*5 Decisions will be entered under Rule 50.
1. Petitioners operate a cattle ranch in Kansas, purchasing one or more groups of beef cattle each fall from a Texas ranch, feeding them for several months, and then selling them as beef cattle. Some of the groups were composed of 8-year-old cows which were bred on the Texas ranch, or petitioners' ranch soon after purchase. These cows were held over for a crop of spring calves and were then conditioned for and sold to the beef market. Held, that these cows were held for sale to customers in the regular course of petitioners' business of fattening and marketing beef cattle and that the gains on such sales are taxable in full as ordinary income rather than as capital gains under section 117 (j), I. R. C.Held, further, that such cows were not subject to depreciation allowances.
2. In their returns petitioners deducted the full cost of each group of cattle from the first sales of cattle from that group, before reporting any gains. For 1945 the respondent required an allocation of a portion of the cost basis of the entire group to each cow in the group. Held, that as to 1945 sales, petitioners are entitled to the use of such*6 bases for all cattle sold in that year, notwithstanding that they had deducted the full cost of some of the groups against sales of 1944.
*999 These proceedings involve deficiencies in petitioners' income taxes for 1945 and 1946 as follows:
| Clayton E. | ||
| Kline & | ||
| Leonard C. | Kathryn A. | |
| Kline | Kline | |
| Docket | Docket | |
| Year | No. 24161 | No. 24162 |
| 1945 | $ 8,383.70 | $ 3,940.86 |
| 1946 | 9,212.60 |
Petitioner Leonard C. Kline claims an overpayment for 1945 in the amount of $ 7,944.56, and petitioners Clayton E. Kline and Kathryn A. Kline claim an overpayment for 1945 in the amount of $ 774.57. The issues relate entirely to the income from a cattle ranching business which petitioners operated as a partnership under the name of Kline Brothers.
It is alleged that in determining the partnership income respondent erred (1) in denying petitioners the benefit of section 117 (j), Internal Revenue Code, in determining taxable gain on the sale of breeding cattle held for more than 6 months; (2) in failing to allow depreciation on such cattle, and (3) in not allowing*7 the correct cost basis for computing the gains on the sale of cattle from certain groups, where the entire cost of the group had been deducted from the sales of a prior year.
The proceedings were not consolidated for hearing and opinion, although it was stipulated at the trial that the same evidence should apply in both cases. For reasons of convenience, and for economy, the proceedings are now consolidated for the purpose of this opinion.
FINDINGS OF FACT.
Some of the basic facts have been stipulated and are so found.
Leonard C. Kline and Clayton E. Kline are brothers and are engaged in the operation of a cattle ranch as a partnership, operating under the name of Kline Brothers. The former resides in Johnson County, Kansas, where he also conducts an insurance business. The latter resides in Topeka, Kansas, and is engaged in the practice of law. Petitioners both filed their income tax returns for 1945 with the collector of internal revenue for the district of Kansas. Leonard C. Kline filed his income tax return for 1946 with the collector of internal revenue for the sixth district of Missouri.
Petitioners have operated the ranch for a number of years. It is located near Miller, *8 Kansas, and contains about 5,000 acres, some 950 acres of which are in cultivation. The principal products of the ranch are cows and hogs, although some grain and hay crops are produced. The ranch has the capacity to handle about 2,500 head of cattle. If more than that number are on hand at any one time additional grazing lands are leased from nearby land owners.
*1000 For a number of years petitioners conducted their cattle business solely as a feeding operation. They purchased ranch cattle and after grazing or feeding them for a few months sold them to the beef market. In 1938 they started an Angus herd, purchasing eight cows and a registered bull of that breed. At that time, they also had a small herd of Milking Shorthorns, consisting of 15 or 20 cows and a bull.
In October 1942 petitioners purchased 690 white-faced (Hereford) cows from the JA Ranch near Amarillo, Texas. These cows were all about eight years old and were all purchased as feeder cattle. They were shipped directly from the JA Ranch to petitioners' ranch for fattening. They had all been bred at the JA Ranch to Hereford bulls and some of them showed that they would calve within a few months. About 84*9 of these "springers", as they were called, were cut out of the beef herd and later sold at auction as breeders in February 1943. The others were sold as feeders in February or March of that year. For convenience, this group of cattle was identified in petitioners' books as group "17 JA."
In November 1943 petitioners purchased another group of 280 bred cows from the JA Ranch, identified as group "4 JA." They sold about 54 of this group in the early spring of 1944 but kept the others until after they had calved. Most of these were sold as feeders in July 1944 after the calves were weaned.
