*141 Decision will be entered for the respondent.
At his death in 1953, M owned all of the capital stock of S, a corporation in the general auctioneering and appraising business. M's will directed that the executor arrange to have S convey title to its business premises, which S then owned in fee, to the residuary trust under the will for the benefit of certain named individuals and charities; the trustee thereof was directed to grant S the right to lease such property for 50 years at a specified rental, provided S continued in its present business under its same name on the high standard that had been maintained during M's lifetime. In 1956 pursuant to M's will S's business premises were transferred to the trust, and S signed a 50-year lease on the premises with the trustee. Held, that S is not entitled to a depreciation deduction on the lease because (a) the lease in fact had no fair market value or bonus value; and (b) S did not "acquire" the lease from the decedent under section 1014, I.R.C. 1954, so as to give it any depreciable basis.
*203 The Commissioner determined deficiencies in petitioner's corporate income tax for the taxable years 1956 and 1957 in the amounts of $ 525 and $ 900, respectively.
The question presented is whether, in the circumstances of this case, petitioner is entitled to depreciate the so-called bonus value, if any, of petitioner's 50-year lease on its business premises.
FINDINGS OF FACT.
The facts stipulated by the parties are incorporated by this reference.
Petitioner is a corporation organized and existing under the laws of the District*143 of Columbia and engaged in the business of auctioneering and appraising at 715 13th Street, NW., Washington, D.C. It filed its corporate income tax returns for the taxable years 1956 and 1957 with the district director of internal revenue, Baltimore, Maryland.
Mark Mck. Sloan, hereinafter sometimes referred to as the decedent, died testate on December 4, 1953. At his death, among other assets, he owned all of the capital stock of petitioner, consisting of 5,000 shares. Petitioner owned the premises it occupied at 715 13th Street, NW., at the time of the decedent's death.
The decedent's will was duly admitted to probate in the United States District Court for the District of Columbia, and the National Savings and Trust Company qualified as executor.
*204 In his will the decedent directed that as soon as possible after his death the executor should arrange to have the improved real estate owned and occupied by petitioner at 715 13th Street, NW., Washington, D.C., conveyed to the trustee of his residuary estate, subject to whatever encumbrance may then be secured thereon, and to have this property thereafter constitute a part of the trust created by the will for the benefit of*144 certain persons and charities. Subject to prior compliance with the foregoing provision, the will provided that the decedent bequeathed 3,500 shares of petitioner's stock to James M. O'Brien and the remaining 1,500 shares to William Fairfax Edelen, provided that each was in the employ of petitioner at his death. In the event that either of them should not be in the employ of petitioner, it was provided that the bequest of stock to him would lapse and such stock would fall into the residuary estate. In fact, both O'Brien and Edelen were in the employ of petitioner at the time of the decedent's death.
In the section of the decedent's will providing for a trust of his residuary estate and naming the National Savings and Trust Company as trustee thereof, it was provided that:
After Lot 833, Square 288, improved by 715 Thirteenth Street, Northwest has been conveyed to my Trustee, pursuant to ITEM IV hereof, I direct my said Trustee to grant C. G. Sloan & Co., Inc., the right to lease said property for fifty years or for any shorter period said C. G. Sloan & Co., Inc., may wish, at a monthly rental of $ 600. net, plus one-twelfth of the annual real estate taxes, with a provision that*145 the tenant will keep the property in repair at its own expense, make all necessary improvements and alterations, such as may be required by the regulations of District of Columbia, the egress regulations, or by other Municipal, Federal, or other authorities, and maintain proper insurance of all kinds whatsoever to the entire satisfaction of my said Trustee, and that it will continue the general auctioneering and appraising business under the present firm name, on the high standard that has been maintained during my lifetime.
The will further directed the trustee to make stipulated monthly payments to a number of named individuals and, upon the death of the last surviving beneficiary, the trust is to terminate and the remaining corpus together with all accrued and accumulated income is to pass to two named charitable organizations.
