*229 Decision will be entered for the respondent.
Petitioner, upon the facts, held not to be entitled to deduct, as ordinary and necessary business expenses, the cost of furnishings, equipment, and fixtures it installed in hotels it operated under an oral understanding with the owner thereof.
*561 This proceeding involves deficiencies in income tax in the amounts of $ 2,134.70 and $ 1,046.87 and in declared value excess profits tax in the amounts of $ 883.73 and $ 172.28 for 1944 and 1945, respectively. The issues are whether respondent erred in capitalizing each year, subject to depreciation, certain amounts claimed in returns as ordinary and necessary business expenses, and not allowing, as a deduction in 1944, a net operating loss*230 of not less than $ 2,765.59 during 1946. Petitioner filed its returns for the taxable years on the cash basis with the collector for the district of Oklahoma.
FINDINGS OF FACT.
On December 15, 1910, Andrew Kingkade leased to L. Rardin and C. T. Williams for a term of 10 years, at a total rental of $ 328,800, a hotel building then under construction in Oklahoma City, Oklahoma. The lease provided, among other things, that:
Said lessees shall * * * personally conduct therein a first-class, modern hotel * * *.
Said lessees shall quit and surrender said premises at the end of said term, in as good condition as the reasonable use thereof will permit, and shall not make any alterations, additions or improvements in said premises without the written consent of the lessor, and all alterations, additions or improvements which shall be made on said premises during the term hereof, shall be at the expense of the lessees and shall be the property of the said lessor and shall remain upon and be surrendered with the premises as a part thereof at the termination of this lease, without disturbance, molestation or injury; Provided, that the lessees may, at the end of the term, remove all fixtures*231 placed in said building by them which fixtures can and shall be removed strictly without injury to the building. If the tenant continues to occupy said premises on any pretense whatever after the expiration of the time in this lease provided without a contract in writing with the lessor, he shall be deemed and held to be a tenant at sufferance.
The lessor covenants to keep the roof of said building in proper repair * * *. Every other part of said building and appurtenances including the water tank on top of roof and pipes and connections leading to and from same, is to be kept by the lessees in first-class condition, at their own expense, and regardless of the cause of the injury, except as hereinafter specified. * * *
* * * *
*562 It is hereby agreed that the lessor shall have a lien, as security for the rent above specified and for the performance of all conditions and terms of this lease, upon all furniture, fixtures and furnishings placed upon said property by the lessees * * *.
The building, known as the Kingkade Hotel, was completed in 1911, in which year the lessees furnished and equipped the hotel and opened it for business.
The Kingkade Hotel Co., an Oklahoma corporation, *232 hereinafter referred to as the owning company, was organized in 1912 to acquire, and in that year acquired, the hotel building and lease thereon from Andrew Kingkade. In about 1913 the lessees failed in business and in 1914 the owning company acquired the furnishings and equipment the lessees had installed in the hotel. The owning company acquired the Bristol Hotel, located in Oklahoma City, completely furnished, in 1923, and the Ewell Hotel, unfurnished, with garage and parking lot, located in Oklahoma City, in 1933, and since those times has owned the three properties.
The Hotel Kingkade, the petitioner herein, was organized in 1914, under the laws of Oklahoma, to operate the Kingkade Hotel. On April 28, 1914, the lessees assigned their lease on the Kingkade Hotel to petitioner, and since then it has operated the hotel.
Upon the expiration of the term of the lease in 1920, the owning company and petitioner had an oral understanding, under which they considered that the latter would continue operation of the Kingkade Hotel under the terms thereof, except that the rental was to be in accordance with the ability of petitioner to pay rent, depending on the amount of its profits. *233 In 1923 petitioner entered into a like arrangement for the operation of the Bristol Hotel, and since that time it has operated the property in accordance therewith. Petitioner has operated the Ewell Hotel, garage, and parking lot since 1933 under similar arrangements, subject, however, to an understanding that petitioner would pay the costs of repairs and maintenance and pay the balance of its income to the owning company as rent. Petitioner currently paid its profits to the owning company as rental unless some portion thereof was retained as a reserve to meet some anticipated expense. In 1942 the owning company was out of debt and permitted petitioner to retain some of its profits to create a cash reserve to meet operating requirements in later years.
For the period from 1929 to 1941, inclusive, the petitioner had aggregate net income of $ 231.03 after payments to the owning company as rent, and an aggregate net loss of $ 352.99 after payment of taxes. Its aggregate net income for the years 1942 to 1945, inclusive, was $ 24,960.84 after payment of amounts to the owning company as rent, and $ 18,516.41 after paying taxes in the total amount of $ 6,444.43.
