*168 Decisions will be entered under Rule 50.
Petitioners' decedent was the owner at the time of his death of a one-half interest in a leasehold which had a remaining term of 25 years to run. The leasehold had been acquired without any cost to the decedent. It was a valuable property and the Commissioner included the value of decedent's interest at his death as a part of decedent's estate. Decedent, at the same time he owned a one-half interest in the leasehold, also owned a one-fifth interest in the reversion. Held, petitioners acquired a basis under section 113 (a) (5), I. R. C., equal to the fair market value of decedent's interest at the time of his death, and applying the doctrine adhered to in Milton H. Friend et al., Trustees, 40 B. T. A. 768, affd., 119 F. 2d 959, petitioners are entitled to deduct amortization on four-fifths of the value of the leasehold at the time of decedent's death, spread over the remaining life of the lease.
*1260 These proceedings*169 involve a common issue and have been consolidated.
Docket No. 23188 involves a deficiency in income tax of the estate of John W. F. Hobbs, deceased, Leon P. Hobbs, et al., trustees for the year 1946 of $ 658.98. In the determination of the deficiency the Commissioner made four adjustments to the net income as reported on the return. Only one of these adjustments is contested which is adjustment "(a) Rental income $ 2,577.72." That adjustment is explained in the deficiency notice as follows:
The deduction of $ 2,577.72 which is described in Schedule G of your 1946 return (Form 1041) as depreciation on "Land lease & imp." is disallowed because the asset with reference to which deduction is claimed is not an asset subject to depreciation or amortization allowance.
The petitioner estate by an appropriate assignment of error contests the correctness of the aforesaid adjustment.
Docket No. 23189 involves deficiencies determined by the Commissioner in the income taxes of the estate of John W. F. Hobbs, deceased, Leon P. Hobbs, et al., executors, as follows:
| Year | Deficiency |
| 1944 | $ 155.25 |
| 1945 | 198.05 |
The adjustments made by the Commissioner in the determination of the foregoing*170 deficiencies are not contested by the petitioner. However, the petitioner alleges that the Commissioner committed error in his determination of the deficiencies in that "the respondent has failed to allow as an allowable deduction for depreciation or amortization the sums of $ 2,506.12 for the calendar year 1944, and $ 2,577.72 for the calendar year 1945, on a leasehold estate."
Petitioner prays that we may find overpayments in the amounts of $ 813.50 and $ 884.98 for the years 1944 and 1945, instead of the deficiencies which the Commissioner has determined.
FINDINGS OF FACT.
The facts have been stipulated and are adopted as stipulated. Such of these facts appear below as are deemed necessary for an understanding of the issues which we have to decide.
*1261 In these proceedings the petitioner is the estate of John W. F. Hobbs, deceased, by its duly appointed executors and trustees under the will of John W. F. Hobbs. The income tax returns of petitioner for the taxable years which are involved were filed with the collector of internal revenue for the district of Massachusetts.
1. On February 1, 1921, Joseph O. Hobbs leased to John W. F. Hobbs and Leon P. Hobbs, two of his sons, *171 for a term of 45 years beginning March 1, 1924, premises situated at 268-272 Elm Street, West Somerville, Massachusetts, known as the Studio Building Annex. The lessees agreed to pay the lessor $ 150 each month.
2. At various times thereafter, John W. F. Hobbs and Leon P. Hobbs made alterations and improvements on the leased property. They rented the property to several different sublessees for varying terms.
3. On January 2, 1922, Joseph O. Hobbs conveyed several parcels of real estate, including the above-mentioned property, in trust to John W. F. Hobbs, Leon P. Hobbs, and Clarence L. Newton, as trustees, for certain designated uses and purposes. The trust instrument provided the trust should be known as the "Joseph O. Hobbs Trust."
4. Joseph O. Hobbs died on January 16, 1927.
5. On October 20, 1938, the trustees of the Joseph O. Hobbs trust assigned all their interest as lessors of property to Helen M. Woodfin.
6. On October 20, 1938, John W. F. Hobbs nominated Marion Miller of Dedham, Massachusetts, as the person to whom Helen M. Woodfin should assign his share of such lessor's interest.
7. On October 20, 1938, Leon P. Hobbs nominated Marjorie Chapman of Newton, Massachusetts, *172 as the person to whom Helen M. Woodfin should assign his share of such lessors' interest.
