*2991 1. The total amount expended by the petitioner for the reconstruction of a building destroyed by fire, which it occupied as lessee, is not deductible in the computation of net income for 1920, but may be amortized, and an aliquot part thereof, less amounts recovered on fire insurance and salvage, may be deducted in each of the remaining years of the lease beginning with February 14, 1920.
2. The petitioner is entitled to deduct the amount of loss sustained by it in 1921 by reason of the demolition of a building in that year which was acquired by it in the spring of 1920.
*300 These proceedings, which were, upon motion of counsel, consolidated for hearing and decision, are for the redetermination of deficiencies in income and profits taxes for the years 1919, 1920, and 1921, amounting to $897.15, $10,999.06 and $8,182.24, respectively.
*301 The errors alleged by the petitioner, upon which the parties have joined issue, are:
1. Failure on the part of the respondent to determine its profits taxes for the years 1919 and 1920 in accordance*2992 with the taxes paid by the corporations described in section 328 of the Revenue Act of 1918, and his further failure to determine its profits tax for the year 1921 in accordance with the provisions of sections 327 and 328 of the Revenue Act of 1921, and
2. The failure of the respondent to allow as a deduction in the computation of net taxable income for the year 1920, an amount expended by it, to wit; $40,000, for the erection of a building to replace one occupied by it as lessee, which was destroyed by fire, and
3. The failure of the respondent to allow as a deduction in the computation of net taxable income for 1921, the sum of $14,067.19, representing the value of certain buildings razed by the petitioner and the cost of said razing.
FINDINGS OF FACT.
The petitioner is a corporation, organized and incorporated under the laws of the State of Virginia, with its principal office at Danville, where it conducted three motion picture theaters during the years in controversy, known as the Broadway, the Majestic, and the Bijou, which were the only ones operated in that city for white patrons.
In January, 1915, a North Carolina corporation, known as the Piedmont Amusement*2993 Co., leased a lot and building located at 409 Main Street in the City of Danville, which is the site of the Broadway theater now operated by the petitioner, from the owners thereof, for a period commencing January 1, 1915, and ending January 1, 1925, with the understanding that said company was to conduct a motion picture theater thereat. The lease running to said Piedmont Amusement Co. provided:
* * * That it will deliver up said premises at the end of the term hereinbefore limited, and sooner if default be made, in as good order and condition, fire and other unavoidable accidents and ordinary wear and tear excepted as at the time of the commencement of this lease.
* * *
The lessors agree that they will pay all taxes and legal assessments against the property herein leased during said term; that they will keep the building on said lot insured for its fair value, and that it event of loss by fire they will apply the proceeds from the fire insurance policies towards the restoration of said building to its condition prior to the fire, and that during the time said building is being restored the rent under this lease shall be abated; * * *
By contract and bill of sale, dated*2994 June, 1916, reciting that a sale had been effected whereby the Broadway Theater was to be transferred to the petitioner, and furthermore, that petitioner was to assume the lease on the premises, the petitioner became sublessee of the premises occupied by said Piedmont Amusement Company under the *302 lease hereinbefore referred to, and at the same time became the owner of the assets of the theater operated by that company, together with the lease, etc., in consideration of the payment of $7,000. The only modification of the original lease by that contract was with respect to the amount of rent which the petitioner was required to pay under its sublease.
Before its conversion in 1915 from a store building to motion picture theater, the building hereinabove discussed, exclusive of land, had a fair market value of $20,000, and the improvements made at that time cost $10,500. In 1916 further improvements were made to the building at a cost of $21,000, which rendered it practically new. The building, after all improvements, was 27 feet wide, 130 feet deep, 40 feet high, constructed with brick foundations, tiled floors, tar and gravel roof, had a seating capacity of 450 people, *2995 and it had a probable life of 40 years from January 2, 1920. The improvements made in 1915 were paid for by the lessor and those in 1916 were paid for by the petitioner. As it was improved on January 2, 1920, it would have cost $50,000 to replace a building of that character and the fair market value thereof was $45,000.
