*2450 Five individuals, who were doing business as a partnership, retained five-sevenths of the voting stock of a corporation that succeeded the partnership. Held, respondent was correct in applying the limitation set forth in section 331 of the Revenue Act of 1918.
*1085 Respondent upon audit of petitioner's income and profits-tax return for 1920, determined a deficiency in tax of $3,598.50. Petitioner brings this proceedings for a redetermination of the deficiency based upon the following allegations of error:
(1) That respondent failed to allow as invested capital the fair market value of a certain lease; and
(2) That respondent failed to allow a deduction representing a proportionate amount for exhaustion of the said lease.
FINDINGS OF FACT.
The petitioner is a corporation organized in June, 1919, under the laws of the State of New York to acquire the assets and continue the *1086 businesses which had been conducted by the River Sand Co. and the Mitchell Builders Supply Co. It was capitalized at $210,000, with $70,000 of preferred stock*2451 and $140,000 of common stock.
The River Sand Co., a partnership, was organized in 1910 to acquire a lease on a dock owned by the Niagara Falls Power Co. and to conduct a business in river-washed sand and gravel. The dock acquired was located at the foot of navigation in the upper Niagara River and was the only dock in Niagara Falls in 1910 and 1918 where cargo boats could moor and discharge their cargo. In addition to water transportation facilities the dock had railroad connections with the Erie and New York Central railroads through the Niagara Junction Railroad Co., a subsidiary of the Niagara Falls Power Co. The Niagara Junction Railroad Co. afforded switching facilities to the manufacturing establishments in the vicinity of Niagara Falls. The dock was favorably situated for team or truck haulage as it was located at the foot of Sugar Street, a north-and-south highway, which was intersected nearby by River Road, or Buffalo Avenue, an east-and-west highway. The dock was known locally as the Sugar Street dock. At the time the dock was leased to the River Sand Co. a number of firms were seeking to acquire it.
The River Sand Co. was composed of five partners, and three*2452 of them were officials of the Niagara Falls Power Co., the owner of the dock. These three partners were P. P. Barton, vice president and general manager of the power company, Frederick L. Lovelace, secretary and counsel for the power company, and R. V. Rose, assistant chief engineer of the power company. The other two partners were Charles F. Braas, a prominent builder of Niagara Falls, and John W. Broderick, who was the active manager and sole salesman. None of the partners invested any money in the business and their only asset in 1910 when they began business was a verbal lease on the dock from the power company. However, it secured favorable agreements with the Perry Sand Co. of Buffalo in 1910 and with the Empire Limestone Co. in 1911, whereby the partnership was provided with necessary equipment for operating. Various assets were subsequently purchased by the River Sand Co. out of earnings or surplus.
On February 1, 1912, a written lease was entered into between the River Sand Co. and the Niagara Falls Power Co. which leased the dock to the partnership for five years from the date of the lease, with five-year renewal privileges which allowed the term of the lease to be*2453 extended to January 31, 1932. Rental was charged at 5 cents per cubic yard for merchandise handled over the dock, and the River Sand Co. covenanted to pay a yearly minimum rental of $1,200. Subsequently, and on April 23, 1918, an amended lease was entered into by the same parties, leasing the dock for five years from May 1, *1087 1918, with provisions for renewals up to April 30, 1948. The annual rental provided for in the amended lease was $2,000 per annum. The amended lease gave the River Sand Co. an option to lease certain adjoining acreage at a stipulated figure per acre, and gave the partners a right to assign their respective interests in the said lease without affecting the lease, and the right to assign the lease to a New York corporation organized to succeed the partnership.
The River Sand Co. operated successfully almost from its inception. It was able by means of cheap water transportation and its dock facilities to undersell competing firms by 45 cents per cubic yard, as these firms had to ship in their sand and gravel by rail. During the period 1912 through May 31, 1919, the net earnings of the partnership and the withdrawals of profits by the partners, *2454 not including salaries or commissions, were as follows:
| Year | Earnings | Withdrawals |
| 1912 | $2,500.00 | |
| 1913 | 7,500.00 | |
| 1914 | $9,410.28 | 10,000.00 |
| 1915 | 5,866.02 | 7,500.00 |
| 1916 | $23,012.58 | 8,750.00 |
| 1917 | 14,091.84 | 7,500.00 |
| 1918 | 10,476.11 | ,027.45 |
| 1919 (5 months) | 12,153.98 | 10,000.00 |
During the last two years of the partnership's existence, Barton, Rose, Lovelace, and Braas drew salaries. Braas was the president of the partnership and Rose was secretary and treasurer. Broderick was the active manager of the business and was paid on the commission basis.