*563 During the *234 years 1944, 1945, and 1946 the petitioner charged the amounts of $ 15,909.56, $ 13,448.86, and $ 10,484.29, respectively, to "Repairs and Maintenance." In its returns for 1944 and 1945 petitioner claimed as deductions the amounts of $ 15,909.56 and $ 13,448.66, respectively, for repairs and maintenance. In his determination of the deficiencies for the taxable years, the respondent determined that, of the amounts claimed as deductions for repairs and maintenance in such years and 1946, $ 9,310.48 in 1944, $ 5,497.16 in 1945, and $ 3,959.66 in 1946 constituted capital expenditures under the provisions of section 29.24-2 of Regulations 111 and was not deductible as business expenses. The amounts disallowed by the respondent were paid by the petitioner during the year for which the respective amounts were claimed as deductions. The amounts disallowed by the respondent as business expenses consisted of the following (the amounts include Oklahoma state sales tax included in the invoices):
| 1944 | 1945 | 1946 | |
| Carpets and rugs | $ 4,712.75 | $ 348.28 | $ 1,996.91 |
| Ozite (padding under carpet) | 104.04 | ||
| Refrigerator with ice maker | 484.50 | ||
| Reflue and repair heating and hot water | |||
| boilers | 2,219.91 | ||
| Closet tanks and bowls and pipe and other | |||
| fittings therefor, and toilet covers | 1,789.28 | 459.85 | |
| Cloth material | 236.85 | ||
| Dishwasher | 810.90 | ||
| Remove old hot water tank | 650.00 | ||
| Adding machine | 205.20 | ||
| Fire hose and appliances | 564.89 | ||
| Electric fans | 483.99 | ||
| Roofing and sheet metal contracts | 1,737.20 | ||
| Cooking ranges | 587.85 | ||
| Potato peeler and trays | 224.40 | ||
| Tile work on kitchen walls and showers | 1,180.50 | ||
| Total | 9,310.48 | 5,497.16 | 3,959.66 |
*235 All of the amounts were treated on the books of petitioner as current repairs and replacements and maintenance and charged to expense. The carpet was acquired to replace worn and damaged carpets. The refrigerator, dishwasher, adding machine, fire hose, electric fans, cooking ranges, and potato peeler and trays replaced like worn out equipment. The closet tanks were replacements for broken or damaged equipment. Ozite, closet tanks, and fixtures therefor and other bathroom fixtures and fire hose were replaced, and heating and hot water boilers were repaired and reflued in years prior to 1944, and petitioner charged the cost thereof to expense.
Equipment and furnishings of the general character of those involved herein have at all times been treated on the books of petitioner as business expenses. In addition to some of the equipment, furnishings, fixtures, and work of the kind involved herein, other items of a similar nature charged to expense in 1940, 1941, 1942, and 1943 included cabinets, dressing tables, chairs, living room furniture, repairs *564 to mattresses, meat block, stool seats, cuspidors, counter top, and cigar stand.
In May 1924, a Deputy Commissioner notified*236 the petitioner that an examination of its returns for the years 1919 to 1922, inclusive, disclosed additional tax liability for 1920, resulting from the disallowance of contributions made in 1920. The internal revenue agent in charge of the Oklahoma City office notified the petitioner that recommendations would be made to the Commissioner that its returns for the years 1924 and 1925 and 1929 to 1936, inclusive, be accepted as correct. The Commissioner notified the petitioner that its return for 1926 was considered to be correct as submitted and would be regarded as closed, unless additional information was discovered, in which event he reserved the right to reopen the case in accordance with provisions of existing law. Amounts claimed by the petitioner for repairs and replacements in returns filed for the years 1937 to 1943, inclusive, were not disallowed.
During the years 1916 to 1919, inclusive, petitioner maintained accounts entitled "Renewals" and "Repairs" for the Hotel Kingkade. Thereafter it had an account entitled "Repairs and Maintenance" for that hotel and the Bristol Hotel. Petitioner charged to the former accounts a total of $ 440.43 for renewals and $ 538.96 for *237 repairs. To the latter account for the Hotel Kingkade it charged a total of $ 57,986.35 for the years 1920, 1921, and 1922. During subsequent periods and years it charged the following total amounts to the "Repairs and Maintenance" accounts for both of the hotels:
| 1923-1932, incl | $ 146,821.66 |
| 1933-1942, incl | 53,007.18 |
| 1943 | 7,845.98 |
| 1944 | 15,909.56 |
| 1945 | 13,448.86 |
| 1946 | 10,484.29 |
The percentage of amounts charged to the accounts to gross revenue ranged from a low of .776 per cent in 1932 to a high of 10.218 per cent in 1928. The ratio was 4.544, 3.742, and 2.905 per cent in the years 1944, 1945, and 1946, respectively.
The controlling stock interest in petitioner and the owning company in 1944, 1945, and 1946 was held by Andrew Kingkade and his wife, their son, and the son's wife and daughter.
