*284 Decision will be entered under Rule 50.
1. Petitioner purchased land which it had under lease for a period of 21 years for a consideration of $ 2,100,000. The fair market value of the land was $ 660,000, if it had been unimproved on the date of purchase. Petitioner claims that the remaining $ 1,440,000 was paid to secure the cancellation of a burdensome lease which had 21 years to run. Petitioner claims deduction of the $ 1,440,000 which, it maintains, should be allocated to the cost of canceling the lease as an ordinary and necessary business expense under section 23 (a) of the Code. Held, the $ 1,440,000 is not deductible in the year paid as an ordinary and necessary business expense. Cleveland Allerton Hotel, Inc. v. Commissioner, 166 F. 2d 805, reversing Memorandum Opinion of this Court, not followed.
2. In the alternative, petitioner claims that it should be permitted to amortize over the remaining term of the lease all that it paid in excess of the value of the land, if it had been unimproved at the time of purchase, as the cost of canceling a burdensome lease. Held, that petitioner, in procuring the cancellation of its lease*285 as a part of the transaction in acquiring the land, did not acquire a capital asset in the cancellation of its lease and has no legal ground for the amortization deduction which it claims under its first alternative.
3. In its second alternative, petitioner claims that all that it paid in excess of the fair market value of the land in an unimproved condition should be allocated as additional cost of its building and that it should be allowed depreciation based on this additional cost spread over the remaining useful life of the building. Held, that petitioner already owned the building and had been permitted to recover by way of depreciation, including the amount of depreciation allowed by the Commissioner in the taxable year, the full amount of the cost of its building and has no unrecovered cost which it is entitled to recover by way of depreciation. It has no additional cost of its building by reason of the transactions here.
4. In the taxable year petitioner incurred and paid $ 16,500 attorneys' fees in acquiring title to the land and cancellation of the lease. The Commissioner disallowed petitioner the deduction of said amount on the ground that it was a capital expense. *286 Held, the expenditure was made in the acquiring of capital assets and is not deductible.
*818 The Commissioner has determined a deficiency in petitioner's excess profits tax for the year 1945 of $ 39,465.62. The deficiency is due to five adjustments made by the Commissioner to the income as reported by petitioner on its return. These adjustments were:
| (a) Capital stock tax | $ 5,000.00 |
| (b) Legal expense | 16,500.00 |
| (c) Prepaid rent | 8.33 |
| (d) Depreciation | 15,679.32 |
| (e) Net short term capital gain | 1,899.38 |
| Total | $ 39,087.03 |
*287 Adjustment (b) is explained in the deficiency notice as follows:
(b) Deduction of legal expenses, in the amount of $ 16,500.00, incurred in connection with the acquisition of your property has been disallowed because it represents a capital expense.
Adjustment (d) is explained in the deficiency notice as follows:
(d) A reasonable allowance for the depreciation of your building and improvements is determined to be $ 65,330.57, rather than the amount of $ 81,009.89 deducted in your return.
No allowance has been made with respect to a payment by you to allegedly obtain the cancellation of a lease, in the absence of information showing that a deductible business expense was incurred.
In its original petition petitioner made two assignments of error:
(a) The Commissioner of Internal Revenue has failed to allow as a deduction an ordinary and necessary business expense in the amount of $ 1,600,000.00 incurred to secure a release from a 21 year lease with a minimum rental of approximately $ 225,000.00 per annum.
(b) Alternatively to sub-paragraph (a) above, petitioner contends the Commissioner of Internal Revenue has failed to allow an additional deduction for depreciation in the amount*288 of $ 35,961.60.
At the hearing petitioner filed an amended petition changing paragraph (b) above and adding (c) and (d), as follows:
(b) Alternatively to sub-paragraph (a) above, petitioner contends the amount paid in excess of the value of the land, namely $ 1,500,000, should be amortized over a period of 21 years. Commissioner of Internal Revenue has failed to allow a deduction for such amortization.
(c) In the further alternatives to sub-paragraphs (a) and (b) above, Commissioner of Internal Revenue has failed to allow an additional deduction for depreciation in the amount of $ 36,000.00.
(d) Commissioner of Internal Revenue has failed to allow as a deduction that part of the legal expense in the amount of $ 16,500.00 and sundry expense in the amount of $ 4,552.50 incurred in connection with obtaining a release by the petitioner from its lease agreement with the landlord.
The respondent's other adjustments are not contested.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found accordingly.
Petitioner is a corporation with its principal office in New York *819 City. The returns for the period involved here were filed with the collector for the third district*289 of New York.