From this experience petitioners decided to breed and raise some of their own cattle. In October 1944 they purchased from the Theis Cattle Co. of Pampa, Texas, 404 Hereford heifers of various ages and in June 1945 they purchased 4 registered Hereford bulls from a ranch in Jackson County, Missouri. They selected and bred 200 of the heifers in June or July and had them inoculated against Bang's disease. In the fall of that year the cattle market reached such a high point that the petitioners decided to sell, and did sell, the entire lot of heifers as beef cattle. They realized a profit on them*10 of approximately $ 70 a head.
At about the same time that they purchased the 404 heifers, October 1944, petititoners bought from the JA Ranch two lots of 8-year-old cows, group "7 JA" of 298 and group "5 JA" of 62. These cows had all been bred on the JA Ranch. They were bought by the pound at an average cost of $ 52.93 a head. They produced a spring calf crop of about 200 and in the fall of 1945 were all sold as beef cattle at an average price of $ 82.81 a head. Some of the calves were sold for veal and the others held over and sold for beef when about a year and a half old.
In September 1945 petitioners bought from the JA Ranch 420 8-year-old bred cows, identified as group "10 JA" at an average cost of $ 60.32 a head. Three of these cows were sold in 1946, because of defects, and the others during the summer and fall of that year. They *1001 were all sold as beef cattle and brought an average price of $ 123.79 a head. They produced 259 calves, all of which were held for not more than two years and sold as beef cattle.
The following table shows the dates of the purchases and of the sales of the cows in each of the groups referred to as "4 JA," "5 JA," "7 JA," and "10 JA": *11
| Purchases | Sales | |||
| Group | Head | Date | Head | Date |
| #4 JA Cows | 280 | 11-22-43 | 51 | Feb. '44 |
| 3 | Apr. '44 | |||
| 54 | July '44 | |||
| 45 | Aug. '44 | |||
| 80 | Sept. '44 | |||
| 1 | Oct. '44 | |||
| 1 | Nov. '44 | |||
| 28 | Feb. '45 | |||
| 1 13 | ||||
| 2 4 | ||||
| 280 | ||||
| #5 JA Cows | ||||
| (from #4) | 13 | 11-22-43 | 13 | Mar. '45 |
| #5 JA Cows purchased | 62 | 11-20-44 | 6 | Mar. '45 |
| 37 | Aug. '45 | |||
| 15 | Oct. '45 | |||
| 2 4 | ||||
| 75 | ||||
| #7 JA Cows | 298 | 10-24-44 | 95 | 6-26-45 |
| 20 | July '45 | |||
| 147 | Aug. '45 | |||
| 28 | Oct. '45 | |||
| 2 8 | ||||
| 298 | ||||
| #10 JA Cows | 420 | 9-25-45 | 1 | Jan. '46 |
| 2 | Feb. '46 | |||
| 187 | July '46 | |||
| 118 | Aug. '46 | |||
| 27 | Sept. '46 | |||
| 41 | Oct. '46 | |||
| 70 | Dec. '46 | |||
| 446 | ||||
| 3 26 | ||||
| 420 |
The average cost per head at the JA Ranch and the average sale price of the "5 JA," "7 JA," and "10 JA" groups were as follows:
| Group | Cost | Sale price |
| 5 JA | $ 52.93 | $ 82.81 |
| 7 JA | 52.92 | 88.59 |
| 10 JA | 60.32 | 123.79 |
Petitioners have continued this practice up to the present time. Each year they have purchased one or more groups of cows from the JA Ranch and sold them from six to twelve months later, after*12 they produced a single crop of calves.