Shortly after the amended lease was procured, but prior to the consolidation of the three power companies in Niagara Falls, friction developed among the partners over the amount of withdrawals, Broderick being on one side and Barton, Rose, and Lovelace on the other. These four held a number of conferences and it was finally agreed between them that they would each give the other a verbal option on a buy or sell basis, each partner's interest being offered at $15,000 cash. Broderick desired to buy the interests of the other partners and approached Frederick Krull of Niagara Falls in this regard. *2455 Krull brought into the negotiations as interested parties, Francis H. Salt, vice president and trust officer of the Power City Bank, Paul A. Schollkopf, president of the Power City Bank, and also president of the consolidated power company, and Ross R. Coddington, general superintendent of the consolidated company. The consolidation of the power companies had been effected while Broderick was negotiating the purchase of the partners' interests, and the officials of the consolidated company were very anxious to acquire control of the River Sand Co., due to prospective developments on or adjoining the premises under lease to the partnership.
*1088 When Broderick attempted to exercise his option and buy out Lovelace, Barton, and Rose, the three partners, led by Lovelace, attempted to back out of the agreement, but upon being informed that the parties desiring to purchase were their superior officers in the consolidated company, they agreed to sell their interests in accordance with the terms of the verbal option which they had given Broderick. Braas sold his interest for the same price when Krull informed him it was a case of selling for what he could get or being forced*2456 out of business. Broderick retained his one-fifth interest in the River Sand Co., which was thereafter composed of Broderick, Krull, Salt, Coddington, and Schollkopf.
Shortly after the acquisition of the controlling interest in the River Sand Co. by Krull and his associates, Schoellkopf and Burton J. Mitchell, president of the Mitchell Builders Supply Co., who had been personal friends for years, entered into negotiations looking forward to the consolidation of the Mitchell Builders Supply Co. with the River Sand Co. The Mitchell Builders Supply Co. was a New York corporation engaged in handling builders' supplies and needed the dock of the River Sand Co. to protect and round out its building supply business. Mitchell had attempted to secure a location for another dock but found that the cost of acquiring the dock site, constructing the dock, and the necessary dredging of the river at the dock site, would cost between $250,000 and $300,000 and that even then he would be without railroad facilities.
The negotiations were finally culminated by the two companies transferring all their assets to the petitioner in exchange for all its capital stock. The assets of the Mitchell*2457 Builders Supply Co. were acquired for 1,100 shares of the capital stock of the petitioner, which was composed of 700 shares of preferred stock and 400 shares of common stock, each share having a par value of $100. The assets of the River Sand Co. were acquired in exchange for 1,000 shares of the common stock of the petitioner, each partner receiving 200 shares. Only the common stock had voting rights, the preferred being preferred as to dividends and as to assets. The stock issued was considered as evidencing the proportionate interests of the Mitchell Builders Supply Co. and the River Sand Co. in the petitioner, rather than as measuring the value of the assets which petitioner acquired.
The River Sand Co.'s lease on the Sugar Street dock had never been carried on its books in any amount. When the books of the petitioner were opened the auditors entered in the capital account the depreciated value of the tangible assets which petitioner had purchased out of earnings and surplus in the amounts shown on the River Sand Co.'s books. These assets as of June 1, 1919, amounted to $46,948.14. An entry was then made by the auditors charging the *1089 difference between the par*2458 value of the stock issued for the River Sand Co.'s assets, and $46,948.14, or $53,051.86, to the lease and contracts assigned to petitioner by the partnership. This latter entry was a mere balancing figure and was made without regard to the actual value of the assets so charged.
Thereafter this entry was called to the attention of the board of directors of the petitioner and at a meeting of the board, held on December 30, 1919, the following action was taken with respect thereto:
Upon motion seconded and unanimously carried, the following preamble and resolution were unanimously adopted, after a full and complete discussion thereof, and a careful investigation of the conditions upon which the same are based: -
WHEREAS, upon the organization of this company, it acquired a lease from The Niagara Falls Power Company of a wharf in the City of Niagara Falls, which leasehold interest is carried upon the books of this company at the sum of $50,000; and
WHEREAS, it is obvious that the possession and use of said wharf under said leasehold agreement is inherently of great value, and that said leasehold is worth at least $100,000 in excess of the $50,000 paid for it upon the organization*2459 of this company, said value being based upon the fact that no other site for a wharf in said city is or could be made available for less than $100,000, and that it has an earning capacity of even much larger amount;
Now, THEREFORE, BE IT RESOLVED, that the officers of this company be authorized and directed to place upon its books as of the date of the organization hereof, a valuation of said leasehold of $100,000 in excess of the $50,000 paid therefor; that said amount of $100,000, being the excess of value of the cost thereof, be carried upon the books as a fixed and undistributable surplus, to be reduced pro rata annually during the life of the lease.
