*157 Decision will be entered for the respondent.
The petitioner owned a railroad of approximately 110 miles, subject to a 999-year lease executed in 1890, which provided for delivery, at the end of the lease, of the property in the original good order and condition. In 1940 the petitioner, in accordance with the terms of the lease, joined the lessee in securing permission to abandon 1.97 miles of the road, and it was abandoned. The rental payable under the lease was not increased or decreased by the abandonment. Held, the petitioner incurred by the abandonment no loss deductible under section 23 (f) of the Internal Revenue Code.
*136 This case involves Federal income tax for the calendar year 1940. *158 Deficiency was determined in the amount of $ 11,935.36. The issue presented is whether the petitioner sustained a deductible loss, within the purview of section 23 (f) of the Internal Revenue Code, in connection with the abandonment of a small portion of a railroad right of way owned by it, but under a 999-year lease to another railroad company.
FINDINGS OF FACT.
The major portion of the findings is stipulated and we find the facts as so stipulated. The following is a summary of the stipulated facts, so far as pertinent to the examination of the issue involved, together with facts found from evidence adduced.
The petitioner filed its Federal income tax return for the year 1940 with the collector of internal revenue for the third district of New York.
The petitioner, a corporation organized in 1898, was the owner of a railroad approximately 110 miles in length, subject to a 999-year lease made in 1890 by its predecessor to the predecessor of the New York Central Railroad Co. (hereinafter sometimes referred to as New York Central), the owner of such lease in the taxable year here involved. A small portion of the railroad, consisting of 1.97 miles, in Pennsylvania, was maintained*159 in connection with an industrial spur with the view of serving two coal mines. This was a portion of the road at the time of the lease. The petitioner was advised by the operators of the mines that they would not again be operated. That part of the railroad became unnecessary for use in the public interest.
In April 1939 the New York Central adopted a resolution directing that application be made to the Interstate Commerce Commission for authority to abandon that part of the railroad line; in February 1940 the petitioner adopted a like resolution; and on March 5, 1940, petitioner and the New York Central jointly applied to the Interstate Commerce Commission for permission to abandon, and for permission to abandon operation on the 1.97 miles of railroad. The Interstate Commerce Commission on May 1, 1940, granted permission for the abandonment of that part of the railroad and the operation thereof, and later, during the year 1940, that part of the railroad was abandoned and the property retired. The property so retired (exclusive of certain additions and betterments which had been made by the lessee) was carried on petitioner's books under a balance sheet "Account No. *137 *160 701 -- Investment in Road and Equipment," in accordance with the Interstate Commerce Commission classification of accounts, in the total amount of $ 46,433.75, which the petitioner concedes should be reduced to $ 40,325.59. Petitioner during the year 1940 used the retirement method of accounting for retirement of road property. It entered in its books a credit to the account in the amount of $ 46,433.75. The salvage from the property was retained by the New York Central in the net amount of $ 6,328.35, which petitioner charged on its books to "Account No. 706 -- Investment in Affiliated Companies," and charged the balance, $ 40,105.40, to profit and loss. In its Federal income tax return for 1940 the petitioner deducted $ 40,105.40 from gross income as a loss on retirement. The Commissioner in the deficiency notice disallowed such deduction and added to income $ 9,625.29 as rent income, representing income and income defense taxes computed on the $ 40,105.40.
The 999-year lease provided in pertinent part as follows: That the lessor lease to the lessee and its assigns the railroad then owned by it or which at any time during the term of the lease might be acquired by it, also *161 all railroad stock, assets and personal property of every kind, and its franchises; in consideration of which the lessee agreed to pay as rental 4 percent interest on $ 5,000,000 bonds issued against lessor's property, also dividends at the rate of 4 percent per annum upon $ 5,000,000 capital stock of lessor; to discharge a certain guaranty made by lessor; to defray the expenses of maintaining lessor's corporate organization, but not more than $ 6,000 per year; and to pay all taxes and assessments payable by the lessor. The lessee further agreed to keep and maintain the railroad and appurtenances in good order and repair; to keep in public use, manage, and efficiently operate the railroad; and to surrender same at the expiration or other determination of the term in the same good order and condition as at the date of the lease. It was further agreed that the lessee could, with the consent of the lessor, evidenced by its becoming a party to the conveyance, sell and convey any part of the real estate which in the opinion of the lessee should become unnecessary for carrying on the business over the railroad, the proceeds of any such sale to be applied to the payment of any incumbrance*162 upon the property so sold for the payment of which the lessor was liable and the surplus to be applied to the payment of lessor's indebtedness, after which the annual rental should be decreased by an amount equal to the annual interest payable upon such indebtedness; also, that additions, extensions or improvements upon the premises might be made by the lessee, or lessor's obligations paid by the lessee, in which case, upon the vote of holders of three-fourths of the capital stock of the lessor, bonds or capital stock of the lessor equal to the cost of such additions, extensions, or improvements, or payments, should be issued to the lessee, after which the rental payable should be increased *138 accordingly. The terms of the lease were binding upon the parties, their successors, and assigns.
The amounts which the lessee was required to pay under the lease were not increased or decreased by reason of the abandonment of the 1.97 miles of railroad.
The New York Central owns 25 shares and, through the New York & Harlem, controls 1,000 shares of the capital stock of the petitioner, out of 120,000 shares issued. The books of account of the petitioner were kept by employees of the*163 New York Central.