On January 3, 1920, the building aforesaid was completely destroyed by fire and immediately thereafter the land upon which the building was located was cleared of the debris by the petitioner and negotiations were entered into with the owners with the view to obtaining additional land for the erection of a larger building to replace the one that burned. An architect was employed by the petitioner, and after having succeeded in getting 35 feet of additional land in the rear of the lot, he proceeded with his plans for a new building.
On February 14, 1920, the petitioner entered into an agreement with the owners of the premises aforesaid, reading, in part, as follows:
NOW THEREFORE the parties to the said lease, that is, the estate of J. B. Clark and the Amusement Company have agreed that the lease dated the 1st of January, 1915 shall be changed and amended*2996 in the following particulars and in these particulars only, otherwise to remain exactly as written.
(1)
The estate of B. J. Clark agrees to pay Eight Thousand Dollars ($8,000) towards rebuilding the theater on said property.
(2)
The Amusement Company agrees to rebuild said theater and extend same back to the rear property line. * * *
* * *
(4)
*303 The said estate agrees to accept $200.00 per month as rental until January 1, 1925 and $300.00 per month for two years thereafter, which will make the original lease in full force and effect until December 31, 1926.
(5)
In case of fire during the term of this tenancy, the Amusement Company agrees to pay for the rebuilding and restoring this building to its original condition at the completion of the building now to be constructed and the said Clark estate will apply whatever money paid by the Fire Insurance Company towards the payment of the cost of said restoration.
(6)
The Amusement Company agrees to let the contract to rebuild said theater at once with the distinct understanding that the work must be pushed to completion just as rapidly as possible, the parties having agreed that the rent on said property*2997 will begin when building is completed and ready for occupancy.
Although the foregoing agreement specifies $8,000 as the amount to be paid by the owners toward reconstruction the petitioner actually received $8,300.
The new building was completed in November, 1920, at a cost of $80,214.54. Adding to this amount the cost of moving picture equipment, the total cost of reconstruction was $95,318.54. This building had a seating capacity of from 600 to 700 persons.
In computing the tax liability of the owners of the Broadway upon reconstruction thereof by the petitioner, the respondent arrived at a depreciated cost of the building and fixtures which burned of $42,270.83, and the cost of the new building and fixtures of over $95,000.
The petitioner also conducted a motion picture theater in the City of Danville, known as the Majestic, on premises leased by it on February 16, 1917, for the period September 1, 1917, to August 31, 1922. Adjacent to the land upon which the Majestic was built is a piece of property known as the Williamson lot, upon which there was a three-story brick tenement building, containing 18 rooms and all modern improvements, such as bath, gas, water, light*2998 and electricity, which building was occupied in 1920 and rent was regularly received therefrom then and after acquisition by the petitioner as hereafter explained.
In 1920 there was a threatened invasion of the petitioner's monopoly on the moving picture business in the City of Danville. Its officers were informed by one Williamson, who was one of the owners of the so-called Williamson lot, hereinabove referred to, and a stockholder of the petitioner, that certain interest from Richmond and Norfolk, Va., were attempting to buy that lot. The matter was laid *304 before the board of directors of the petitioner and it was finally decided to purchase the Williamson lot with the improvements thereon, which was done in the fall of 1920 at a cost of $60,000. This being the only available property in Danville suitable for a moving picture theater, the petitioner felt that acquisition thereof would prevent encroachment upon its monopoly by outside interests and it made the purchase principally for that purpose and with the intention of renting or selling at a profit. The petitioner had no intention of demolishing the old buildings at that time.
The acquisition of the Williamson*2999 lot was effective and the interests referred to did not open a theater in Danville.