On August 15, 1955, the executor filed a petition in the probate proceedings seeking instructions from the court. The petition alleged, among other things, that the real estate at 715 13th Street, NW., had been appraised for Federal estate tax purposes at $ 200,000 and is subject to a deed of trust securing an indebtedness of $ 27,600, resulting in a *146 net value for the real estate under this appraisal of $ 172,400; that the rent prescribed to be paid during the 50-year lease which the testamentary trustee is directed to grant the corporation (petitioner herein) is apparently less than the actual rental value; that the market value of the real estate, subject to such lease, would appear to be *205 approximately $ 120,000; that the real estate in question is carried on the books of the corporation as of December 31, 1954, at $ 38,801.51; that the surplus of the corporation was $ 31,861.81 as of December 31, 1954; that a District of Columbia statute appears to forbid the conveyance directed in the will because it would necessarily impair the capital of the corporation to the extent of approximately $ 7,000; and that if the provisions of the decedent's will are carried into effect by a conveyance of the real estate by the corporation either directly to the trustee or to the executor and then in turn to the trustee, under recent court decisions the executor would be deemed to receive a dividend for Federal income tax purposes in the amount of the net value of the property and taxable at ordinary income tax rates, which on the basis*147 of a net value of $ 172,400 would result in a tax of $ 131,980 and on the basis of a net value of $ 92,400 ($ 120,000 less $ 27,600 encumbrance) would result in a tax of $ 52,308.
The petition suggested that if the corporation were dissolved only a capital gains tax would be payable on the excess of the value of the corporation's assets received in liquidation over the value of the stock held by the estate at the decedent's death, and that after the dissolution the real estate could be conveyed to the trustee and all of the remaining assets of the corporation could be conveyed to the legatees O'Brien and Edelen. As an alternate method of "complying with the terms of decedent's will without incurring prohibitive income tax liability," the petition suggested that the stock be distributed to the trustee and to O'Brien and Edelen in the proportion that the net value of the real estate bears to the value of the corporation's other assets, after which the trustee could have its stock redeemed in exchange for the real estate.
The petition asked that process be issued against the legatees and devisees under the will and that the executor be instructed whether, without dissolving the corporation, *148 it should arrange to have the real estate conveyed directly to the trustee or whether it should instead follow one of the alternate procedures which it suggested.
On December 20, 1955, the Probate Court issued an order directing the executor to apply to the Internal Revenue Service for a ruling as to whether the conveyance of the real estate by the corporation to the trustee as directed in the decedent's will would constitute a taxable dividend to the executor and, if so, whether the amount of such dividend would exceed the earnings and profits of the corporation. The order further directed that if the Internal Revenue Service ruled in the negative as to either question, the executor should proceed promptly to have the real estate conveyed to the trustee and to file its final account showing distribution in accordance with the decedent's will.
On December 30, 1955, the executor applied to the Internal Revenue *206 Service for a ruling as directed by the Probate Court. On March 2, 1956, the executor amended its request for a ruling to ask whether any tax consequence would result if, instead of an outright conveyance of the real estate from the corporation, the executor surrenders*149 stock to the corporation equal in value to the real estate and receives the real estate in exchange therefor.
On April 11, 1956, the Commissioner of Internal Revenue issued a letter-ruling to the executor which provided, in part, as follows:
1. The conveyance by the Corporation of the real estate in question to the estate will be treated as a dividend to the estate taxable in accordance with the provisions of section 301 of the Internal Revenue Code of 1954. The fair market value of the real estate, subject to the liabilities in connection therewith, will be treated as a dividend includible in income to the extent of the Corporation's earnings available for dividends within the meaning of section 316 of the 1954 Code. That portion which is not a dividend will be treated as a return of capital and applied against the basis of the stock.
2. Relative to the question contained in Mr. Powell's letter dated March 2, 1956, you are advised that the estate will cease to have proprietary interest in the Corporation after the provisions of the will have been carried out. Accordingly, in view of the provisions of Rev. Rul. 54-458, CB 167, if the portion of the shares*150 of the Corporation attributable to the real estate, subject to the liabilities in connection therewith, are surrendered in exchange for such real estate gain or loss will be recognized to the estate measured by the difference between the fair market value of the real estate at the time of the exchange and the basis of the shares surrendered. Such gain or loss will constitute capital gain or loss subject to the provisions and limitations of Subchapter P of Chapter 1 of the 1954 Code. The holders of the Corporation's stock will, after conveyance of the real estate and distribution of the stock as directed in the will, own the same proportionate interest in the same assets regardless of the number of shares outstanding.