On April 30, 1924, petitioner leased land located at the northeast corner of Seventh Avenue and 38th Street, New York City. The size of the plot is 98 feet 9 inches on the east side of Seventh Avenue and 200 feet on 38th Street. The lease provided for an annual net basic rental of $ 100,000, plus the income taxes that would be incurred by the lessor upon the receipt of the $ 100,000 per annum. The lease between petitioner and the landlord was amended on November 30, 1935, to provide for an annual net rental of $ 118,840 without petitioner being liable for reimbursing the landlord for any income tax thereon. On April 16, 1945, petitioner exercised the option contained in the lease agreement to extend the lease of a period of 21 years to April 30, 1966.
In accordance with the terms of the lease, the petitioner-tenant erected a 22-story loft building at a cost of 3 million dollars, including taxes, interest, and insurance during construction on the leased land. Title to the building, improvements, and fixtures belonged to the tenant-petitioner. Title to this property was to vest in the landlord at the expiration of the last term of the lease only at the option of the*290 landlord. In the event of the destruction of the building by fire or other causes, the petitioner-tenant was still liable on the lease and could not abandon the lease. In the event of the destruction, in whole or in part, of the building petitioner-tenant at its own cost had to make the building whole. At the expiration of the lease or any renewal period, petitioner-tenant was to surrender the premises and the building to the landlord at his option, free and clear of all encumbrances, without the landlord being obligated to pay for such property. Petitioner-tenant had the option to renew the lease for two successive 21-year periods. The ground rent for the renewal period was to be 6 per cent of the value of the land at the termination of each period of the lease but not to be less than the basic rent of $ 100,000, plus the additional rent of $ 18,840. The value of the land was to be determined as if vacant and unimproved. The rent at 6 per cent of the value of the land in May 1945, would have been less than the minimum basic rental of $ 100,000.
On May 11, 1945, petitioner entered into an agreement of sale with Wendel Foundation, the owner of the land. Title to the land was*291 taken by petitioner on June 11, 1945. Petitioner purchased the fee and obtained release from the obligations of the renewed lease for $ 2,100,000. Petitioner purchased the fee to be released from the terms of the lease. Petitioner was most concerned about the annual rental of $ 118,840, which it deemed excessive, and the contingent liability to remove the building from the premises at the expiration of the lease upon the request of the landlord. The agreement of sale *820 between Wendel Foundation, the lessor and owner of the fee, and petitioner contained, among other provisions, the following:
WITNESSETH that the Seller agrees to sell and convey and the Purchaser agrees to purchase:
[Here follows a description of the premises.]
The price is TWO MILLION ONE HUNDRED THOUSAND DOLLARS ($ 2,100,000) payable as follows: TWO HUNDRED TEN THOUSAND DOLLARS ($ 210,000) on the signing of this contract, receipt whereof by check subject to collection is hereby acknowledged, the non-payment of which check in due course shall give Seller the option of cancelling this agreement; and the balance, ONE MILLION EIGHT HUNDRED NINETY THOUSAND DOLLARS ($ 1,890,000) on the delivery of the deed as*292 hereinafter provided, by certified check satisfactory to the Seller, the check to be drawn to the order of the Seller and payable through the New York Clearing House.
* * * *
Seller shall execute upon request of Purchaser an agreement cancelling and terminating said lease as of the time of the actual closing of title hereunder. It is agreed however that regardless of whether Purchaser accepts title to the premises subject to the aforementioned lease or elects to have an agreement cancelling and terminating same, the idemnity [sic] agreements of Purchaser contained in the said lease shall continue in full force and effect after closing of title in favor of the Seller with respect to any liabilities or obligations of Seller assumed by or imposed upon it by the terms of the lease or any such agreements of amendment, modification, extension or renewal or arising out of Seller's ownership of the said premises.