8. On October 20, 1938, Helen M. Woodfin assigned to Joseph Harold Hobbs, Paul Wesley Hobbs, Lemira Mae Hobbs Richards, Marion Miller, nominee of John W. F. Hobbs, and Marjorie Chapman, nominee of Leon P. Hobbs, as tenants in common, all the lessors' interest previously assigned to her by the trustees of the Joseph O. Hobbs trust.
9. On October 20, 1938, the trustees of the Joseph O. Hobbs trust terminated the trust by conveying the then remaining trust assets to the five children of Joseph O. Hobbs, viz: Joseph Harold Hobbs, Paul Wesley Hobbs, Lemira Mae Hobbs Richards, John W. F Hobbs, and Leon P. Hobbs, as tenants in common.
10. On October 20, 1938, the above-named five children of Joseph O. Hobbs transferred in trust to John W. F. Hobbs, Leon P. Hobbs, and Clarence L. Newton, as trustees, the property which the trustees of the Joseph O. Hobbs trust had conveyed directly to the five children as tenants in common by the deed terminating the Joseph O. *1262 Hobbs trust. The several transfers in trust by the five children were identical.
11. On October 20, 1938, Marion Miller transferred*173 in trust to John W. F. Hobbs, Leon P. Hobbs, and Clarence L. Newton, as trustees, the interest in leases assigned to her by Helen M. Woodfin. The trustees were to hold such interest for the uses and purposes set forth in the deed of trust executed on the same day by John W. F. Hobbs to the same trustees.
12. On October 20, 1938, Marjorie Chapman transferred in trust to John W. F. Hobbs, Leon P. Hobbs, and Clarence L. Newton, as trustees, the interest in leases assigned to her by Helen M. Woodfin. The trustees were to hold such interest for the uses and purposes set forth in the deed of trust executed on the same day by Leon P. Hobbs to the same trustees.
13. John W. F. Hobbs died testate on January 10, 1944. After certain specific bequests in his will, he provided that the remainder of his estate should be placed in trust naming his wife, Erminie B. Hobbs, and his son, John W. F. Hobbs, Jr., as principal beneficiaries. He also exercised in favor of this testamentary trust the power of appointment reserved in his deed of trust of October 20, 1938.
14. Erminie B. Hobbs, Leon P. Hobbs, and Claude L. Allen were appointed executors of the estate of John W. F. Hobbs on February 17, *174 1944. On November 23, 1945, the same parties were appointed trustees of a testamentary trust created by John W. F. Hobbs.
15. The executors filed a Federal estate tax return including the leasehold interest mentioned in paragraph 1 above as an asset of the estate. For Federal estate tax purposes this lessee's interest of John W. F. Hobbs was valued by the Commissioner at $ 64,800. This valuation was arrived at in the following manner:
The value of the leasehold is computed as follows:
| Gross income | $ 14,000.00 | |
| Expenses: | ||
| Tax on building | $ 605.28 | |
| Repairs reserve | 120.00 | |
| Insurance | 87.00 | |
| Exterior repairs and reserve | 120.00 | |
| Depreciation on building (4 per cent) | 600.00 | |
| Yield on building investment (6 per cent) | 900.00 | |
| Management fee | 840.00 | |
| Land lease rent | 1,800.00 | |
| 5,072.28 | ||
| 8,927.72 |
| 6 per cent P. W. factor 25 years = 12.783 | ||
| $ 8,927.72 x 12.783 = | $ 114,600 -- | Value of leasehold. |
| 15,000 -- | Building value. | |
| 129,600 -- | Total value. | |
| Value of decedent's 1/2 interest, $ 64,800. |
*1263 16. At the date of death of John W. F. Hobbs, John W. F. Hobbs and Leon P. Hobbs were receiving the following rentals from the various*175 subleases mentioned in paragraph 2 above:
a. Clear Weave Hosiery Stores, Inc. March 1, 1942 -- March 1, 1947 Rental $ 3,600.00 per annum plus 7% of gross sales over $ 51,428.00.
b. Fanny Farmer Candy Shops, Inc. March 1, 1939 -- February 29, 1944 Rental $ 2,000.00 per annum plus 12% of all sales in excess of $ 16,666.67.
c. Spencer Chain Stores, Inc. October 1, 1942 -- September 30, 1945 Rental $ 6,000.00 per annum plus 6% of net sales in excess of $ 100,000.00.