On June 28, 1956, the Probate Court issued an Order Instructing Executor which recited that the Commissioner of Internal Revenue had ruled that if the portion of the shares of petitioner attributable to the real estate is surrendered in exchange for such real estate gain or loss will be recognized to the extent of the difference between the fair market value of the real estate at the time of the exchange and the basis of the shares surrendered. The order directed the*151 executor to arrange to have petitioner convey to it as executor the real estate owned by petitioner in exchange for the surrender of 4,420 shares of the stock of petitioner. The order stated that it was intended thereby, in order to comply fully with the ruling of the Commissioner, that the basis of the shares surrendered shall not be less than the fair market value of the real estate (less the encumbrance thereon) at the time of the conveyance and exchange. The order further directed the conveyance of the real estate by the executor to the trustee and the distribution by the executor of the remaining 580 shares of capital stock of petitioner to the legatees O'Brien and Edelen, seven-tenths or 406 shares to the former and three-tenths or 174 shares to the latter. *207 The order further directed the executor to execute and deliver an indemnifying agreement to O'Brien and Edelen in the form attached to the order. The terms of the indemnifying agreement were that the executor agrees to indemnify and save harmless both O'Brien and Edelen, as well as petitioner, from all income taxes, penalties, and interest which may be assessed by reason of the conveyance of the real estate *152 by petitioner to the executor pursuant to the authorization contained in the order of the Probate Court "or by reason of any act or omission that is a deviation from the express words" of the decedent's will.
The Order Instructing Executor was consented to in writing by counsel for the legatees O'Brien and Edelen, the executor, and the charities which were beneficiaries of the residuary trust established in the decedent's will. In addition, the order recited that the interested parties had consented to the order. It does not appear from this order that petitioner (apart from the executor which held all of petitioner's stock and did consent to the order) consented to the order of the court.
The real estate and capital stock of petitioner were conveyed and transferred as ordered by the Probate Court. Petitioner's deed of the real estate to the executor, dated July 10, 1956, and the executor's deed to the trustee, dated July 10, 1956, each specifically provided that the conveyance was made pursuant to the provisions of Item IV of the decedent's will which provided that the property would constitute a part of the residuary trust.
On or about July 11, 1956, the trustee under the decedent's*153 will entered into a lease of the real estate with petitioner. This lease was for a term of 50 years from June 1, 1956, and was for a rental of $ 360,000, payable in monthly installments of $ 600 on the first of each month, plus an additional monthly rental of one-twelfth of the annual real estate taxes assessed against the real estate. The lease was made subject to the provisions specified therefor in the decedent's will, and petitioner expressly agreed to comply with and perform all of such provisions. In addition, petitioner separately covenanted not to sublet the premises or any part thereof or assign the lease or any portion of the term or use the premises for any purpose other than a general auctioneering and appraising business under the name of C. G. Sloan & Co., Inc., without the written consent of the lessor.
The Federal estate tax return for the decedent's estate, filed with the director of internal revenue, Baltimore, Maryland, reported the decedent's ownership of all of the capital stock of petitioner, consisting of 5,000 shares. The Commissioner of Internal Revenue and the executor agreed upon a value of $ 41.03 per share for such stock, totaling $ 205,150, and the*154 Federal estate tax liability of the decedent's estate was determined by inclusion of the stock at this value.
*208 The improved real estate at 715 13th Street, NW., is located in the retail shopping area of downtown Washington, D.C. It was originally acquired by petitioner in 1919, and petitioner has conducted its auctioneering and appraising business at that location since that time. The main part of the building is Victorian in style, constructed of brick and frame, without structural steel support, five stories in height with a full basement, and is more than 90 years old. At one time this building had been used for residential purposes. Constructed in the rear of the building is a three-story addition of brick with structural steel beam support, built in the 1920's. The main part of the building is distinctly old fashioned, and its condition above the second floor is very poor. This latter area is used by petitioner for storage purposes. Considering both the condition of the building and the nature of the business conducted therein, the property is not being devoted to its highest and best use.