* * * *
The deed shall be in proper statutory short form for record in the usual form of a Bargain and Sale deed containing no covenant or warranty and shall be duly executed and acknowledged by Seller at Seller's expense, * * *
The agreement of cancellation of the lease was*293 executed June 11, 1945, and contains, among other things, the following language:
WHEREAS, the Tenant requested the Landlord to accept a surrender of the demised term and the Landlord agreed to accept such surrender provided this agreement was executed simultaneously with the execution of the formal agreement of surrender, which formal agreement of surrender is being executed and delivered simultaneously herewith:
NOW, THEREFORE, in consideration of the premises and the sum of One Dollar ($ 1.00) and other good and valuable consideration by each of the parties hereto to the other in hand paid, receipt whereof is hereby acknowledged, the parties hereto do hereby mutually release one another and their successors and assigns from any and all obligations under said lease and modification agreement and under said agreement of renewal and extension thereof, * * *
The land purchased by petitioner contained 19,750 square feet and was located in Block No. 814, bounded by 38th Street, Seventh Avenue, 39th Street, and Broadway. The Millinery Center Building and the land on which it stood were assessed for real estate tax purposes as follows:
| Year | Land | Building | Total |
| 1943-1944 | $ 1,470,000 | $ 2,305,000 | $ 3,775,000 |
| 1944-1945 | 1,410,000 | 2,165,000 | 3,575,000 |
*294 *821 The remainder of Block No. 814, comprising 45,178 square feet and improvements thereon, was sold on December 2, 1943, for $ 1,250,000. This property had a frontage of 205 feet on the west side of Broadway, 301 feet on 39th Street, 165 feet on 38th Street, and 98 feet and 9 inches on Seventh Avenue, and was assessed for real estate tax purposes as follows:
| Year | Land | Building | Total |
| 1943-1944 | $ 3,830,000 | $ 115,000 | $ 3,945,000 |
| 1944-1945 | 3,735,000 | 100,000 | 3,835,000 |
Lot 64 of Block No. 813 on the southeast corner of 38th Street and Seventh Avenue had the same frontage with identical dimensions as the property in question and was located directly across the street. Lot 64 was offered for sale in 1945 for an amount less than $ 600,000 but remained unsold. That lot with improvements was previously sold on March 1, 1944, for $ 600,000. This property was assessed for real estate tax purposes as follows:
| Year | Land | Building | Total |
| 1943-1944, and 1944-1945 | $ 1,225,000 | $ 35,000 | $ 1,260,000 |
Lot 55, Block No. 813, was leased in December 1924 by the landlord for a net basic rental of $ 115,000, plus the income taxes thereon, for a term of 21 years with*295 two renewal options of 21 years each. The rental was changed to $ 138,000 in lieu of $ 115,000, plus the income tax thereon. Pursuant to the terms of the lease, the lessees had erected a 23-story building which was completed in 1926. The lease was renewed on April 26, 1945. On May 8, 1945, the fee to the land, on which was the building erected by the tenant and subject to a long-term lease, was sold to the Woodmen of the World for $ 2,250,000.
In 1945, the United States Government restrictions on building construction plus the restrictions contained in New York State rent laws adversely affected the value of land. Limitations Order L-41 restricting building construction became effective in 1942 and was still in effect through the year 1945.
The value of the land, vacant and unimproved, upon which the petitioner's property stood was $ 660,000 when purchased by petitioner in 1945.
Petitioner incurred legal fees aggregating $ 16,500 in connection with the purchase of the fee and the release from the obligations under its lease with the Wendel Foundation.
OPINION.
Petitioner states the issues raised by the pleadings, in its brief, as follows:
I
Is the petitioner entitled to deduct*296 the amount of $ 1,500,000 or any part thereof incurred in connection with the cancellation of a burdensome lease as an *822 ordinary and necessary expense under Section 23(a) or as a loss under Section 23(f) of the Internal Revenue Code? Or, in the alternative, is the petitioner entitled to amortize the said $ 1,500,000 or any part thereof incurred in obtaining a release from the burdensome 21 year lease over the remaining term of such lease?
II
In the further alternative, is the petitioner entitled to capitalize that part of the price paid of $ 2,100,000 over and above the actual land value as the purchase price of the building and depreciate said cost of building over the remaining building life of 30 years?
III
Is the petitioner entitled to deduct that part of the $ 16,500.00 legal expenses incurred to acquire the fee and to cancel a burdensome lease that is applicable to the cancellation of the burdensome lease?
The principal issue in this proceeding is whether petitioner, a lessee in possession who purchases the fee and the cancellation of the lease for a price greater than the value of the land, may allocate a portion of the purchase price to the purchase of the lease *297 and deduct the allocated portion as a business expense under section 23(a) of the Code. Respondent in his deficiency notice determined that "No allowance has been made with respect to a payment by you to allegedly obtain the cancellation of a lease, in the absence of information showing that a deductible business expense was incurred." Respondent still contends that no part of the purchase price of $ 2,100,000 paid by petitioner in 1945 to the Wendel Foundation can be deducted as a business expense and that petitioner is not entitled to use any part of this purchase price as a basis for amortization or depreciation deductions. For reasons which we will presently give, we think respondent must be sustained in each of these contentions.
Business Expense.