In the meantime, petitioners have been building up a breeding herd of cattle and have had success in cross breeding the Angus and Hereford breeds. The cross breeds are all sold as feeder cattle. Petitioners' total cattle inventory as of May 8, 1950, was as follows:
| Description of Breed (Explanation) | Bulls | Cows | Calves | Heifers | Steers |
| ANGUS BREED | 18 | 50 | 40 | 0 | |
| Bulls: | |||||
| 13 raised. | |||||
| 4 purchased 1949. | |||||
| 1 purchased 1949. | |||||
| Cows: | |||||
| 42 raised. | |||||
| 8 purchased 1938-9. | |||||
| Calves: | |||||
| 40 raised. | |||||
| JA HEREFORDS | 5 | 355 | 100 | 135 | 153 |
| Bulls: | |||||
| 5 purchased JA Ranch in 1948. | |||||
| Cows: | |||||
| 355 purchased 1949. | |||||
| Calves: | |||||
| 100 raised. | |||||
| Heifers: | |||||
| 135 raised from JA calf crop of 1949. | |||||
| Steers: | |||||
| 153 raised from JA calf crop of 1949. | |||||
| OTHER HEREFORDS | 0 | 346 | 142 | 0 | |
| Cows: | |||||
| 172 raised from JA calf crop of 1948. | |||||
| 166 Hay Hooks, purchased 1949. | |||||
| 8 Winner cows, purchased 1948. | |||||
| Calves: | |||||
| 142 raised from the above 172 2 year | |||||
| olds. | |||||
| MILKING SHORTHORNS | 0 | 15 | 15 | 0 | |
| Cows: | |||||
| 2 purchased in 1938. | |||||
| 13 raised. | |||||
| Calves: | |||||
| 15 raised 1950 crop. | |||||
| MISCELLANEOUS | 0 | 0 | 0 | 270 | 0 |
| Heifers: | |||||
| 270 yearling heifers purchased JA Ranch | |||||
| 1949. | |||||
| Totals | 23 | 766 | 297 | 405 | 153 |
*13 *1002 In purchasing the JA Ranch cows it was petitioners' intentions at all times to hold the cows until after they had produced a crop of calves and then sell them as beef cattle. They never intended to hold the cows for a second calf crop and never intended to use them for breeding purposes at their own ranch, except for the single calf crop. About 15 or 20 per cent of the JA cows were found not to be with calf when purchased and these were bred to petitioners' bulls. The normal useful life of these cows as breeders lasted until they were about 12 years old. Petitioners did not run the risk of having the cows die on their hands. They found it more profitable, considering the cost of carry-over and other factors, to purchase a new lot of cows each year and keep them just for a single crop of calves. Most of the calves from these cows were sold for beef when about a year and a half old. Some of the heifers, however, were transferred to the breeding herd. No records were kept of the exact number transferred from one herd to the other.
For a number of years petitioners reported their gains on the sale of cattle by deducting the total cost of each group of cattle from the*14 first sales out of that group, before reporting any gains. In this manner they reported gains in their partnership returns for 1944, 1945, and 1946 as follows: *1003
| Cost | ||
| Group Number | ||
| Head | Amount | |
| 1944 | ||
| #2 Mt. Dora | 624 | $ 48,073.16 |
| #3 Heifers | 254 | 14,935.78 |
| #4 JA cattle | 280 | 26,372.94 |
| #5 Steers | 351 | 36,745.27 |
| 1945 | ||
| #2 Mt. Dora | ||
| #3 Heifers | ||
| #4 JA cattle | ||
| #5 Steers | ||
| #6 Calves | 232 | $ 11,221.70 |
| #8 Calves (Theis) | 404 | 23,916.52 |
| 1946 | ||
| #6 Calves | ||
| #8 Calves (Theis) |
| Sales | ||||
| Gain | ||||
| Group Number | Head | Amount | Basis used | reported |
| 1944 | ||||
| #2 Mt. Dora | 407 | $ 71,476.37 | $ 48,073.16 | $ 23,403.21 |
| #3 Heifers | 160 | 19,559.25 | 14,935.78 | 4,623.47 |
| #4 JA cattle | 235 | 29,550.28 | 26,372.94 | 3,177.34 |
| #5 Steers | 250 | 40,482.06 | 36,745.27 | 3,736.79 |
| 1945 | ||||
| #2 Mt. Dora | 217 | $ 36,543.77 | $ 36,543.77 | |
| #3 Heifers | 82 | 9,339.44 | 9,339.44 | |
| #4 JA cattle | 29 | 2,853.50 | 2,853.50 | |
| #5 Steers | 101 | 16,231.59 | 16,231.59 | |
| #6 Calves | 165 | 21,986.11 | 11,221.70 | 10,764.41 |
| #8 Calves (Theis) | 232 | 29,528.34 | 23,916.52 | 5,611.82 |
| 1946 | ||||
| #6 Calves | 67 | $ 9,184.68 | $ 9, 184.68 | |
| #8 Calves (Theis) | 170 | 22,194.60 | 22,194.60 |
The respondent determined*15 that the method used by the petitioners was incorrect and that they should have used a so-called "average cost method," allocating a proportionate part of the cost of an entire group of cattle to each unit in the group. He adjusted the 1945 and 1946 returns accordingly but for 1945 he allowed no cost basis on the sales from those groups designated above as "#2 Mt. Dora," "#3 Heifers," "#4 JA Cattle," and "#5 Steers," since the entire cost of those groups had been deducted in the 1944 return. As to those groups, the respondent treated the entire amount of the sales as gains, in accordance with petitioners' returns for that year.