On its 1956 and 1957 corporate income tax returns, petitioner claimed deductions*155 for depreciation in the amounts of $ 1,750 and $ 3,000, respectively, on the lease of its business premises at 715 13th Street, NW., Washington, D.C. Such deductions were computed on the basis of a value for the lease of $ 150,000, amortized at the rate of 2 percent per annum as of the effective date of the lease, June 1, 1956. The Commissioner disallowed such deductions and determined the deficiencies here in issue.
The lease did not have any fair market value or bonus value in the hands of the lessee at the time of the decedent's death or at any relevant time thereafter.
OPINION.
Briefly stated, petitioner's position is that it was devised a 50-year lease on its business premises under the will of its former sole stockholder, Mark Mck. Sloan; that this lease had a so-called bonus value to petitioner as of the date of the decedent's death based on the alleged fact that the rent specified was less than the fair rental value of the property for the 50-year term; and that petitioner is entitled to an allowance for depreciation during the term of the lease because the lease's bonus value constituted property used in its trade or business.
The Commissioner has put forward three alternative*156 grounds for upholding his disallowance of the contested depreciation deductions. First, even if the petitioner acquired the lease by devise from the decedent, it in fact had no fair market or bonus value that could be depreciated over its life. Second, petitioner was not "devised" the lease in question; it in fact owned the property in fee at the time of decedent's death, and, in effect, retained a carved-out portion of the fee, i.e., the leasehold interest in the property, when it conveyed its interest in fee pursuant to the decedent's will. Therefore, assuming *209 that the lease had some market value, petitioner did not acquire a separate, depreciable basis in the leasehold from the decedent as of his death. Third, if petitioner acquired anything under the decedent's will, it was only an option to lease the real estate in question; the value, if any, of such option is not properly a part of its basis in the lease after the option has been exercised, citing Helvering v. San Joaquin Fruit & Investment Co., 297 U.S. 496">297 U.S. 496; J. Gordon Mack, 3 T.C. 390">3 T.C. 390, affirmed 148 F. 2d 62 (C.A. 3), *157 certiorari denied 326 U.S. 719">326 U.S. 719; Valleskey v. Nelson, 271 F. 2d 6 (C.A. 7), certiorari denied 361 U.S. 960">361 U.S. 960; but cf. Kalbac v. Commissioner, 298 F. 2d 251 (C.A. 8), affirming in part and remanding in part a Memorandum Opinion of this Court.
After careful consideration of the relevant facts and circumstances as well as the arguments of counsel, we think that the Commissioner correctly determined that petitioner is not entitled to the depreciation allowance in issue.
1. Most of the facts were stipulated by the parties. The value, if any, of the subject lease as of the decedent's death is the only matter upon which evidence was presented at the trial. Both parties introduced expert testimony on this question. 1*159 Upon review of such testimony and the other evidence of record relevant to the possible value of this lease, we conclude that the lease did not have any fair market or bonus value as of the decedent's death. Taking into account (1) the poor condition of the building, (2) the disproportionate amount of work (and cost) necessary to modernize it so that the*158 property could be put to its highest and best use (assuming that the building is susceptible of such modernization at a cost that would not exceed the cost of demolishing it and erecting a new structure), (3) the fact that the lessee was required to bear the burden of real estate taxes and all other expenses of repair and maintenance of this old building for 50 years to come, and (4) the restrictive use 2 of the property required by the terms of the lease and the will, we think that the prescribed rental was fair to both the lessor and the lessee. Thus, even assuming that petitioner did inherit the right or option to lease its business premises from the decedent, we could not on this record sustain its contention that such interest had any fair market or bonus value as of the decedent's death.
2. However, we do not rest our decision solely on the foregoing *210 ground. Wholly apart from the question of the value of the lease, we think that the Commissioner's determination must be upheld. Petitioner has assumed on its tax returns, at the trial, and on brief that it acquired the lease from the decedent by devise and that, therefore, it is entitled under the statute to a depreciable basis in the lease equal to its fair market value as of the date of the decedent's death. Section 1014, I.R.C. 1954, contains the provisions relied upon. But section 1014 deals with property "acquired from a decedent," and the difficulty*160 here is that, in our opinion, petitioner did not "acquire" any property from the decedent.