Petitioner paid $ 2,100,000 under the agreement of May 11, 1945, to the Wendel Foundation. Credible and uncontradicted testimony placed the value of the land at $ 660,000, if it had been in an unimproved condition at the time of purchase. But it must be remembered that petitioner did not purchase the land in an unimproved condition. The land, when petitioner purchased it in 1945, was improved by a building which had been erected*298 by petitioner in a prior year at a cost of $ 3,000,000, and the land was leased to petitioner for a term of 21 years still to run at an annual rental of $ 118,840. What petitioner paid Wendel Foundation $ 2,100,000 for was the bundle of rights which it obtained in the purchase. Included in this bundle of rights was the cancellation of the lease which still had 21 years more to run. Petitioner contends that all above $ 660,000, which was the value of the land if it had been in an unimproved condition, or $ 1,440,000, represented the price which it paid for the cancellation of its lease and that this entire amount of $ 1,440,000 should be allowed in the *823 taxable year 1945 as a deductible business expense under section 23(a) of the Code printed in the margin. 1 Petitioner, in contending that the entire amount of $ 1,440,000 should be allowed as a deduction for business expense in the taxable year, relies heavily upon Cleveland Allerton Hotel, Inc. v. Commissioner, 166 F. 2d 805, reversing Memorandum Opinion of this Court. In that case the Court of Appeals said:
As purely legalistic formalism, this argumentation bears an aura of validity. *299 Realistically considered, however, it will not stand analysis. The status of the petitioner does not approximate that of a third person investor, buying real estate to which is appurtenant a long-term profitable lease. The petitioner already had the use of the land with full control and dominion over it, subject only to its obligation to surrender it at the end of the term. The lease was a liability which it sought to extinguish. This it was impossible to do merely by buying acquittance and giving up possession of the premises. It had thereupon a valuable hotel building which it could not take away with it. The only interest in the land it secured by the purchase that it did not already have was the reversionary interest, which all parties appear to consider as of only nominal value. To consider that remainder a capital asset with a value of $ 441,250 requires, it seems to us, a naivete not attributable to experienced and sophisticated taxing authority. * * *
If numerous admonitions that taxation is a practical matter, that taxing authority may look through form to substance, is not mere rhetoric where the taxpayer's interest is involved, and a working formula only when it*300 is of advantage to the Treasury, it would seem to be clear that the petitioner paid all over $ 200,000 to escape from a burdensome lease, and should be able to write that off as an expense of doing business.
We are unable to agree with the learned court that in a case like the Cleveland Allerton Hotel case or the one which we have here, the taxpayer should be allowed to deduct as a business expense in the year when paid that part of its payment which it claims should be allocated to the cancellation of a burdensome lease. The court in holding that the amount which the taxpayer claimed should be allocated to the cancellation of the burdensome lease and should be allowed as a deductible business expense in one year said:
This being so, we find ourselves in accord with the decision of the Third Circuit in Cassatt v. Commissioner, 3 Cir., 137 F. 2d 745 and with the decision of the Board of Tax Appeals in Appeal of Denholm & McKay Co., 2 B. T. A. 444, that payments of this character must be deducted on the taxpayer's tax return as an expense of doing business in the year when made. * * *
*301 *824 We think Cassatt v. Commissioner, 137 F. 2d 745, affirming 47 B. T. A. 400, and Denholm & McKay Co., 2 B. T. A. 444, are distinguishable. In Denholm & McKay Co., the taxpayer did not own the building which it was renting. Both building and land were owned by the Denholm & McKay Realty Co. and what the taxpayer purchased from the Realty Co. was a complete cancellation of the lease and a surrender of possession under that particular lease and the securing of a new lease of the same building under much more favorable terms than the old lease. Denholm & McKay did not acquire title to the land from the Realty Co. In Cassatt v. Commissioner, supra, the court pointed out that:
In the early part of January, 1935, Cassatt and Company were obligated on several leases of office space for terms not expiring until 1941. The aggregate prospective rentals for these leases was $ 1,076,000. A settlement was effected with the various landlords whereby for $ 346,524.06 the leases were cancelled for the unexpired terms. * * *
Thus, in that case there was*302 not only a cancellation of the leases but a complete surrender of possession thereunder to the landlords.
We have no such case here. As we have already pointed out, petitioner, in making purchase of the cancellation of the lease from Wendel Foundation, had no notion of surrendering possession to the landlord. If it had done so, we would, of course, have an entirely different case from the one we have here. It owned a 22-story steel and concrete building which, according to testimony, had a remaining useful life of 30 years. What petitioner purchased for $ 2,100,000 is shown in its contract of purchase dated May 11, 1945, followed by the deed to the property which petitioner received on June 11, 1945. Petitioner purchased a capital asset and we sustain the Commissioner in his determination that no part of the purchase price can be deducted as a business expense in 1945. Cf. Home Trust Co. v. Commissioner, 65 F.2d 532">65 F. 2d 532.
