*1160 Petitioner, a personal holding company, having acquired for its capital stock a remainder over after intervening life estates in Connecticut real estate, held, not to be entitled to deductions for real property taxes and fire insurance premiums paid by it on the property pursuant to its agreement with the life tenant grantor; held further, deduction for depreciation thereon disallowed to petitioner. Revenue Act of 1934, sec. 23(1).
*638 This proceeding was brought for a redetermination of deficiencies in petitioner's income tax and surtax, together with a penalty thereon, as follows:
| Year | Income tax | Surtax | Penalty | Total |
| 1934 | $684.24 | $1,160.22 | $290.06 | $2,134.52 |
| 1935 | 650.20 | 1,251.31 | 62.57 | 1,964.08 |
Petitioner charges that the respondent erred (a) in failing to allow as a deduction taxes paid by petitioner within the years in question on real estate owned by petitioner; (b) in failing to allow as deductions premiums*1161 paid by petitioner on fire insurance policies covering its properties; (c) in failing to allow deduction for depreciation on petitioner's buildings; and (d) in imposing the penalties for late filing.
*639 FINDINGS OF FACT.
Petitioner is a Connecticut corporation, with principal offices at New Haven, Connecticut. It filed its income tax returns for the years in question with the collector for the district of Connecticut. Its returns were on the cash receipts and disbursements basis.
Petitioner was organized in 1931, with an authorized capital stock of 4,000 shares of a par value of $100 per share.
Annie O. Mitchell, under date of July 30, 1931, offered petitioner's incorporators a proposition whereby, in exchange for 3,995 shares of its capital stock (5 shares to be issued as qualifying shares to five directors), she would transfer to them cash and securities in the amount of $250,000 and convey to them all of her real property in the towns of New London and Waterford, Connecticut, "subject however to a life estate therein" to herself, and an outstanding life estate in a portion thereof in her sister, Louise H. Tiffany:
* * * on the condition, however, that the*1162 Corporation will agree to pay all taxes, assessments and insurance premiums on all of the property during my life, and as to the portion thereof a life estate in which i have conveyed to my sister Louise H. Tiffany, that the Corporation will continue to pay all taxes, assessments and insurance premiums, and also to pay for the upkeep and any repairs and replacements which may be necessary during her life if she shall survive me.
This proposition was accepted in an even-date letter from the incorporators.
After the issue of the 3,995 shares to Annie O. Mitchell, she gave them to her two children and eight grandchildren, and since that time has had no further interest in the stock or the affairs of petitioner.
Annie O. Mitchell, pursuant to this contract, transferred by warranty deed the real property in New London, Connecticut, to petitioner by an instrument recorded August 3, 1931. The deed recited the reservation of a portion of two described tracts as subject to the life use therein of Louise H. Tiffany, and further provided:
RESERVING, however, to myself the use, improvement, occupation, enjoyment and income from all of said premises, for and during the full term of*1163 my natural life.
In further pursuance of the contract, Annie O. Mitchell transferred by warranty deed her Waterford, Connecticut, property to petitioner by an instrument recorded August 4, 1931, with a similar reservation of a life estate to herself.
In 1934 and 1935 petitioner paid taxes on the real estate which it had acquired from Annie O. Mitchell in the sums of $4,876.37 and $4,671.95, respectively, which sums petitioner deducted from its gross income on its Federal income tax returns for the years in question. *640 These deductions were disallowed by respondent in his notice of deficiency.
In 1934 and 1935 petitioner paid premiums of $99.92 and $79.31, respectively, on fire insurance policies covering the improvements on the property conveyed to it by Annie O. Mitchell. Petitioner in its Federal tax returns did not deduct the premium of $99.92 in 1934 but did deduct the $79.31 in 1935. Respondent did not allow either of the amounts as deductions in determining petitioner's taxable income for the years in question.
Petitioner made no claim in its Federal tax returns for the years 1934 and 1935 for a deduction for depreciation.
Petitioner's Federal income*1164 tax returns for the years in question did not disclose any rents, or report any gain or loss from the operation of its real property.
The property was situated just off Long Island Sound. The Waterford property was not improved by any buildings. The New London property was improved by frame homes of the cottage type which had a remaining useful life in 1931 of twenty-five years.
During the summer seasons of the years in question one of the cottages was occupied by Annie O. Mitchell, another by her sister, Louise H. Tiffany, another by a nephew, Donald G. Mitchell, and another by the gardener. Donald G. Mitchell did not pay any rent for the cottage he occupied.
Petitioner filed its income tax return for 1934 on March 14, 1935, and its income tax return for 1935 on March 10, 1936. Its returns were prepared by the Union & New Haven Trust Co., which was also petitioner's fiscal agent. At the time of filing the 1934 and 935 returns the officers of the trust company knew that the Department's regulations called for the filing of a personal holding company return, but believed that petitioner was not a personal holding company under the law and that such returns therefore were*1165 not necessary. No attempt was made to obtain official advice on this question. On examination of the returns by the revenue agent, he was of the opinion that holding company returns on Form 1120-H were necessary. Thereupon, on April 15, 1936, the Union & New Haven Trust Co. filed holding company returns on Form 1120-H for petitioner for the years 1934 and 1935 to stop the accrual of penalties and interest, if any.
Petitioner was a personal holding company under the law.
OPINION.
