deductible as ordinary and necessary operating expenses. ; ; ; ; ; and . There is nothing in the record to indicate the nature of the expenses for which petitioner seeks a deduction; but the parties are agreed*2918 that they were expended in connection with petitioner's organization. The respondent's disallowance of the item is approved.
Decision will be entered for the respondent.