Claim for Amortization Deduction.
Petitioner's first alternative is stated thus in its brief:
However, in the event the Court should find that the amount paid in excess of the land value to effect a saving in rent expense *303 is a capital asset, petitioner then claims it is entitled to amortize said asset over 21 years, the remaining life of the cancelled lease.
Petitioner does not cite any authority in support of this first alternative contention and we do not know of any. It is, of course, true that if a taxpayer purchases a lease which has, say 21 years to run, and does not purchase the fee his purchase is a wasting asset and the cost of the lease is not deductible in the year of purchase but must be amortized over the life of the lease. See Home Trust Co. v. Commissioner, supra, and many cases there cited. But here petitioner has not purchased any lease. In the transaction which has been consummated petitioner has obtained title to the land and has secured *825 the cancellation of the lease which, under the circumstances then existing, it regarded as burdensome. It is true, of course, that petitioner in the purchase of land acquired a capital asset but it is not an asset which is subject to depreciation or amortization. Its value may increase from year to year or, on the other hand, may decrease but gain or loss can be taken only when the land is finally*304 disposed of. But, while it is true that petitioner in the purchase of the land in 1945 acquired a capital asset, we do not think it can be said that petitioner in procuring the cancellation of its burdensome lease acquired a capital asset which it can amortize over the remaining term of the lease. The lease was at an end when petitioner procured its cancellation in 1945. We think petitioner's first alternative contention must be denied.
Additional Depreciation on the Building.
Petitioner's second alternative is stated in its brief, as follows:
In the event the Court should find that no part of the payment of $ 2,100,000 represents an allowable deduction for obtaining a release from a lease agreement, petitioner then contends that $ 1,500,000 represents the cost of building which it is entitled to depreciate over a remaining life of 30 years.
The following facts with reference to depreciation seem to be undisputed by the parties: The respondent, for the taxable year, has allowed petitioner depreciation on the building equivalent to petitioner's unrecovered cost because its first 21-year term of the lease ended in 1945. That depreciation deduction is not in dispute here. During*305 this original 21-year term of the lease, including the part of it which expired in 1945, petitioner has recovered tax free through depreciation deductions the entire 3 million dollar cost of erecting its building. Petitioner has claimed, however, on its return for 1945, that it acquired the building in effect for the second time in 1945 and has claimed depreciation on this second cost. This latter amount of depreciation the Commissioner has disallowed and has confined his allowance for depreciation deduction to petitioner's unrecovered cost of its building. Petitioner having fully recovered the cost of its building by way of depreciation deductions in 1945 and prior years had no unrecovered cost of its building.
We think that the bundle of rights which petitioner acquired by its contract of purchase of May 11, 1945, followed by the deed of June 11, 1945, was so inextricably entwined in the acquiring of the land as not to be separable therefrom. We think that no part of the $ 2,100,000 which petitioner paid can be allocated to the cost of the building which petitioner already owned and which it had been allowed to fully depreciate over the first 21-year term of the lease. The *306 building and the lease were not bargained for or purchased separately. They were included, insofar as the lessor had any interest therein, in the single *826 transaction of the contract of purchase of the land and the deed to petitioner thereof. If petitioner were allowed additional depreciation deductions for the building which it claims in its second alternative, it would then have depreciated the building once since it has been erected and paid for by petitioner and a second time because it had purchased the land under the building. Petitioner cites no case which would support such a deduction and we know of none. Petitioner's second alternative is denied.
The only other issue which remains for our decision was stated in petitioner's brief as follows: "Is petitioner entitled to deduct that part of the $ 16,500.00 legal expenses incurred to acquire the fee and to cancel a burdensome lease?" The Commissioner in his disallowance of this deduction stated in his deficiency notice: "Deduction of legal expenses, in the amount of $ 16,500.00, incurred in connection with the acquisition of your property has been disallowed because it represents a capital expense." We think the Commissioner*307 must be sustained in the disallowance of this claimed deduction. It was made to obtain capital assets and, as such, did not represent a deductible expense.
Decision will be entered under Rule 50.
Arundell, Murdock, Opper, Tietjens, Raum, and Rice, JJ., dissenting: Some part of the purchase price should be allocated to the additional rights in the building acquired in the purchase, using the principle of Cohan v. Commissioner, 39 F. 2d 540, if necessary. This additional cost of the building would then be recovered through depreciation.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) Expenses. --
(1) Trade or business expenses. --
(A) In General. -- All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business; and rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.↩