*1948 1. Where a lumber company extends its railroad facilities for the purpose of making more accessible timber which had not previously been served by any track and placing itself in a position to negotiate a contract for the operation of the timber tract, the cost of the railroad extension is not deductible as an expense item.
2. Rate of depreciation on certain assets determined.
*1223 Proceeding for the redetermination of a deficiency of $5,524.05 in income and excess-profits taxes for the year 1920. The issues not settled by stipulation at the hearing are: (1) Whether freight charges on an engine and the cost of grading and laying a railroad track are expense or capital items; (2) whether the depreciation allowed by respondent on certain assets of petitioner is adequate; and (3) whether invested capital should be adjusted on account of an incorrect allowance for depletion on timber for 1917.
FINDINGS OF FACT.
Petitioner, a West Virginia corporation, with its principal office at Albright, W. Va., during*1949 and prior to 1920 was engaged in the lumber business. For several years, including 1920, it was also engaged in mining coal on its property.
In 1917 the petitioner acquired at a cost of about $247,000 a tract of land near Albright, W. Va., containing about 45,000,000 feet of *1224 standing timber. Subsequently it purchased additional adjoining tracts containing about 8,000,000 feet of timber.
Petitioner, in 1920, entered into negotiations with the Kendall Lumber Co. to operate its plant on a stumpage basis. The Kendall Lumber Co. refused to consider taking over the plant unless petitioner constructed in a certain location on the tract one and three-quarters miles of additional railroad track. Thereupon, in 1920, petitioner constructed the extension and charged the cost of grading and laying the track, amounting to $12,580, to "Railroad Maintenance." The extension reached a section of the timber which had not previously been served by any track, and had for its purpose making more accessible such timber, and also placing petitioner in a position to negotiate a contract with the Kendall Lumber Co. for the operation of the tract.
The negotiations between petitioner*1950 and the Kendall Lumber Co. for the operation of the former's plant continued until 1924, when an agreement was reached and the latter took possession of the property, including the railroad extension. The extension was never used by the petitioner. In 1924 the Kendall Lumber Co. abandoned 1,000 feet of the extension because of its location. It never used the track which it abandoned, but used the remainder of the extension in and after 1924 in its timber operations. The cost of grading the section of the track abandoned was $1,000, laying the rails $500, and the ties $300. When the trackage was torn up the rails were laid elsewhere and the ties were abandoned.
In its return for 1920 the petitioner claimed depreciation as follows:
| Cost | Rate (per cent) | Amount | |
| Railroad equipment | $119,374.01 | 5 | $5,968.70 |
| Rights of way | 5,741.45 | 7 | 401.90 |
| Mill and shop | 31,665.56 | 7 | 2,216.59 |
| Houses and store | 10,500.00 | 4 | 420.00 |
| Horses and camp supplies | 3,955.71 | 15 | 593.36 |
| Automobile | 1,000.00 | 20 | 200.00 |
The assets classified by the petitioner as railroad equipment consisted generally of grading, ties, steel rails, locomotives and cars. The railroad track*1951 and most of the other equipment was acquired in 1917. The grading and ties will have no value upon completion of the timber operations. The cost of taking up the rails at that time will about equal their salvage value. The locomotives, owing to their condition and the location of a market for them, will have little or no value at the close of petitioner's timbering operations. The cars have to be rebuilt almost every year and their wheels must be renewed every four or five years. The woodwork on the cars has *1225 been renewed several times since 1920. The rights of way will not have any value when petitioner completes its timbering operations on the tract. The mill was first used at William, W. Va. After it had served its purpose at that place the mill was torn down and reconstructed on the Albright site. The mill and shop were on the timber tract when petitioner acquired it. The houses and store were built at William, W. Va., in 1913 and 1914. In 1917 they were torn down and rebuilt on petitioner's timber tract. It would not be feasible to take the houses apart and use the lumber again elsewhere.
A reasonable allowance for depreciation on the railroad equipment, *1952 rights of way, mill and shop, and railroad extension is at an annual rate based upon a useful life of eleven years.
Some of the horses owned by the petitioner in 1920 were acquired in 1917. The remaining horses were acquired after 1917. None of the horses, harnesses used to work them, and other camp supplies included in the group, had a useful life in excess of five years. A reasonable allowance for exhaustion of the assets in this group is at the rate of 20 per cent per annum.
The following amounts of timber were cut on the tract from 1917 to 1929, inclusive:
| Year | Feet |
| 1917 | 1,475,311 |
| 1918 | 2,480,608 |
| 1919 | 4,148,911 |
| 1920 | 3,434,151 |
| 1921 | 892,356 |
| 1922 | 348,169 |
| 1923 | 3,211,153 |
| 1924 | |
| 2,239,533 | |
| 1925 | 5,513,977 |
| 1926 | 6,248,471 |
| 1927 | 2,983,103 |
| 1928 | 7,103,943 |
| 1929 | 8,358,335 |
The remaining number of feet of timber in the tract, to wit, about 5,000,000, will be cut in 1930.