In 1921 one Hill, representing certain North and South Carolina interests, came to Danville and finally succeeded in leasing the Majestic Theater from the owners thereof. In the spring of 1921, when the petitioners learned of the negotiations taking place between the Hill interests and the lessors of the Majestic Theater building, it demolished the tenement building on the Williamson lot and placed a large signboard thereon stating that it intended building a new and up to date theater thereon. Notwithstanding this move on the part of the petitioner to prevent the Hill interests from invading its monopoly, the negotiations between Hill and the lessors of the Majestic progressed. Therefore, the petitioner procured plans for a new building and on December 3, 1921, let a contract for the erection of a theater, office, and store at a cost of $112,000, to be completed before September 3, 1922. The construction contract provided for the cancellation of all work and material to be furnished in connection with the theater portion of the building upon the giving of a specified notice and for finishing*3000 the building as stores and offices and for reduction in the contract price hereinabove stated to $36,000. At or about this time Hill and the owners of the Majestic Theater building mutually agreed to cancel their lease, and the petitioner's lease was on April 15, 1922, renewed for a 10-year period ending August 31, 1932, and the petitioner thereupon took advantage of the provision in the contract of December 3, 1921, with the building contracts for altering the plans, and the building was completed with three stores and eight offices, for which the sum of $36,000 was paid.
The cost to reproduce the old tenement building upon the Williamson lot and the fair market value thereof when purchased in March, 1920, were $20,000 and $15,000, respectively. The cost of demolition was $800, and the amount of salvage realized therefrom was $300.
By stipulation of the parties it was agreed that the correct excess-profits tax of the petitioner, determinable under section 328 of the 1918 Revenue Act applied to 1919, is 22.44 per cent of the income of the petitioner for the year 1919 as determined in the respondent's *305 30-day letter dated June 23, 1925, that is, $45,534.41, and, furthermore, *3001 that no further issue exists with respect to the year 1919 and that the petitioner's tax for that year should be redetermined upon that basis.
Petitioner's books and records were kept on the cash receipts and disbursements basis.
The respondent denied the petitioner's application for relief in 1919 and 1920 under the provisions of sections 327 and 328 of the Revenue Act of 1918 on the ground that a comparison with representative concerns engaged in a like or similar trade or business disclosed that the rate of tax as determined was fair and equitable.
The Broadway Theater building is included in the petitioner's statement of assets and liabilities at December 31, 1919, at $31,134. The amount of loss claimed in its 1920 return because of the Broadway Theater fire is computed as follows:
| Broadway Theater - fixtures before fire | $3,752 |
| Broadway Theater - building before fire | 31,134 |
| 34,886 | |
| Salvage from fire Jan. 3, 1920 | 1,205 |
| Loss | 33,681 |
The respondent disallowed the foregoing deduction in the taxable year 1920, for the reason that no loss was sustained and there was no replacement of property involuntarily converted within the meaning of section 234*3002 of the Revenue Act of 1918.
The petitioner also deducted in its 1920 income-tax return amortization on its Broadway Theater building which it computed as follows:
| Cost of rebuilding | $83,952.78 | |
| Cost of refurnishing | 11,367.76 | |
| Cost of restoration | 95,320.54 | |
| Deduct insurance | 3,750.00 | |
| Net cost of restoration | 91,570.54 | |
| Less: loss | 33,681.00 | |
| Add to capital | 57,889.54 | |
| Lease period 6 years - amortization one-sixth of addition to capital | $9,648.25 |
The petitioner deducted an amount of $13,215.80 in its return for 1921 representing one-sixth of the cost of the Broadway Theater, computed as follows:
| Building cost | $88,943.08 |
| Depreciation, 1920 | 9,648.25 |
| 79,294.83 |
*306 The petitioner divided the remainder of the building cost, $79,294.83, after deducting depreciation for 1920, by 6 years, which was the remaining life of the lease, thereby arriving at the amount of the deduction of $13,215.80.
Petitioner also deducted $14,067.19 in the computation of its net taxable income for 1921, representing the loss which it claims was sustained by reason of razing the building on the Williamson lot, which amount the respondent has disallowed*3003 in accordance with the findings of the revenue agent.
OPINION.