OPPER: Petitioner, a personal holding company, claims to be entitled to deductions for taxes, fire insurance, and depreciation on *641 real property acquired by it in exchange for a part of its capital stock. A further question is the liability for a delinquency penalty resulting from petitioner's failure to file a personal holding company return within the time prescribed.
The primary issues would be simple of solution were it not for the fact that petitioner's interest in the real property in question is limited to a remainder over after one, or possibly two, intervening life estates. These were reserved by the grantor at the time of conveyance, and payment of the expenses in question*1166 was the result, not of petitioner's contemporaneous use of the property, but of provisions of the contract of conveyance.
Petitioner is entitled to the deductions for the taxes in question only if it can be said that they were imposed upon it; for, otherwise, even though their payment by petitioner was proper or in fact obligatory under the contract, they would not be permissible deductions from current income, ; ; ; but should be treated as capital expenditures incurred in the acquisition of the property, ; affd., (C.C.A., 7th Cir.).
On this question authorities dealing with the law of Connecticut, in which state the property was located, are of less help than might be hoped. The statute 1 apparently covering the subject is not free from ambiguity. And the Connecticut cases cited by the parties throw no light upon the present question. Considering all the circumstances, we conclude that these were not the taxes of petitioner within the meaning of*1167 the revenue act. They were annual or periodic charges arising out of or resulting from the beneficial use, ownership or enjoyment of the property. 2 In the current years it was the life tenants and not the petitioner to whom those beneficial rights inured. It seems not unreasonable to assume that such a distinction is the purpose of the provision in the Connecticut statute referring to the *642 "use" of real estate "for life * * * by gift or devise and not by contract." These words may well be the result of an attempt to emphasize situations where one enjoying the immediate use and possession of property does so in his own right, not through or under the remainderman, and hence without consideration or compensation to the holder of the remainder. There would then be an absence of rent or other available return from the property out of which the taxes could be expected to flow. The interest in the property reasonably subject to the burden of periodic taxation imposed by public authority would then seem to be the estate carrying the present use and enjoyment thereof. 3 On that analysis it is clear that the taxes in question should be regarded as imposed upon the holders*1168 of the life estates and not upon this petitioner. The life tenants held their interests, if not by "gift or devise", certainly by a right more analogous thereto than to "contract." For the grantor retained her interest by way of reservation or exclusion from the conveyance, and therefore as a result of the original acquisition by her, the source of which does not appear; and her sister presumably acquired her estate as a gift from petitioner's grantor. Neither owed to the remainderman any "contract" or other duty such as the payment of rent in return for her right of occupancy. That being so, the taxes are not to be treated as imposed upon petitioner or as deductible by it but are in the nature of capital expenditures involved in the acquisition of a capital asset.
*1169 Similar considerations dispose of the small item of fire insurance. Here, again, there is no evidence that such expenditures were the current outcome of any trade or business. For the reasons stated in , they should be disallowed, leaving the opportunity to petitioner of course to deal with them as a capital item in accordance with the principles already discussed.
As to depreciation, respondent must be sustained primarily on the ground that such deduction is specifically 4 denied to petitioner. And see It so happens that petitioner also fell short of sustaining its burden of proof, since it entirely failed to produce admissible evidence of the fair market value of the property at the time of acquisition, of its cost, or of the cost to its transferor. See *643 Revenue Act of 1934, sec. 113(a)(8). The only proffer 5 was the local assessment lists, which were excluded, as we think they had to be. *1170 ; . In any event their exclusion was not prejudicial here, since the point must be decided against petitioner for the reason first noted.
As to the delinquency penalty, respondent must be sustained. The delinquency penalty is applicable to a personal holding company return. ; *1171 . And the failure of petitioner's fiscal agent to acquaint itself with petitioner's responsibility under the law is not that "reasonable cause" which will preclude application of the penalty section. ; (appeal pending, C.C.A., 2d Cir.).
Reviewed by the Board.
Decision will be entered for the respondent.
Footnotes
1. SEC. 1132. TENANT FOR LIFE OR YEARS TO LIST PROPERTY. When one is entitled to the ultimate enjoyment of money at interest, real or personal estate, and another is entitled to the use of the same as an estate for life or for a term of years by gift or devise and not by contract, such estate shall be set in the list of the party in the immediate possession or use thereof, except when it is specially provided otherwise; and real estate so held shall be charged with the payment of any tax laid upon it, and the community laying such tax, or the tax collector or other authorized officer thereof, may collect or secure such tax in any manner provided by law for collection or securing of taxes on real estate; provided, upon the failure of the life tenant or person in immediate possession or use of such real estate to pay any tax laid upon it, the person or persons entitled to the ultimate enjoyment of such real estate may pay such tax and shall be subrogated to all the rights and remedies of the community laying the same for the collection or securing of such tax. [Connecticut General Statutes, Revised 1930.] ↩
2. "* * * That is taxation which compels one to pay for the support of the government from his own gains and of his own property. * * *" [.] ↩
3. This would also be the rule as to the obligation owed by life tenant to remainderman were it not for petitioner's specific agreement. Restatement of the Law, Property, vol. I, secs. 129, 130. ↩
4. Revenue Act of 1934 -
SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * *
(1) DEPRECIATION. - * * * In the case of property held by one person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner of the property and shall be allowed to the life tenant. * * * ↩
5. Petitioner's counsel stated: "I might say that this is not offered for the purpose of proving value, but to prove assessed value * * *"; and shortly thereafter: "The assessed value is not in issue." ↩