In 1920 the respondent determined petitioner's invested capital to be in the amount of $242,230.43. In its return for 1917 the petitioner claimed as a deduction for depletion of its timber tract the sum of $9,132.86.
OPINION.
ARUNDELL: It has been stipulated that the following*1953 allowances should be made in redetermining the deficiency:
| Depletion on timber | $18,612.28 |
| Repairs to engine (item capitalized by respondent as cost of a pair of scales) | 386.50 |
| Depreciation on steam shovel | 323.06 |
| Depletion on coal in lieu of amount allowed by respondent | 508.38 |
In his computation of the deficiency in dispute the respondent capitalized the sum of $284.98 expended for freight on an engine and the cost of constructing the extension to its railroad. It is contended *1226 by petitioner that the sums were properly charged to "railroad maintenance" and should be allowed as expense deductions.
No evidence was offered to show the circumstances under which the freight charges were incurred or paid. Accordingly, we must sustain the respondent's action in treating the charges as a capital item.
Among the authorities cited by the petitioner in support of its contention that the cost of the railroad extensions should be allowed as an expense item, and not capitalized, as was done by the respondent, is the district court's decision in *1954 , which was cited with approval in , reversing on the issue before it, .
The decisions cited above rested, in part, upon a showing that the mining equipment, the cost of which was sought to be deducted as an expense, did not add anything to the value of the mines, increase their output, or decrease production costs, but merely enabled the taxpayer corporations to maintain the output of fully developed properties. In the Marsh Fork case considerable weight was given to authorities on accounting as applied to mining operations in view of the requirements of the taxing statute that net income shall be computed pursuant to the accounting methods of the taxpayer except where the method employed does not clearly reflect income. Evidence of this character is lacking here. The court also pointed out that at best there is a degree of uncertainty in mining operations, as one does not know definitely what is under the ground, and was careful to point out that ordinarily the cost of assets, such as machinery, *1955 having a useful life greater than one year should be capitalized. While petitioner's witness made the broad statement that the extension was built to maintain output and not increase it, it must be obvious that until the necessary spurs and extensions are made to reach the timber, the cutting of which is a part of the planned operations, it may not be said that the tract has been fully developed. It is also important to remember that this extension was made at the time to meet the objection of the Kendall Lumber Co., which refused to consider the taking over of operations until this facility was provided.
The trackage had a useful life considerably in excess of one year, for all of its except the 1,000 feet abandoned by the Kendall Lumber Co. has been used continuously since 1924. The respondent committed no error in capitalizing the cost of the extension.
In the brief filed on petitioner's behalf it is contended that the cost of the 1,000 feet of trackage never used should not be capitalized, but allowed as a deductible "expense or loss" on the theory that the property was abandoned in 1920. There is considerable doubt as to *1227 whether the petition raises such*1956 an issue. The petition merely alleges as error the respondent's treatment of the cost of the railroad extension as a capital expenditure instead of an expense for railroad maintenance. If it could be said that the question is properly before us, the petitioner would not be entitled to recover. The failure of the petitioner to use the track after it was laid did not have the effect of converting the cost thereof from a capital to an expense item, and if a loss occurred it was sustained after 1920. It must also be borne in mind that the extension was built with a view to its use by the Kendall Lumber Co. and it was not until 1924 that that company determined that the 1,000 feet would be of no use to it.
The evidence fully supports the claim of petitioner that its assets grouped as railroad equipment, rights of way, mill and shop and houses and store, will not have a useful life beyond 1930, when it will complete its timbering operations on the tract. These assets, together with the railroad extensions built in 1920, should be exhausted on the basis of such a useful period. Depreciation on the assets classified as horses and camp supplies should be increased from 15 to 20 per*1957 cent per annum upon the showing that they did not have a useful life in excess of five years. The respondent's action in exhausting the automobile at the rate of 20 per cent per annum will not be disturbed in the absence of any evidence on the correctness of the allowance.
Under the remaining issue it is claimed that petitioner's invested capital for 1920 should be adjusted because of an excessive allowance made for depletion for 1917. All of the facts alleged in the petition on the issue were denied by the respondent in his answer except his determination of invested capital of $342,230.43, and no testimony was produced at the hearing to show how the amount was reached. The petitioner has failed to furnish proof of error and the respondent's determination of invested capital will not be disturbed. .
Decision will be entered under Rule 50.