It is a stipulated fact that the petitioner held a fee simple interest in the real estate on the date of the decedent's death. It is difficult to understand, therefore, how petitioner can maintain either in theory or in point of fact that it was devised a lesser interest, a leasehold, in the same property by the decedent. To begin with, in so arguing, petitioner in essence puts itself in the paradoxical position of attempting to deny its own existence by suggesting that its stockholder, the decedent, and not itself was the true owner of the property. This is at odds not only with its status as a taxpayer and as petitioner in this case, but also with the inherent second phase of its argument that it is a legal entity capable of holding property and of receiving a leasehold interest by bequest or devise. To be sure, all of petitioner's stock was owned by the decedent when he died, and as a result the decedent was in a position to direct in his will what should be done thereafter by the corporation with certain of its assets as well as who should receive his 100-percent stock interest in*161 petitioner. But this does not mean that the decedent owned petitioner's assets as against the petitioner itself. Nor does it follow that the decedent, by providing that petitioner should have the right to lease the property after it conveyed its fee simple interest therein to his testamentary trustee, thereby intended to make a testamentary gift of such leasehold right to petitioner.
We think that the proper construction of the pertinent portions of the decedent's will is that the decedent intended to separate the real estate from the other assets of petitioner as a going business, that he intended to make a gift of such real estate (subject to a restricted right in petitioner to lease it for 50 years) to the beneficiaries of the residuary trust, and that he intended to make a gift of the going business (minus the fee interest in the subject real estate) to two of petitioner's trusted employees. So understood, we think, that petitioner did not acquire a leasehold interest in the property under the will but, in fact, relinquished a greater interest therein (i.e., its fee simple interest) as a result of the will's provisions.
The will required the executor to arrange to have *162 petitioner convey the property to the testamentary trustee, which in turn was obligated *211 by the terms of the trust to lease the land to petitioner. The net result was that petitioner, in effect, retained a leasehold interest in the premises. Its conveyance to the executor and the executor's conveyance to the trustee were both made specifically subject to the will's provision putting the real estate under the trust. Petitioner conveyed and the trust ultimately received the real estate subject to a right in petitioner to lease the premises in accordance with the rental terms and use restrictions provided in the decedent's will. Petitioner's control over and occupancy of the premises was uninterrupted. We agree with the Commissioner that the same end result might have been accomplished simply by one deed from petitioner to the trustee reserving in petitioner the leasehold interest, and the fact that a more circuitous route was taken (at least in part, it is clear on this record, in order to reduce the ultimate tax against the decedent's estate) 3 does not change the substance of what was intended or of what actually occurred. Petitioner's leasehold interest in its business*163 premises was an interest retained by it pursuant to the decedent's will, not one inherited by it under the will. As such, putting to one side the valuation question, petitioner is not entitled under the statute to any depreciable basis in the lease due to the decedent's death or the provisions of the decedent's will. Petitioner has suggested no other means by which it acquired a depreciable basis in the lease. Therefore, the claimed depreciation deductions cannot stand.
*164 We do not pass upon the Commissioner's further alternative argument that, assuming that petitioner was devised an option to lease its premises and that such option possessed some ascertainable fair market value, such value is not properly a part of petitioner's basis in the lease after the option has been exercised.
Decision will be entered for the respondent.
Footnotes
1. While petitioner claimed on the tax returns in issue that the market or bonus value of this lease amounted to $ 150,000 and that such figure constituted its basis therein for depreciation purposes, at the trial petitioner's expert witness valued the lease at $ 112,287. On brief, petitioner now contends that only the lower figure should be its basis in the lease.↩
2. The decedent's will specifically provided that a condition of petitioner's tenancy under the lease be that "it will continue the general auctioneering and appraising business under the present firm name, on the high standard that has been maintained during my lifetime." In the actual lease signed by the petitioner this condition was incorporated specifically in a separate covenant as well as incorporated generally by reference to the provisions in the decedent's will.↩
3. Neither party has contended that the steps taken to minimize the tax of the estate pursuant to the Commissioner's letter-ruling to the executor should in any way affect the decision herein. Such steps were obviously outside of the expressed intent of the decedent in his will. It is, however, interesting to note that the Probate Court also evidently did not consider petitioner as a devisee under the decedent's will, since petitioner's consent was not obtained as an interested party to the court's Order Instructing Executor regarding the redemption of part of the estate's stock in petitioner in exchange for the subject real estate.↩