RESOLVED, that the officers of this company be authorized to do and take such further steps in respect to said matter as may in their judgment be requisite and proper.
The petitioner formally acquired the lease by a written assignment dated July 24, 1919. The value of the lease when acquired was not less than $153,051.86.
In computing its invested capital for 1920 petitioner included $100,000 as paid-in surplus, represented by the lease and contracts acquired in exchange for its capital stock. Respondent eliminated this*2460 item from invested capital, and after certain other adjustments, not here material, determined a deficiency for 1920 of $3,598.50.
OPINION.
MORRIS: Two questions are raised by this proceeding, both of which relate to the value of the leasehold, the one for invested capital, and the other for exhaustion purposes. The petitioner contends that the value of the lease when acquired should be included in its invested capital. Respondent contends that section 331 of the Revenue Act *1090 of 1918 limits the amount which petitioner may include in its invested capital and that since the lease was acquired subsequent to March 1, 1913, cost is the proper basis for determining the deduction for exhaustion. The pleadings raise no question as to the life of the lease, and counsel on brief have contended that any value determined therefor should be exhausted over a 30-year life.
We have found as a fact that the leasehold when acquired had a value of not less than $153,051.86, so that the next question to determine is whether this amount may be included in invested capital. Respondent has computed invested capital by allowing a value for the lease of $53,051.86, and he asserts that*2461 section 331 limits the petitioner to this value. Section 331 of the Revenue Act of 1918 provides as follows:
In the case of the reorganization, consolidation, or change of ownership of a trade or business, or change of ownership of property, after March 3, 1917, if an interest or control in such trade or business or property of 50 per centum or more remains in the same persons, or any of them, then no asset transferred or received from the previous owner shall, for the purpose of determining invested capital, be allowed a greater value than would have been allowed under this title in computing the invested capital of such previous owner if such asset had not been so transferred or received: Provided, that if such previous owner was not a corporation, then the value of any asset so transferred or received shall be taken at its cost of acquisition (at the date when acquired by such previous owner) with proper allowance for depreciation, impairment, betterment or development, but no addition to the original cost shall be made for any charge or expenditure deducted as expense or otherwise on or after March 1, 1913, in computing the net income of such previous owner for purposes*2462 of taxation.
The transfer to petitioner occurred after March 3, 1917, and, since by the ownership of a majority of the voting stock of the petitioner an interest or control in the lease of more than 50 per centum remained in the same persons, the above quoted section is applicable, and the respondent's determination on this point is approved. .
The second issue relates to the deduction for exhaustion of the lease on the Sugar Street dock. Under the provisions of section 234(a)(7) of the Revenue Act of 1918 the deduction for exhaustion, wear and tear of property allowed to a taxpayer in the case of property acquired subsequent to March 1, 1913, is computed on the basis of cost. . As the petitioner acquired the lease subsequent to November 1, 1913, the question to be determined is the amount to be recognized as its cost. The cost of an asset to a corporation when it is acquired for its capital stock is the fair market value of the stock issued therefor, and in a number of cases, where practically only one asset was owned by the corporation, and that was acquired by the*2463 issuance of capital stock we have taken the fair market value of the asset at the date of acquisition as *1091 the basis for exhaustion. ; . Such basis was used on the theory that the fair market value of the asset reflected the fair market value of the stock.
In the instant case the petitioner introduced evidence to establish the fair market value of the lease at the date of acquisition, and we are satisfied from such evidence that the lease had the value contended for. In the absence of sales of the petitioner's stock at or near the date of organization, there are other factors which must be considered in determining the fair market value of the stock. In addition to the lease, the petitioner acquired from the River Sand Co. assets having a depreciated cost as of June 1, 1919, of $46,948.14. It acquired from the Mitchell Builders Supply Co. for 1,100 shares of its capital stock, the assets of that company. No evidence was introduced as to the nature or value of those assets. It is therefore impossible to determine the fair market value of the stock at the date of its issuance*2464 for the assets or that the cost of the lease was in excess of the amount allowed by the respondent. The respondent's determination of the exhaustion thereon for the taxable year is accordingly approved.
Judgment will be entered for the respondent.