*4089 A retrospective appraisal based upon reproduction cost less theoretical depreciation is not a sound or reliable basis for the valuation of property and is not acceptable as a measure of value for invested capital and depreciation purposes.
*510 This is a proceeding for the redetermination of income and profits taxes for the year 1917, for which the Commissioner has determined a deficiency of $10,789.35. The petitioner alleged that the Commissioner erred (1) in rejecting an appraisal showing the value of its fixed assets on January 1, 1917, from which there could be computed the value of such assets on the date of its organization, June 1, 1916; (2) in omitting from the valuation of such assets a value for water *511 power used by the petitioner; and (3) in the adjustment of the inventory as at December 31, 1917.
FINDINGS OF FACT.
The petitioner is a partnership organized June 1, 1916, with its principal place of business at Chester, Conn., and is engaged in the manufacture of articles from iron, steel, *4090 and brass wire, such as screw eyes, hooks, cotter pins, coat hangers, shoulder hooks and wire specialties.
This business, originally established about 50 years ago, has been continuously operated as a family enterprise since its beginning, and for many years prior to the organization of the present partnership was conducted under the firm name of M. S. Brooks & Sons. For a period prior to June 1, 1916, the partnership consisted of two brothers, H. C. Brooks, who owned a two-thirds interest, and S. S. Brooks, who owned a one-third interest. The property employed in the partnership business prior to June 1, 1916, was held under three distinct titles, one by H. C. Brooks, another by the partnership of M. S. Brooks & Sons and the third by H. C. and S. S. Brooks. All the properties, however, were considered partnership assets and partnership property, except certain water-power rights owned by H. C. Brooks and rented to the firm. The pond from which the water power was obtained and the canal through which the water was brought to the factory were located upon lands held in the names of H. C. and S. S. Brooks.
In May, 1916, S. S. Brooks died and an appraisal committee, composed*4091 of Harry Moore, a contractor, H. C. Brooks and L. M. Brooks, was appointed to appraise the partnership property, for the purpose of determining the amount of the deceased's interest therein. Moore appraised the lands and buildings and H. C. Brooks and L. M. Brooks appraised the machinery, tools, raw materials, inventory and other assets. The appraisal and valuation of the partnership assets was made by this committee on or about June 1, 1916, and was as follows:
| Book accounts in bank and cash | $45,072.83 |
| Coal | 520.85 |
| Horses, wagon, and sled | 600.00 |
| Buildings and land | 19,400.00 |
| Machinery and tools | 21,712.65 |
| Inventory | 33,465.34 |
| Total | 120,771.67 |
The machinery and tools, appraised by H. C. and L. M. Brooks, were listed and valued at cost less an estimated amount for depreciation.
*512 The buildings and land, appraised at $19,400, included the property held in the names of H. C. and S. S. Brooks, which was as follows:
| Nichols house | $550 |
| Ponds Extract Shop | 200 |
| Shop land | 500 |
| Land, Nichols house | 200 |
| Land, Ponds Extract | 400 |
| Ed. Watrous House (land, $300; house $1,000) | 1,300 |
Subsequent to the appraisal of all the property*4092 at $120,771.67, H. C. Brooks and L. M. Brooks determined that the shafting, belting, and accessories had been omitted from the valution of the machinery and tools and that the machinery had been undervalued. To supply this omission and to adjust the machinery values, the total valuation was increased to $135,000.
Upon the basis of this adjusted appraisal and valuation, H. C. Brooks purchased the one-third interest of his deceased brother and partner, S. S. Brooks, and paid therefor $45,000 to his estate. All the assets and property of the partnership were thus acquired and owned by H. C. Brooks, the transaction being completed sometime in July or August, 1916.
Pending the completion of the appraisal of his brother's interest and the purchase thereof from his estate, H. C. Brooks, on or about June 1, 1916, entered into a verbal agreement with his sons, L. M. Brooks and M. G. Brooks, for the formation of a new partnership, granting to each of his sons a one-fourth interest and retaining for himself a one-half interest in the new firm. No formal articles of partnership were entered into and no deed or other written instrument was executed transferring any of the property, real*4093 or personal, to the partnership or any interest therein to the two sons. It was mutually understood, however, that all property held by H. C. Brooks and employed in the partnership business, including water-power rights, was the property of the firm and not of any individual. The property held by H. C. Brooks and used by the partnership was the same property used by the prior partnership and appraised as set forth above, and the water-power rights. Subsequent to June 1, 1916, the profits of the business have been distributed, one-half to H. C. Brooks and one-fourth to each of his sons.
In the operation of its plant the petitioner used water power approximately 275 days of the year and steam power the remaining 25 days. The cost of operation by water power was approximately $1 per day and by steam power was approximately $11 per day.
OPINION.
VAN FOSSAN: At the hearing the petitioner withdrew its assignment of error relating to the valuation of the inventory, leaving *513 for our determination only the value of certain fixed assets and water-power rights paid in to the new firm. The particular asset items in controversy are the buildings and land, the machinery*4094 and tools, and the water-power rights acquired by the petitioner at the time of its organization on June 1, 1916. The petitioner claims a total value of $191,903.56, as at June 1, 1916, for the property paid in to the partnership. The respondent allows $120,771,67. The increased value is claimed on the items above listed.
The only evidence offered by the petitioner in support of the increased value is a retrospective appraisal made in 1925 by an appraisal company upon data supplied by the petitioner. The value of machinery, tools, and buildings thus determined by the appraisal company is based upon the cost of reproduction at date of valuation less estimated depreciation. This Board, in a number of cases, has held that a retrospective appraisal of property is not a sound or reliable basis of valuation. (See ; ; and .)
A similar observation applies to the appraisal of the water rights. The value determined for the water-power rights is computed by capitalizing at 10 per cent the estimated savings from the use of*4095 water power instead of steam power. No actual measurement of the flow of the water, the height of the fall or the efficiency of the wheel was taken, nor was any consideration given to sales of riparian rights or any other pertinent data. The basis employed is entirely inadequate to establish value for invested capital purposes. (See .)
In general support of his contention for an increased value, petitioner submitted proof of a sale in July or August, 1919, of a one-third interest in the partnership for $45,000. Under the circumstances of this case, we believe this sale is entitled to considerable weight and it is our conclusion that the assets in question were reasonably worth $135,000.
Judgment will be entered on 15 days' notice, under Rule 50.