On January 10, 1944, John W. F. Hobbs had a one-fifth remainder interest in realty situated at 268-272 Elm Street, West Somerville, Massachusetts, known as the Studio Building Annex which remainder interest was subject to the lease of the Studio Building Annex between Joseph O. Hobbs, as lessor, and John W. F. Hobbs and Leon P. Hobbs, as lessees. For Federal estate tax purposes this one-fifth remainder interest was valued as of January 10, 1944, the date of John W. F. Hobbs' death at $ 1,972.17. Leon P. Hobbs, Claude L. Allen, and Erminie B. Hobbs filed income tax returns for the calendar years 1944 and 1945 as executors of the estate of John W. F. Hobbs. Leon P. Hobbs, Claude L. Allen, and Erminie B. Hobbs *176 filed income tax returns for the calendar year 1946 as trustees of the testamentary trust created by John W. F. Hobbs.
18. The trustees of the testamentary trust created by John W. F. Hobbs took a deduction in the amount of $ 2,577.72 on the income tax return filed for the calendar year 1946 as amortization of the leasehold interest included as an asset of the estate of John W. F. Hobbs.
19. On June 24, 1946, the executors of the estate of John W. F. Hobbs filed claims for refund of income taxes for the years 1944 and 1945, claiming the deductibility of $ 2,506.12 in 1944, and $ 2,577.72 in 1945, as amortization of the leasehold interest mentioned in paragraph 18 above.
20. After transfers dated October 20, 1938, John W. F. Hobbs was a colessee with his brother, Leon P. Hobbs, of the Studio Building Annex and also owned a one-fifth undivided interest in the reversion. At the date of death of John W. F. Hobbs, January 10, 1944, the lease to John W. F. Hobbs and Leon P. Hobbs had 25 years and 18 days to run. The fair market value of the one-half interest in the leasehold at the date of death of John W. F. Hobbs was $ 57,300, and the fair market value of the one-fifth interest in the*177 reversion was $ 1,972. *1264 Petitioners, as executors and later as trustees, succeeded to the ownership of a one-half interest in the leasehold and a one-fifth interest in the reversion.
OPINION.
Petitioner states the issues involved in these consolidated proceeding in its brief, as follows:
1. Is the estate of a decedent, which estate is the successor co-lessee together with another person of certain commercial property upon a long-term lease which had several years to run at the date of death of decedent, and which leased property was sub-let to various commercial establishments, and in the reversion of which real estate, the estate owned a one-fifth undivided interest, entitled to recover the cost basis of the leasehold interest, being the fair market value of the leasehold at the date of death of the executors' testate, over the remaining term of the lease?
2. Is a trust under the will of a decedent, which trust is the successor co-lessee together with another person of certain property upon a long-term lease which had several years to run at the date of death of decedent, and which leased property was sub-let to various commercial establishments, and in the reversion of*178 which real estate, the trust owned a one-fifth undivided interest, entitled to recover the cost basis of the leasehold interest, being the fair market value of the leasehold at the date of death of the trustees' testate, over the remaining term of the lease?
1. We shall first take up Issue 1. The applicable sections of the Internal Revenue Code are printed in the margin. 1
*179 *1265 In the first place, we think we should point out that this is not a case where the lessors of a long term lease seek depreciation deductions on a building erected on the leased land by a lessee at no cost to the lessors, and where the useful life of the building is of shorter duration than the remaining life of the lease, and where the leasehold has been acquired by successors by bequest, devise, or inheritance as in Charles Bertram Currier, 7 T. C. 980; J. Charles Pearson, Jr., 13 T. C. 851, revd. (C. A. 5, 1951), 188 F. 2d 72; Mary Young Moore, 15 T. C. 906. In the instant case decedent John W. F. Hobbs and his brother, Leon P. Hobbs, leased for a term of 45 years from their father on February 1, 1921, certain property described in our findings of fact for an annual rental of $ 1,800. They constructed certain improvements on the property and subleased it to other tenants from whom they received annual rentals shown in our findings of fact.