OPINION.
Our first question is whether the gains from the sale of the so-called JA cows are taxable in full as ordinary income, as respondent has determined, or at the capital gains rate under section 117 (j), Internal Revenue Code. 1 Respondent's position is that the cattle in question were held for sale to customers in the regular *1004 course of business as feeder cattle and not for breeding purposes as petitioners contend.
*16 For a number of years petitioners conducted their ranch principally as a feeder operation. They purchased beef cattle which they grazed or fed until ready for market and sold them to the trade as beef cattle. They purchased a large number of cows each year from the JA Ranch in Texas. These, for the most part, were 8-year-old cows that had served their usefulness as breeding cattle at the JA Ranch. Petitioners found that by keeping them on their ranch for a period of six months to a year they could harvest a crop of calves from them and still sell them on the beef market at a profit. It was for this purpose that petitioners purchased the "5 JA," "7 JA," and "10 JA" cows in 1943, 1944, and 1945, from which the sales in dispute were made in 1945 and 1946.
The fact that petitioners purchased these cows with the intention of harvesting a single crop of calves from them before putting them on the beef market does not establish that they purchased or used them as breeders, as distinguished from feeder cattle. Feeding and marketing the cows for beef might still have been and, we think, was petitioners' predominant purpose. As to this breed of cattle, petitioners had long been conducting*17 a strict feeder operation. They did maintain a small herd of Milking Shorthorns and another of Angus but they are not involved here. As to the Herefords, petitioners' established practice was to purchase from the JA Ranch each year a group of old cows, feed or graze them for a few months, and sell them for beef. The only departure from that practice, as to the matter in controversy here, was in 1943 when they began holding over most of these cows for a few months in order to harvest a spring calf crop from them. The evidence is that even the calves from these cows, or most of them, were fed and sold as beef cattle, although some unknown number of heifer calves were added to the breeding herd each year. The inventory figures as of May 8, 1950, give some insight into this phase of the operations in later years. For instance, they show that on that date, May 8, 1950, petitioners had on hand in the JA cattle groups 355 cows purchased in 1949, 100 calves raised on the ranch, and 135 heifers and 153 steers raised from the calf crop of 1949. They also had 172 Hereford cows, raised from the 1948 JA calf crop, and 142 calves raised from them. They also had 270 miscellaneous yearling*18 heifers purchased from the JA Ranch in 1949. Thus, it is seen that petitioners had on hand no JA cows or calves from JA cows which they had held for more than about two years.
A cow does not reach her maturity as a breeder until about two years of age. There is no evidence that there is or has ever been any common practice in the cattle industry of regularly selling cows *1005 from a breeding herd on the beef market after they have produced one calf. All of the JA cattle involved in this dispute were purchased and sold on a per pound basis as feeder cattle. Breeder cattle of an established breed usually sell for a much higher price.
Petitioners rely strongly upon Albright v. United States, 173 Fed. (2d) 339, and the several cases in which we followed that case, including Isaac Emerson, 12 T. C. 875, and Fawn Lake Ranch Co., 12 T. C. 1139. Those cases, we think, are distinguishable. In the Albright case the petitioner maintained his own dairy herd and sold off the surplus cows and calves from time to time. In holding that the profits from such sales were taxable as capital*19 gains, the court said:
* * * A dairy farmer is not primarily engaged in the sale of beef cattle. * * * Such sales as he makes are incidental to his business and are required for its economical and successful management. * * *
Petitioners here were engaged primarily in the sale of beef cattle. They were not raising these cattle from their own herd, that is, not the JA cattle, but were purchasing them. The JA Ranch and not petitioners were the breeders. One of petitioners testified in this proceeding that the cows which they purchased from JA Ranch showed improvement each year.
We can reach no other conclusion on the evidence here than that petitioners purchased the JA cows primarily as feeder cattle to be sold on the beef market in the regular course of their business.
