*1380 1. Bond discount should be recovered by pro rata deductions over the life of the bonds.
2. Where a new issue of bonds is sold and with part of the proceeds an earlier issue of bonds is retired, any unrecovered bond discount on account of the earlier issue should be recovered by deduction in the year of such retirement.
*32 This proceeding was brought to redetermine a deficiency in income tax of the petitioner for the year 1923 in the sum of $6,300.
The petitioner alleges that the respondent erred:
(1) In refusing to allow the cost of financing extensive alterations of an office building in 1919, represented by discounts on short-term bonds, as an essential part of the petitioner's investment cost; and
(2) In treating the unamortized portion of such cost as an expense for the year 1920.
FINDINGS OF FACT.
The facts were stipulated as follows:
1. In February, 1919, immediately after its organization, the petitioner, The East Ninth Euclid Company, negotiated the acquisition of a ninety-nine year lease on land at the northwest corner*1381 of Euclid Avenue and East Ninth Street, Cleveland, having thereon the eight-story office building on these premises known as the Hickox Building.
2. For the purpose of financing obligations assumed in the purchase of the aforesaid leasehold estate with building thereon and extensive alterations thereof immediately undertaken, the petitioner issued $400,000 of bonds secured by the property, which were to mature as shown in the following paragraph, the time of maturity being computed from February 1, 1919.
3. The issuance of the bonds comprehended a financing cost of $50,400, represented by bond discounts as follows:
| Principal | Discount | |
| First mortage 5-year bonds | $250,000 | $20,400 |
| Second mortgage 2-year bonds | 150,000 | 30,000 |
| $400,000 | $50,400 |
4. The aforesaid cost incurred, $50,400, was set up on the petitioner's books of account as part of the cost of acquisition and alteration of the building and no bond discount account was entered on the books.
*33 5. The extensive remodeling of the building was undertaken immediately and involved the dispossession of tenants to an extent that the property was nonincome-producing during the years*1382 1919 and 1920.
6. The petitioner had arranged the issuance of the aforesaid short-term first and second mortgage bonds (five years and two years respectively) pending the completion of the extensive remodeling undertaken and in December, 1919, when the remodeling was substantially completed, greatly enhancing the value of the building, the petitioner arranged for replacement of the short-term bonds with twelve-year first mortgage 7 per cent bonds to be issued February 1, 1920.
7. Pursuant to this arrangement the twelve-year bonds were issued in the amount of $525,000, with incidental retirement in said year 1920 of the short-term bonds hereinbefore referred to.
8. On December 20, 1919, the petitioner notified the trustee under the first mortgage bond issue that the bonds were to be redeemed at February 1, 1920, notice of forty days being required under the deed of trust.
9. In computing the gain or loss on the sale made in the year 1923 of the leasehold estate referred to in paragraph one of this stipulation the petitioner treated the bond discount of $50,400 as shown in paragraph three hereof, as a part of the cost of the property sold, whereas the respondent has disallowed*1383 this item and increased the taxable income of petitioner in the amount thereof, as shown by the statement attached to the deficiency letter in this proceeding and the revenue agent's report dated May 2, 1927, referred to in the statement,
10. The books and accounts of the petitioner were kept on the accrual basis and the tax return was rendered on that basis.
Subsequent to the hearing, on request of the Board, a supplemental stipulation of facts was filed, consisting of six exhibits, as follows:
Exhibits
A Trust deed covering $250,000 first mortgage bonds.
B Trust deed covering $150,000 second mortgage bonds.
C Newspaper clipping describing acquisition of Hickox building with advertised bond circular.
D Letter from Otis and Company, December 11, 1919.
E Letter to Guardian Savings and Trust Company, Trustee, dated December 20, 1919.
F Bond circular respecting $525,000 first mortgage bonds issued February 1, 1920.
The trust deed, marked Exhibit A, states the purpose behind the five-year first mortgage bond issue of $250,000 to be "to provide itself with funds for the payment of the cost of acquiring said leasehold estate and for the betterment and improvement*1384 of the building situated *34 on said premises and for additions thereto and for its other lawful corporate uses and purposes." Article First, section 1 of Exhibit A refers to the bonds to be issued as "the permanent definitive bonds" and authorizes temporary bonds until the permanent bonds are engraved and printed. Article Second provides for redemption prior to maturity. The bonds bore date February 1, 1919, and maturity date of February 1, 1924. The trust deed was executed February 13, 1919.
The second mortgage deed of trust, market Exhibit B, was executed February 14, 1919, and provided for $150,000 in junior mortgage bonds to be dated January 15, 1919, and mature January 15, 1921. The reason for the bond issue is stated as follows:
The Company desires to borrow money in the exercise of its corporate rights and privileges, for additional working capital, and for developing, enlarging, extending, improving and bettering of its said property, and for other lawful purposes of its incorporation, and for the purposes aforesaid * * *.
The trust instrument provided for redemption prior to maturity.