On January 10, 1944, John W. F. Hobbs died testate and at the time of his death he was the owner of a one-half *180 interest in this leasehold which was acquired by himself and his brother from their father in 1921. At the date of the death of John W. F. Hobbs this lease had 25 years and 18 days to run. The Commissioner in his determination of the estate tax due by the estate of John W. F. Hobbs valued his one-half interest in the leasehold, plus the property situated thereon, at $ 64,800 and valued his one-fifth interest in the reversion at $ 1,972.
Although it has not been commented upon by either party in his brief, it should be noted at this point that the Commissioner has not valued decedent's one-half interest in the leasehold at $ 64,800. The Commissioner valued the leasehold proper at $ 114,600 and decedent's one-half interest therein at $ 57,300. To reach his valuation of $ 64,800 as the value of decedent's interest, the Commissioner added $ 7,500 as decedent's one-half interest in the buildings which decedent and his brother had erected on the leased premises. We have no issue here as to any allowance for depreciation on these buildings. What we do have is an issue as to the amortization of a leasehold which the Commissioner has valued at $ 114,600 at the date of decedent's death, *181 decedent's one-half interest therein being valued at $ 57,300.
Petitioners, as executors and later as trustees, succeeded to the ownership of a one-half interest in the leasehold and a one-fifth interest in the reversion. Petitioners do not claim any amortization of the $ 1,972 value of the reversion but they do claim amortization of the $ 64,800 valuation of the leasehold spread over the remaining life of the lease.
Respondent contends that petitioners are not entitled to any deduction for amortization of the leasehold and relies largely upon our decision in Milton H. Friend et al., Trustees, 40 B. T. A. 768, affd., *1266 119 F.2d 959">119 F. 2d 959. We think the Friend case would be entirely in point if John W. F. Hobbs, the owner of one-half the leasehold had also been the owner of one-half interest in the reversion, but that was not the case. At the time of the death of John W. F. Hobbs he owned only one-fifth interest in the reversion. In the Friend case we said:
We are not dealing here with the case of a taxpayer who has acquired by purchase or by inheritance a right to receive a periodic sum of money for a term of *182 years. Clearly if a taxpayer had invested money in acquiring such right he would be entitled to deduct from the rents received each year an aliquot part of the cost of his investment; for he would be entitled under the statute to recover back the cost of his investment without being taxed thereon.
What we are dealing with here is the case of an estate which owns the fee of real estate which is advantageously leased. The estate had the fee simple title to the real estate located at 6308-6314 South Halsted Street. In a fee simple title all lesser estates, rights, titles, and interests merge. William Robert Farmer, 1 B. T. A. 711. We think it immaterial that for the purpose of determining the tax liability in these proceedings the respondent determined the value of the fee by separately valuing the right to receive rentals over the terms of the leases and the remainder interests.
Petitioners in their brief argue that even if we disregard the differences in the two cases and apply the same reasoning to a lessee as owner of the reversion as the Court did in the Friend case in the situation of a lessor who is the owner of the reversion, then the exhaustion*183 allowable in the instant case would amount to four-fifths of $ 64,800, the fair market value, spread over the remaining term of the lease. Petitioners contend that even if at the end of the term the property was re-leased by the owners of the fee on as favorable terms as presently leased to the sublessees, the gross income from rents to be received by petitioners would be one-fifth of the amount they now receive as lessees from their subleases, so that four-fifths of their property value will necessarily have been exhausted. Petitioners say that it must be remembered that we are here concerned with only that one-half interest in the lease which petitioners' estate owned, for his colessee is alive and still owns his one-half. We think petitioners' distinction between the Friend case and the instant case in the above respect must be sustained. In the Friend case the taxpayers were the owners of the entire fee. In the instant case, petitioners are only the owners of one-fifth of the reversion.