The petitioner had an operating loss of $ 2,765.59 in 1946 after deducting $ 10,484.29 for business expenses, of which $ 3,959.66 is involved herein, and before deducting the amount of $ 2,009.16 allowed by the respondent as an additional allowance for depreciation.
OPINION.
On brief, petitioner contends that the lease under which it operated required it to operate first-class *238 modern hotels, which it could not do with worn-out equipment, and that the amounts *565 in controversy constitute ordinary and necessary business expenses under the rationale of , and .
In the Southern Ry. Co. case the court, in discussing a conclusion of the Board of Tax Appeals that deductions for repairs for which an undermaintenance allowance was made by the Director of Railroads should be disallowed, said that:
* * * It would be inconvenient, if not impractical, in railroad accounting to charge every item having a life of more than one year to capital account * * * and in a great business where thousands of similar replacement or repair items are involved nothing would be gained by such a system of accounting, since, on the law of averages, expenditures for such items during a given year would substantially balance the depreciation for that year. * * * Expenditures for repairs and replacements, therefore, when no greater than necessary to maintain the property of the railroad at the normal level*239 of maintenance, merely counterbalance depreciation and are deductible from income, just as depreciation is deductible, in that they represent a necessary expense in the earning of income. * * * So long as the expenditure for this purpose does not exceed that which is necessary to preserve the normal level of maintenance, it is properly treated as an ordinary and necessary expense of the operation of the business, and is deductible from income as such.
In the Illinois Central R. Co. case the taxpayer's subsidiary, as lessee, was required to repair and replace, at its expense, the leased property during the long terms of the leases, so that the property would at all times be in as good condition as when the leases were entered into. The lessor was to reimburse the lessee for betterments to the leased property. Amounts expended for locomotives and freight cars to replace like equipment which had been retired were allowed as a business expense.
We find no justification for extending the rule applied in the cases relied upon by petitioner to the facts here. There is no showing here that it would be inconvenient, if not impracticable, to charge the cost of the property to capital*240 and obtain recovery through yearly deductions for exhaustion, as is generally done in the case of depreciable assets having a useful life in excess of one year. Neither can we say, from the proof made, that the expenditures did nothing more than maintain the property, as a whole, in normal condition, and merely counterbalanced depreciation. The petitioner, according to the terms of the original lease under which, in general, it operated until 1920, was granted "reasonable use" of the building (hotel equipment and furniture and fixtures were not furnished by the lessor under the original lease) and, accordingly, petitioner was under no obligation to surrender the property in as good condition as when taking possession.
*566 The terms of the original lease, executed in 1910 between the then owner of the Kingkade Hotel building and two individuals, were in general, to control the rights of the owning company and petitioner respecting the Kingkade Hotel and Bristol Hotel. None of the amounts involved herein are shown to have been spent in the operation of the Ewell Hotel. The original lease was for the unfurnished Kingkade Hotel building and required the lessees, as above seen, *241 to surrender the premises at the end of the term in as good condition as reasonable use thereof would permit, any improvements to the premises to be at the expense of the lessees. The lessor was required to keep the roof in proper repair; therefore that item, $ 1,737.20, is eliminated at once. In other respects, the lessees were to make the repairs at their expense to keep the building in first-class condition, subject to reasonable use. The hotel furnishings and equipment were acquired by the owning company in about 1914. The Bristol Hotel was acquired by the owning company, completely furnished, in 1923. Fixtures placed in the Kingkade Hotel by the original lessees were subject to removal by them upon the termination of the lease, if it could be done without injury to the building, and the lease contained no clear provision respecting the condition in which the lessees were to maintain it, for, as above noted, it provided that the lessees should surrender the premises at the end of the term "in as good condition as the reasonable use thereof will permit," but also provided that except for the roof, the building and appurtenances should be kept by the lessees in first-class *242 condition at their own expense.
Certainly we find no requirement under the arrangement petitioner had for operating the hotel properties to replace, repair, or otherwise maintain the furnishings. Moreover, even assuming an obligation on the part of petitioner to replace and maintain hotel equipment and furnishings, we are not from the record made able to say that amounts involved herein as replacement costs replaced such property in the buildings when petitioner took over operation of the hotels. For aught we know from the record, it replaced additional property acquired by petitioner. It also appears that $ 650, the cost of removing an old hot water tank, was a cost which should have been charged as a part of cost of the equipment which replaced it.
Petitioner appears to assume that the costs here involved were necessary to comply with a term of the lease requiring the lessee to conduct a modern and first-class hotel in the respective buildings. The provision seems to relate to management, rather than to furnishings and equipment. In any event, the hotels were furnished when petitioner commenced to operate them, and whether the furnishings then in the hotels were sufficient to*243 conduct a first-class, modern hotel is not shown by evidence. No evidence was adduced to show what was required *567 in the way of furnishings and equipment in order to maintain these hotels in first-class condition -- assuming that the petitioner was required so to do.