The manner in which petitioners conducted their cattle business bears some resemblance to the way in which the taxpayer in the Albright case, supra, conducted his hog raising business. There, the brood sows were all sold each year after producing one litter of pigs. However, as the court emphasized in its opinion, the evidence was that that was the common practice in the hog raising business in that *20 locality. There is no evidence that there has ever been among cattle breeders a common practice of selling off all of the cows from a breeding herd each year after a single crop of calves.
In Isaac Emerson, supra, the gains were from sales of cattle from a dairy herd and hogs from a breeding herd as in the Albright case. We said:
We agree with the appellate court [in the Albright case] that a dairy farmer is not primarily engaged in the sale of beef cattle and the sale by him of some of the stock from his dairy herd is not a sale of property held primarily for sale to customers in the ordinary course of his business.
In Fawn Lake Ranch Co., supra., the gains were from the sale of surplus cattle from the taxpayer's breeding herd which was kept separate from the other cattle held for sale to customers in the regular course of business. Only surplus cattle were sold as necessary to maintain the breeding herd at its required number.
*1006 We think that the respondent was correct in treating petitioners' gains from the sale of JA cattle as ordinary income.
Since, as we have found, the JA cows were held by petitioners*21 for sale to customers in the regular course of business, no depreciation is allowable on them, and the respondent correctly so determined.
This leaves the question of the proper basis to be used in computing petitioners' gains from the sale of cattle in certain groups, as set out in the findings above. In their returns petitioners had long followed the practice of deducting the entire cost of each group of cattle purchased from the first sales out of that group. In auditing petitioners' 1945 returns respondent required petitioners to allocate a portion of the cost of each group to each cow in the group. Petitioners now concede that this change in their accounting method was required in order correctly to reflect their annual income.
In their 1945 partnership return petitioners had not claimed any basis for the cattle sold from certain of the groups where the cost of all the cattle in those groups had been deducted from the 1944 sales. The respondent made no adjustment of the 1945 return in this respect and made no adjustment in the 1944 return in which the excessive bases had been used for the cattle sold in that year.
In Commissioner v. Laguna Land & Water Co., 118 Fed. (2d) 112,*22 the Circuit Court of Appeals for the Ninth Circuit held, affirming on this point a memorandum opinion of this Court, that the taxpayer in computing the gain on the sale of parcels of real estate was entitled to use as a cost basis an aliquot portion of the cost of the entire tract when purchased, plus a portion of the cost of improvements to the entire tract, notwithstanding that the original cost of the whole tract had been deducted by the taxpayer in computing the gain from the sale of some of the lots in prior years. There, as in the instant case, the statute of limitations barred the assessment of any additional taxes for the prior years. The court pointed out that the sale of each lot was a separate transaction and rejected the Commissioner's contention that because the taxpayer had recovered the cost of the entire tract in computing its gains on sales in prior years it was not entitled to use any cost basis for the remaining lots sold in the taxable year.
In Commissioner v. Cedar Park Cemetery Association, Inc., 183 Fed. (2d) 553, the Court of Appeals for the Seventh Circuit followed the Laguna Land & Water Co. case, supra, affirming*23 on this point a memorandum opinion of this Court. Both of those cases involved the sale of real estate lots. However, the same rule was applied as to sales of shares of stock in John B. Hollister, 44 B. T. A. 851. The rule is no less applicable, we think, to sales of cattle. The fact that petitioners have used improper bases in computing their gains on sales of cattle in 1944 does not deprive them of their right to use a correct basis in computing their gains on the 1945 sales.
*1007 There is no factual support for respondent's formal plea of estoppel. See Wobber Brothers, 35 B. T. A. 890; John B. Hollister, supra.
We think that petitioners' gains on the sale of cattle described in the findings of fact as "#2 Mt. Dora," "#3 Heifers," "#4 JA Cattle" and "#5 Steers" should be recomputed with the allowance of a basis for each head of cattle sold equal to an aliquot portion of the cost of the entire group, as shown in petitioners' books.
Decisions will be entered under Rule 50.
Footnotes
1. Transferred to 5 JA.↩
2. Dead.↩
3. Ranch raised cows.↩
1. SEC. 117. CAPITAL GAINS AND LOSSES.
* * * *
(j) Gains and Losses From Involuntary Conversion and From the Sale or Exchange of Certain Property Used in the Trade or Business. --
(1) Definition of property used in the trade or business. -- For the purposes of this subsection, the term "property used in the trade or business" means property used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (1), held for more than 6 months, and real property used in the trade or business, held for more than 6 months, which is not (A) property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year, or (B) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business * * *.↩