Petitioners concede that John W. F. Hobbs in his lifetime would not have been entitled to any amortization of his leasehold interest because it cost him nothing. They contend, however, *184 that the situation was changed when decedent died and his estate, and later the testamentary trust, succeeded to his ownership of the leasehold interest. They cite in support of their contention our opinion in Charles Bertram Currier, supra, in which we said:
*1267 * * * But the function of the owner's investment, which in such cases is otherwise absent and which the depreciation deductions are hence not required to replace, cf. Detroit Edison Co. v. Commissioner, 319 U.S. 98">319 U.S. 98, is, in the case of inherited property, performed by the intervention of the estate tax upon the improvements transmitted from decedent to devisee. The basis of inherited property is accordingly not cost, as it was in the Detroit Edison and Reisinger cases, and to say that a property cost the taxpayer nothing makes no contribution to the solution of the present question. As opposed to cost, the basis of property acquired by devise is categorically fixed by statute as fair market value on the date of acquisition. Internal Revenue Code, sec. 113 (a) (5). Hence, if we can discover the fair market value of the property in question*185 at the date of decedent's death, Augustus v. Commissioner (C. C. A., 6th Cir.), 118 Fed. (2d) 88, (or the figure at which it was returned for estate tax purposes, which is recognized as the equivalent, Regulations 103, sec. 19.113 (a) (5)) the upshot would ordinarily be its basis for depreciation in petitioner's hands, without any reference to its "cost." Having acquired a basis by the incidence of the estate tax, the gradually disappearing value of a wasting asset can not be replaced except by periodic depreciation adjustments.
While, as we have already pointed out, the Currier case had to do with claimed depreciation of a building on the leased premises erected by the lessee without cost to the lessor and the instant case has no such question involved, nevertheless what we said as to basis under section 113 (a) (5) is equally applicable here. The upshot of our holding is that while petitioners are not entitled to amortization based on the valuation of $ 64,800 under the doctrine of the Friend case, supra, because they were the owners of a one-fifth interest in the reversion, nevertheless they are entitled, we think, to an amortization*186 deduction of four-fifths of $ 57,300 spread over the remaining life of the lease.
We have already pointed out that the value of decedent's one-half interest in the leasehold was $ 57,300, and not $ 64,800 as contended by petitioners. As to the importance of separately finding the value of the leasehold interests and the value of buildings situated on the leased premises, see the Fifth Circuit's opinion in the recent case of Commissioner v. Pearson, supra. We hold that petitioners are entitled to deduct amortization of four-fifths of the $ 57,300 valuation of the leasehold interests, based on the remaining life of the lease.
2. The second issue stated by petitioners in their brief is the same as Issue 1, except that in Issue 1 the entity involved is the estate of decedent still in the process of administration, whereas in Issue 2 the entity involved is the testamentary trust provided in the will of decedent.
We think the same ruling must apply to Issue 2 as we have made with respect to Issue 1. Our findings of fact show that Erminie B. Hobbs, Leon P. Hobbs, and Claude L. Allen were appointed executors of the estate of John W. F. Hobbs on February 17, 1944. On November *187 23, 1945, the same parties were appointed trustees of a testamentary *1268 trust created by John W. F. Hobbs. It is that testamentary trust which is the petitioner in Docket No. 23188.
The leasehold involved in these proceedings was acquired by the testamentary trust under the will of John W. F. Hobbs and its basis of cost under section 113 (a) (5), I. R. C., is the fair market value of the leasehold at the time of acquisition, which was the date of the death of decedent. This valuation, as we have already held, was $ 57,300. The petitioner trust is not entitled, however, to an amortization deduction on this full $ 57,300 valuation but, for reasons which we have explained under Issue 1 above, is only entitled to an amortization deduction based on four-fifths of said valuation.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * * *
(l) Depreciation. -- A reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) --
(1) of property used in the trade or business, or
(2) of property held for the production of income.
In the case of property held by one person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner of the property and shall be allowed to the life tenant. In the case of property held in trust the allowable deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or, in the absence of such provisions, on the basis of the trust income allocable to each.
SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --
* * * *
(5) Property transmitted at death. -- If the property was acquired by bequest, devise, or inheritance, or by the decedent's estate from the decedent, the basis shall be the fair market value of such property at the time of such acquisition. In the case of property transferred in trust to pay the income for life to or upon the order or direction of the grantor, with the right reserved to the grantor at all times prior to his death to revoke the trust, the basis of such property in the hands of the persons entitled under the terms of the trust instrument to the property after the grantor's death shall, after such death, be the same as if the trust instrument had been a will executed on the day of the grantor's death. For the purpose of this paragraph property passing without full and adequate consideration under a general power of appointment exercised by will shall be deemed to be property passing from the individual exercising such power by bequest or devise. * * *↩