MORRIS: The first allegation herein pertains to special relief for the years 1919, 1920, and 1921 under the provisions of sections 327 and 328 of the Revenue Acts of 1918 and 1921. The rate of tax for 1919 having been agreed to by stipulation between the parties, thereby disposing of the first allegation of error in respect to that year and counsel for the petitioner having moved to postpone consideration of the remaining years included in that allegation until we have determined the questions raised by the other allegations of error, as provided for in Rule 62 of the rules of the Board, we shall address ourselves to the second and third allegations of error urged by the petitioner and the affirmative allegation of error urged by the respondent by amendment to his answer.
At the hearing respondent's counsel moved to amend his answer to allege error on his part in allowing amortization for 1920 on the Broadway Theater building prior to its completion in November of that year, and he further moved to increase the deficiency as found for that year by reason of any adjustment which may be occasioned by a final determination*3004 of this question. It was agreed between the parties, however, that the petitioner is entitled to amortization on the difference between the amount of any loss which we may find for 1920 and the total cost of the building and equipment as destroyed by fire and, furthermore, that if petitioner is entitled to no loss then it will be entitled to amortize the total cost over the remaining life of the lease. We shall determine first, therefore, whether the petitioner is entitled to any loss at all.
Section 234 of the Revenue Act of 1918, which controls the question in controversy, provides that in the computation of net income there should be allowed as deductions:
(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * * including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity.
* * *
(4) *307 Losses sustained during the taxable year and not compensated for by insurance or otherwise.
Section 235 of the same Act provides:
That in computing net income*3005 no deduction shall in any case be allowed in respect of any of the items specified in section 215.
Section 215, in so far as applicable here, provides:
That in computing net income no deduction shall in any case be allowed in respect of -
* * *
(b) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate.
The petitioner contends that where a lessee is compelled to restore a building burned, the cost of replacement of that building at the time of its destruction by fire constitutes a loss to the lessee which is deductible from its gross income for the year in which such destruction takes place and the replacement made. Assuming for the purpose of a preliminary examination of the question involved that an obligation on a lessee to restore improvements when destroyed by fire establishes the right of said lessee to a loss, we can not agree that the petitioner was obligated to rebuild at any time prior to February 14, 1920, when it voluntarily agreed with the owners in writing to do so. In the lease on the premises covering the period January 1, 1915, to January 1, 1925, the terms of which the petitioner*3006 assumed as sublessee of said premises, it was provided that it would deliver up the premises at the end of the term in as good order and condition, "fire and other unavoidable accidents and ordinary wear and tear excepted as at the time of the commencement of this lease." This language without more would seem to clearly establish the fact that the petitioner as sublessee was expressly released from any obligation to rebuild in the event of fire. The petitioner, however, relies strongly upon the further provision of the lease, set forth herein in our findings of fact, which provides that the lessors shall pay all taxes and legal assessments and "that they will keep the building on said lot insured for its fair value, and that in event of loss by fire they will apply the proceeds from the fire insurance policies towards the restoration of said building to its condition prior to the fire, * * *." We do not regard this covenant as requiring the lessees to perform any act or acts whatsoever. As we construe the language used there, the lessors themselves are obligated to keep the premises insured in the event of loss by fire and apply the proceeds from the fire insurance policies toward*3007 restoring the building to its condition prior to any fire that may occur in order that the lessees' period of occupancy under the lease may not be terminated by fire destruction.
*308 We are further convinced that the petitioner was not obligated under its lease to rebuild the destroyed building by the fact that it entered into an agreement on February 14, 1920, by which it agreed to rebuild. Why, if it was obligated under the original lease to replace the destroyed premises, should it have entered into a further agreement for the doing of something which it was already required to do under the former covenants in the lease? Petitioner introduced evidence to the effect that it was the understanding of the parties to the lease that the lessee would rebuild in case of fire and counsel argued that the new building was in course of construction when the contract of February 14, 1920, was entered into. If such were the fact it would lend considerable weight to the testimony as to the understanding of the parties and their interpretation of the instrument, but we are unable to make any such definite finding from the record. In fact in the contract of February 14, 1920, it is*3008 provided that "the amusement company agrees to let the contract to rebuild said theater at once."