In , the taxpayer leased a furnished hotel for a term of 21 years under an agreement obligating it to maintain and replace at its own expense all furnishings, fixtures, and equipment then or thereafter located or used in connection with the leased premises and giving it the right to install additional equipment, any such property to be the property of the lessee and subject to its removal. The question was whether the cost of bedding, carpets, rugs, kitchen equipment, curtains, draperies, and furniture and fixtures should be capitalized, subject to depreciation, as determined by the Commissioner, or deducted as ordinary and necessary expenses. The facts did not show whether the equipment represented replacements of leased property or additional equipment, property of the lessee. We held that the cost of any additional equipment having a useful*244 life substantially in excess of one year must be capitalized and recovered by allowances for depreciation instead of deductions for business expenses. Concerning any of the property purchased to replace leased equipment, absent proof that similar expenditures were made in substantially the same amounts in each of the prior years of operation under the lease, none of which was capitalized, that the items of property had relatively short lives in the hotel, and that similar expenditures might be expected in subsequent years, we declined to disturb the action of the Commissioner in treating the amounts as capital expenditures.
Here, there is proof of similar expenditures in prior years and that the costs were charged to expense, but no showing was made that the life of the equipment was not substantially in excess of one year, or that the equipment replaced furnishings, etc., in the properties when taken over for operation or was additional equipment. Furthermore, as already pointed out, there is no proof that petitioner was obligated to repair or replace leased equipment.
The petitioner cites , as authority for according*245 the expenditures the same treatment the respondent gave similar expenditures in prior years. In that case the taxpayer had for a period of 15 years used the reserve system of reporting bad debts and reported recoveries of bad debts as gross income instead of a credit to the balance in the reserve account. The amount included in gross income in the taxable year as recoveries from bad debts was eliminated by the Commissioner and added to the balance in the reserve account. He disallowed a portion thereof and as a result more than 80 per cent of the petitioner's gross income was personal holding income, with the result that petitioner was classified *568 as a personal holding company and subject to the surtax. Thus, whether or not the taxpayer was a personal holding company depended upon the change made by the Commissioner in the taxpayer's consistent method of accounting. The regulations did not condemn the procedure followed by the taxpayer or approve the use of the Commissioner's method. Under the facts present in the case, we held that the method of accounting employed by the taxpayer clearly reflected its income.
In the Ohio Loan case the controlling question was *246 gross income. The amount of net income was the same, regardless of the method employed. See . Here, it is not a matter of accounting method to reach the same result as net income, but whether capital expenditures are deductible as business expenses, since such treatment by the petitioner over a long period of time was not disapproved by the respondent. Obviously, such an accounting practice does not clearly reflect income; rather, it distorts it by taking as business expense deductions amounts which the statute requires taxpayers to recover only through deductions for exhaustion. We see the Ohio Loan case as distinguished from the instant matter, and the result of consistent treatment by the taxpayer there as not called for or logically permitted here.
Moreover, the petitioner's argument in attempting to apply the Ohio Loan case, that in previous years the Commissioner had allowed deduction of expenditures similar to the items here involved, therefore consistency requires allowance in these years, is not substantiated by the evidence, as to any considerable period. The record includes recommendations by revenue*247 agents to the Commissioner for 1924, 1925, 1929, 1930, 1931, 1932, 1933, 1934, 1935, and 1936, that petitioner's income tax returns be accepted as filed, but with the qualifications as to 1929-1936, that the action is subject to final approval, and such final approval is not shown. For 1926 approval is shown by the Commissioner, subject to reopening in case of discovery of other information. But as to years prior to 1937, there is no showing as to the items of expense claimed in the returns. Though the Kingkade Hotel's manager since 1937 testified that items similar were treated as ordinary expense in prior years, and were allowed, later he said that the auditor made the returns and that he was not personally familiar with the details in that respect, and asked that the auditor help. We can not, therefore, accept his general testimony on the point, for without knowledge of the contents of the returns he did not know whether similar items were therein claimed as expense. The auditor also did not know what exceptions were taken by the Commissioner to repair and replacement items prior to 1937. Thus it is seen that no real showing is made that previously the petitioner had consistently*248 *569 claimed and the Commissioner had allowed over a long period expense deductions essentially the same as now involved. We would not be justified in so holding, or in applying the Ohio Loan case. In that case there was such consistent treatment over a period of 15 years. We have shown above that it is otherwise inapplicable.
We find no error in respondent's action in disallowing the amounts as deductions for ordinary and necessary business expenses.
The amount of the operating loss in 1946 is controlled by our conclusion on the other issue. Accordingly, in view of our holding for the respondent on that question, the amount of the operating loss in 1946 determined by the respondent will not be disturbed.
Decision will be entered for the respondent.