Exhibit C includes a circular or newspaper advertisement offering*1385 the $250,000 five-year first mortgage bonds for sale.
Exhibit D is a letter from Otis and Company agreeing to underwrite an anticipated bond issue of $525,000 and specifying certain conditions to be met.
Exhibit E is a copy of a letter dated December 20, 1919, which reads as follows:
In the First mortgage deed of Trust from the East Ninth Euclid Company to the Guardian Savings & Trust Co., Trustee, Article 2 specifies that in the event the company shall desire to redeem all of the bonds outstanding, it shall notify the Trustee in writing 40 days prior to the date of redemption.
Therefore, pursuant to said requirement, we hereby notify you that it is the company's desire to redeem all of the bonds under said First Mortgage Deed of Trust issued by the East Ninth Euclid Company to Guardian Savings & Trust Co., February 1st 1920 on the basis of par plus 1% and all accrued interest.
Exhibit F is an advance circular dated February 1, 1920, issued by Otis and Company, offering $525,000 seven per cent first mortgage bonds, and states the maturities to be as follows:
| February 1, 1922 | $25,000 |
| February 1, 1923 | 25,000 |
| February 1, 1924 | 25,000 |
| February 1, 1925 | 25,000 |
| February 1, 1926 | 25,000 |
| February 1, 1927 | 35,000 |
| February 1, 1928 | $35,000 |
| February 1, 1929 | 35,000 |
| February 1, 1930 | 35,000 |
| February 1, 1931 | 35,000 |
| February 1, 1932 | 225,000 |
*1386 The circular contains the following statements: "The proceeds of this issue will be used to retire present outstanding bonds in the amount of $250,000, to fund construction loans and to complete improvements now being installed."
*35 OPINION.
VAN FOSSAN: For the purposes of financing obligations assumed under a 99-year lease on a certain building purchased by petitioner and making alterations therein, the petitioner issued as of February 1, 1919, first mortgage bonds maturing in five years in the amount of $250,000, and as of January 15, 1919, second mortgage bonds of 2-year life in the amount of $150,000. These bonds were sold at an aggregate discount of $50,400. In 1920 petitioner issued first mortgage bonds aggregating $525,000, a certain number maturing annually from 1922 to 1932, inclusive. These bonds were sold and with part of the proceeds petitioner retired the five-year bonds. In 1923 petitioner sold the leasehold. In computing gain or loss on such sale petitioner treated the item of bond discount as part of the cost of the property sold. Respondent disallowed the same as such and found the deficiency in question. In the alternative, petitioner contends*1387 that, if the bond discount be not part of the cost of the property sold, the unrecovered cost of the first bond issues should be considered as cost of the new bond issue and spread over the life of the new bonds.
Bond discount is a cost of acquiring capital and he who incurs such cost is entitled to recover it by deductions from income. The Board, supported by the courts, has held that normally such recovery should be prorated over the life of the bonds. See ; ; ; . Moreover, we have held that on sale of the property the unrecovered cost of financing is not to be added to the cost of property sold to determine gain or loss, but may be charged off and deduction taken from gross income. . These decisions dispose of petitioner's first contention.
Consideration of the second contention requires an examination of the facts. From the supplemental proof offered in*1388 the case it is clear that the original stipulation was both incomplete and inaccurate. The statement found in numbered paragraph 6 that "the petitioner arranged for replacement of the short-term bonds with twelve-year first mortgage 7 per cent bonds to be issued February 1, 1920" is inaccurate in its description of the new bonds and misleading in the inference from the suggestion that there was a replacement of the short-term bonds. The new bonds were of varying maturities from two to twelve years. There was no replacement in the sense of an exchange of new bonds for old. The new bonds were sold on the market and part of the proceeds used to retire the original first mortgage issue of $250,000 five-year bonds. The failure *36 of the circular, Exhibit F, to refer to the second mortgage bonds or to suggest their retirement leaves doubt in our mind as to whether the statement in paragraph 7 of the original stipulation is accurate when it refers to "incidental retirement in said year 1920 of the short-term bonds hereinbefore referred to." Petitioner has left to inference or conjecture the facts as to the retirement of the second mortgage bonds.
However, the supplemental*1389 proof makes the situation entirely clear in some respects. The short-term bonds issued in 1919 were paid off and retired in 1920. There was no exchange of bonds or substitution of the new issue for the old. The holders of the two sets of bonds were obviously not the same persons. Cf. .
The legal consequence of these facts is that petitioner may not claim any deduction in 1923. It was entitled to recover the unrecouped bond discount, if at all, in 1920, when the bonds were called before maturity and retired. The bond issue of which they were a part was wiped out and wholly ceased to exist at that time. By the demise of the parent bond issue to which it was attached, the unrecovered bond discount became an orphan. Thereafter, there was no parent to which it might naturally adhere. It is thus necessary to deny both of petitioner's contentions. The respondent's action is approved.
Reviewed by the Board.
Decision will be entered for the respondent.