In this connection it is perhaps noteworthy that section 5179 of the Code of Virginia, 1919, provides that a covenant that a lessee will leave the premises in good repair is, subject to the qualifications of section 5180, to the same effect as a covenant that the premises will, at the expiration of the term, "be peaceably surrendered and yielded up unto the lessor, his representatives, or assigns, in good and substantial repair and condition, reasonable wear and tear excepted." Section 5180 of the Virginia Code provides:
Reduction of rent, if buildings destroyed or lessee deprived of possession. - No covenant or promise by a lessee to pay the rent, or that he will keep or leave the premises in good repair, shall have the effect, if the buildings thereon be destroyed by fire or otherwise, in whole or in part, without fault or negligence on his part, or if he be deprived of the possession of the premises by the public enemy, of binding him to make such payment or repair or erect such buildings again, unless there be other words showing it to be the intent of the parties that he should*3009 be so bound. But in case of such destruction, there shall be a reasonable reduction of the rent, for such time as may elapse until there be again upon the premises buildings of as much value to the tenant for his purposes as what may have been so destroyed; and, in case of such deprivation of possession, a like reduction until possession of the premises be restored to him. (Code 1887, par. 2455.) (Italics supplied.)
We are satisfied, therefore, from the facts which we have briefly discussed and from all the other surrounding circumstances that the petitioner was not, as it contends, obligated under its lease to rebuild the destroyed premises and we shall dismiss that factor from our further consideration of the question.
In National City Bank of Seattle,1 B.T.A. 139">1 B.T.A. 139, the petitioner through its agents entered into a verbal agreement to lease certain *309 premises for a period of five years, under which the lessor was required to make certain improvements to the outside of the building and the petitioner was required to install certain permanent improvements on the inside. The petitioner there took possession of the premises and expended $33,413.99 in*3010 making the required improvements during the year 1918, and in its tax return for that year it deducted that sum in the computation of its net incomeWhich sum was disallowed by the respondent. The Board there sustained the respondent's disallowance of the deduction claimed and the allowance of an amount representing such portion of the exhaustion of the taxpayer's investment as was properly allocable to the year 1918.
Thus it will be seen from the foregoing opinion that notwithstanding the contractual obligation of the lessee to improve the premises as a condition to the enjoyment of its lease, that factor is not determinative of the question at issue.
Considering the National City Bank of Seattle, supra;Texarkana Cotton Oil Co.,1 B.T.A. 1142">1 B.T.A. 1142; Simmons & Hammond Manufacturing Co.,1 B.T.A. 803">1 B.T.A. 803; Gladding Dry Goods Co.,2 B.T.A. 336">2 B.T.A. 336, and Louis C. Levy,2 B.T.A. 361">2 B.T.A. 361, we are of the opinion, that the deduction which the petitioner claims by reason of the reconstruction of the Broadway Theater building, which it occupied as lessee, is not allowable in the computation of net income for 1920.
*3011 Having concluded that there was no loss as contended for by the petitioner, within the year 1920, and it having been agreed between the parties that it is entitled to amortize the total cost over the remaining life of the lease, we have the further question of when the amortization period actually began. In Texarkana Cotton Oil Co., supra, the Board, after determining that the expenditures made for improvements upon leased premises, were not deductible from gross income for the fiscal year in which they were made, held that the amount in controversy should be distributed over the period from the time the petitioner "definitely committed itself to the expenditures" to the date of termination of the lease.
The petitioner here definitely committed itself to rebuild the Broadway Theater on February 14, 1920, and we, therefore, hold that it is entitled to amortize the total cost of its expenditures, less the amounts recovered by way of salvage and insurance, over the remaining life of the lease beginning with February 14, 1920.
In recomputing the amount of the deficiency by reason of the foregoing conclusion the amounts of amortization already claimed by the petitioner*3012 and allowed by the respondent shall, of course, be considered as a part of said recomputation.
*310 The foregoing disposes of the petitioner's second allegation of error and also the affirmative allegation of error urged by the respondent.