Paragraph seventh of the lease provided:
That the Beech Creek Company shall and will, during the term hereby demised, maintain its corporate existence and organization; and at all times, and from time to time, during the said term, when requested by The Central Company, its successors or assigns, shall and will put in force and exercise each and every corporate power, and do each and every act which the Beech Creek Company might now or may at any time hereafter lawfully put in force or exercise, to enable The Central Company to enjoy, avail itself of, and exercise every right, franchise and privilege in respect to the use, management, maintenance, renewal, extension, alteration or improvements of the premises hereby demised, or intended so to be, or the business to be there carried on -- The Central Company agreeing to indemnify and save harmless the Beech Creek Company against all loss, damage, or liability for such exercise of corporate powers, or performance of corporate acts, when exercised or done at the request of The Central Company.
After the execution of the 999-year lease, improvements, including certain extensions, were made upon the railroad. The New*164 York Central charged to such improvements $ 3,606,775.58 as of January 1, 1937, and on December 31, 1940, $ 3,258,732.74.
During 1937 other parts of the railroad were abandoned. Such abandonment was not recorded in the books of the petitioner at that time, but was recorded in the books of the New York Central in 1937 by charging cost, less salvage value, to a profit and loss suspense account. Such entries remained unchanged until July 26, 1940, at which time they were canceled and entries were made in the petitioner's books to reflect a loss from such abandonment.
OPINION.
The petitioner contends that the abandonment of railroad in 1940 constituted a deductible loss to it. There appears to be no difference between the parties as to the amount of the loss, if there was one, or as to the year incurred. The respondent, however, in substance argues that no loss was incurred by the petitioner for several reasons: First, that the petitioner did not release the lessee from its duty of surrendering the railroad at the end of the lease in the same condition as at the beginning, and that, therefore, it is entitled to equivalent property at the end of the lease, and has taken no loss; that*165 if the petitioner did release the lessee from its *139 obligation to replace the abandoned property and surrender the equivalent, such release would be either a gift or a cost of the income which continues to be paid as to the abandoned property; that if petitioner did sustain a loss in the taxable year, it was too infinitesimal to be taken into account for the purposes of tax computation; and that the lease requires the surrender of the railroad, together with extensions, improvements, and betterments added at the lessee's cost, in good order and condition, so that it can not be known before the end of the lease whether the petitioner has taken a loss.
The substance of the petitioner's contention is that it abandoned the 1.97 miles of railroad; that the lessee was not required to provide other property in lieu thereof under the lease, or otherwise compensate the lessor therefor; and that therefore a loss was sustained. Petitioner relies primarily upon Terre Haute Electric Co. v. Commissioner, 96 Fed. (2d) 383. Therein the petitioner owned city and interurban traction lines, and other property, subject to a lease of 999 years to another company. *166 The lessee was the owner of all of petitioner's outstanding common stock, except qualifying shares. Rentals under the lease consisted of dividends payable upon the lessor's preferred and common stock. In the taxable year two interurban lines were abandoned. One of the questions involved in the case was whether there was loss by virtue of such abandonment. The court, on that point, said:
We are unable to see any reason, however, why the contracting parties could not cancel a lease of this character, or any other character for that matter, and relieve themselves of the obligations incurred thereby, provided, of course, it was not to the injury of the third parties. Here, apparently, the parties to the lease in 1931, agreed that two of the lines in question might be abandoned, and, by proper state authority, were directed to be abandoned. Under such circumstances, how can it be said that the lessor is protected from the loss thus sustained? Certainly, thereafter, the lessee would be under no obligation to restore the abandoned property. It seems clear to us that petitioner sustained a deductible loss for the year 1931, on account of the two interurban railways abandoned that*167 year. * * *
In that case two entire lines of interurban railway were abandoned. Nothing indicates that this did not diminish the lessor's rentals (here they were not diminished), and the court obviously came to the conclusion that the lessor's action relieved the lessee of all obligations with respect to the abandoned lines. Here we can not come to the same conclusion. The petitioner joined in the application for abandonment of a small portion of railroad under the terms of the lease requiring it to do so, for therein the lessor agreed to do all acts to enable the lessee to enjoy and exercise its rights "in respect to the use, management, maintenance, renewal, extension, alteration or improvements of the premises" -- and in so doing, was saved harmless against all loss. The quoted expression logically *140 covers abandonment of a small fraction of the line. We see, therefore, in the petitioner's joinder in the application no such release of obligations as the court discerned in the Terre Haute case. Indeed, as just noted, we find here the very protection from loss which the court could not there find. In our opinion, by so joining in abandonment proceedings, under *168 such circumstances, the petitioner did not deprive itself of its rights at the end of the long term lease to receive the property in the same good order and condition as at the date of the lease. But prior to that time, we see no change in the petitioner's position as to profit or loss. Then, and not until then, can the petitioner know whether it has been deprived of anything by the abandonment in 1940. Perhaps at the end of the lease the railroad will be operating, in the same good order and condition as in 1890, the small portion of road here involved.
This feature distinguishes Commissioner v. Providence, Warren & Bristol R. Co., 74 Fed. (2d) 714, and, following and controlled by it, Mississippi River & Bonne Terre Railway, 39 B. T. A. 995 (1003), for in those cases property was sold under a definite contractual provision that all the lessor could ever receive was the proceeds of the sale, and, as expressed in the former case, "the only obligation of the assignee was to account to the respondent [lessor] for that," i. e., the sale price. Patently, the lessor's rights were definitely and permanently determined *169 -- while here the obligation set forth in the lease continued. The clauses construed in the two cases just noted are essentially the same as section twelfth of the lease here involved, providing for sale of real estate, application of proceeds on lessor's obligations, and diminution of rental, and the cases might bear upon this one if we were here dealing with section twelfth; but this case has nothing to do with that section. In our opinion, the petitioner has shown no deductible loss in the taxable year.
We hold that the Commissioner did not err in disallowing the deduction for loss. It follows that the $ 9,625.29 rent income (being income and income defense taxes, computed on the amount deducted as loss by petitioner) was properly added by the Commissioner to petitioner's income.
Decision will be entered for the respondent.