The last allegation of error urged by the petitioner is with respect to the deductibility of the loss occasioned by demolishing the improvements upon the so-called Williamson lot. The petitioner contends that when the said property was acquired in 1920 it had no intention whatsoever of demolishing the building thereon and that, therefore, under section 234(a)(4) of the Revenue Act of 1921 and article 142 of Regulations 62, promulgated thereunder, it is entitled to deduct the loss claimed. Section 234 of that Act provides in part as follows:
That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * *
(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise; * * *
Article 142 of Regulations 62 reads as follows:
Voluntary removal of buildings. - Loss due to the voluntary removal or demolition of old buildings, *3013 the scrapping of old machinery, equipment, etc., incident to renewals and replacements will be deductible from gross income in a sum representing the difference between the cost of such property demolished or scrapped and the amount of depreciation sustained with respect to the property prior to its demolition or scrapping, and allowable as a deduction in computing net income. When a taxpayer buys real estate upon which is located a building which he proceeds to raze with a view to erecting thereon another building, it will be considered that the taxpayer has sustained no deductible loss by reason of the demolition of the old building, and no deductible expense on account of the cost of such removal, the value of the real estate, exclusive of old improvements, being presumably equal to the purchase price of the land and building plus the cost of removing the useless building.
In The Winter Garden, Inc.,10 B.T.A. 71">10 B.T.A. 71, the petitioner took possession of a restaurant on or about December 1, 1921, and after having operated it for three days, it closed its doors because of insufficient patronage, and within a few days thereafter began remodeling. The kitchen and dining*3014 room were practically made over and the guest capicity nearly doubled. The various changes made necessitated discarding most of the equipment, estimated by the petitioner to have a value of $15,000, which was a total loss. The cost of remaking and equipping the cafe was approximately $36,000. In that case we found as a fact that it was the intention of the petitioner to operate the restaurant as it then stood without extensive alterations. In preparing its income-tax return for the year 1921, the petitioner there deducted the $15,000 in computing its net taxable *311 income, which was disallowed by the respondent. The Board having found that it was not the intention of the petitioner to remodel the premises when purchased, and that the said remodeling was an afterthought following three days of experience in operation, held that the loss claimed by the petitioner was actually sustained and, therefore, deductible under section 234(a)(4) of the Revenue Act of 1921.
The record shows that the petitioner here enjoyed a monopoly on motion pictures for white patrons in the City of Danville at the time when the Williamson property was acquired; that in 1920 there was a threatened*3015 invasion of its monopoly by certain interests then operating amusements in Richmond and Norfolk, Va.; that these interests were seeking property in the City of Danville for the purpose of erecting a motion picture theater to operate in competition with the petitioner's shows; that said interests attempted to purchase the Williamson property; that the Williamson property was at that time valuable and also growing more valuable as business conditions progressed in that city; and that it was the only available property in Danville suitable for the operation of a moving picture theater; that the petitioner, realizing the situation and fearing the conditions which competition might bring about, purchased the Williamson lot with improvements thereon on May 15, 1920, and paid therefor $60,000. The record satisfactorily discloses that the petitioner had no intention whatsoever when it purchased this property of demolishing the building and erecting improvements thereon. On the contrary, the testimony is conclusive that the principal reason for purchasing said property was that it would prevent encroachment upon its monopoly by outside interests and for the further purpose of renting or selling*3016 the property at a profit. The acquisition of the Williamson property, as the record shows, was an effective measure, and that the Norfolk and Richmond interests did not carry out their plans of operation in Danville. It was not until 1921 when other and more persistent competitive interests attempted to invade the motion picture field in the City of Danville that the petitioner was required to demolish the building, publish the erection of an up-to-date moving picture theater, and finally carry out its threat by beginning the erection of a building, ostensibly a theater, but in fact, stores and offices. We are satisfied that the petitioner is entitled to the loss sustained by reason of the demolition of the improvements on the Williamson property.
Further proceedings for the years 1920 and 1921 may be had under Rule 62(b) and (c).