*4295 Average unit value of petitioner's interest in standing timber at March 1, 1913, determined for depletion purposes.
*1111 In this proceeding petitioner seeks a redetermination of the income and profits taxes for the years 1919 to 1921, inclusive, for which the Commissioner has determined deficiencies of $9,350.63, $33,337.85, and $1,410.88, respectively. The petitioner alleges error on the part of the Commissioner:
(1) In determining inadequate amounts for depreciation and obsolescence;
(2) In determining inadequate amounts as deductions for depletion of standing timber;
(3) In increasing net income in the year 1919 by $1,253.90 by disallowing said amount as a deduction for bad debts; and
(4) In disallowing a portion of the loss claimed on a sale of sawmill machinery in the year 1920.
In accordance with a stipulation of the parties which the Board accepts, issues (1), (3), and (4) have been settled by the following determinations:
*1112 (1) The deduction for depreciation*4296 of railroad equipment for the years in question is as follows:
| 1919 | $62,842.04 |
| 1920 | 85,723.08 |
| 1921 | 41,135.14 |
These deductions are computed on a unit rate of $2,245 per thousand feet of timber cut during each of the respective years. The basis for computing the rate is the economic life of the railway construction.
(2) The determination of depreciation and obsolescence on all other items as determined by the Commissioner is correct.
(3) The amount of $1,253.90 was incorrectly added to the petitioner's net income and is an allowable deduction therefrom.
(4) The loss sustained on the sale of sawmill machinery in the year 1920, as determined by the Commissioner, is correct.
FINDINGS OF FACT.
The petitioner is a State of Washington corporation, with its principal office at Seattle. Its business is the ownership of timber and timber lands and the manufacture and marketing of the products thereof.
In 1907 the petitioner purchased certain lands, timber, timber rights and plant and equipment for a consideration of $2,000,000, payable as follows: $1,200,000 cash; $405,451.53 notes with 6 per cent interest; $300,000 cash; $94,548.47 payable without interest*4297 as timber is cut. Of this amount, $50,000 was allocated to the sawmill and other personal property.
At the time of purchase a cruise of the standing timber in which petitioner acquired an interest showed a quantity of 663,839,000 feet. Between that date and March 1, 1913, there was cut from the property 89,591,000 feet, and it was determined from the experience gained in cutting this timber that there remained merchantable timber uncut at March 1, 1913, amounting to 388,654,000 feet. From March 1, 1913, the amount of timber cut each year was as follows:
| Feet | |
| 1913 | 16,657,000 |
| 1914 | 502,000 |
| 1915 | none |
| 1916 | 15,463,000 |
| 1917 | 9,471,000 |
| 1918 | 23,317,000 |
| 1919 | 27,992,000 |
| 1920 | 38,184,000 |
| 1921 | 18,323,000 |
| 1922 | 44,068,000 |
| 1923 | 41,147,000 |
| 1924 | 41,347,000 |
| 1925 | 33,099,000 |
| 1926 | 23,433,000 |
All the property acquired by the petitioner and owned by it at March 1, 1913, was located in the County of King, State of Washington, about 35 miles from the City of Seattle, and was traversed by *1113 the main line of the Northern Pacific Railway. It consisted of the fee of 960 acres of lands, the right to cut and remove timber from 1,680 acres of land in*4298 conformity with contracts acquired from the vendor, and the right to cut and remove the timber from 6,480 acres of land owned by the Northern Pacific Railway. The topography of the terrain involved is normal for the Cascade mountain country. The stand of timber averaged between 70,000 and 80,000 board measure feet per acre, which is about double the average stand of similar timber on other lands tributary to the Puget Sound market.
By the terms of the contract under which the petitioner acquired the right to all the merchantable timber from 6,480 acres of land owned by the Northern Pacific Railway it agreed to pay 70 cents per thousand feet as this timber was cut and further agreed to deliver to the railroad company for transportation at least 20,000,000 feet of logs or the manufactured product thereof each year until all of the merchantable timber had been removed from the railroad company's lands and the lands of the petitioner tributary to the railroad, and also agreed to ship all tools, materials, and supplies required by it and all manufactured products over the lines of the railroad company and pay freight at the regular tariff rates of the railroad company. The railroad*4299 company agreed to ship all logs cut by the petitioner from the lands owned by the railroad company or from its own lands or the lands of the Northwestern Improvement Co. from certain specified points to Seattle or Tacoma, at a charge of $1.50 per thousand feet board measure.
At March 1, 1913, the petitioner's timber averaged 62 per cent fir, 18 per cent cedar, 4 per cent spruce and 16 per cent hemlock. Fir, cedar, and spruce are considerably more valuable than hemlock. The fir, cedar, and spruce owned by the petitioner was of higher quality than that on any other land tributary to the Puget Sound market and logs produced therefrom sold readily on such market at premiums that averaged $2 per 1,000 board measure feet. About 75 per cent of the logs produced cut into clear grade of timber. The price of timber on the Puget Sound market averages not less than $1 per 1,000 board measure feet above prices for similar timber sold in the Columbia River market. Between the date of acquisition and March 1, 1913, the timber here involved increased in average value from 50 to 75 cents per 1,000 board measure feet. The average value of the several species of standing timber in question at*4300 March 1, 1913, was $4.75 per 1,000 board measure feet and the average value of the petitioner's interest therein was $4.15 per 1,000 board measure feet.
OPINION
LANSDON: Issues 1, 3, and 4, as set forth in our preliminary statement, having been settled by a stipulation of the parties which we *1114 have accepted, the only matter left for our consideration is the correct amount of annual deductions from its gross income for each of the taxable years to which the petitioner is entitled for depletion of its timber reserves due to its annual logging operations. The parties have stipulated the quantities of timber cut in each of the taxable years and it remains only for us to determine the basis for the computation of depletion for each of such years.
The respondent and petitioner are in substantial agreement that the timber lands and timber rights in question were acquired in 1907 at a cost of $1,950,000, the mill and other depreciable assets at a cost of $50,000, and that the land so acquired had no value. The respondent determined the deficiencies here in controversy on the basis of a value at March 1, 1913, which is less than cost and in support of such action relies*4301 on the provisions of section 234(a)(9) of the Revenue Acts of 1918 and 1921, which are as follow:
(a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * *
(9) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case, based upon cost including cost of development not otherwise deducted: Provided, That in the case of such properties acquired prior to March 1, 1913, the fair market value of the property (or the taxpayer's interest therein) on that date shall be taken in lieu of cost up to that date: * * *
The petitioner contends, first, that the market value of its timber at March 1, 1913, was greater than cost, and, second, that if we should find that the value at the basic date was less than cost, it is entitled to have its annual depletion deductions determined on the basis of cost. We shall first consider the petitioner's contention that at March 1, 1913, the average unit value of its timber was in excess of the cost thereof.
In support of its*4302 contention of value greater than cost the petitioner adduced evidence upon which we have found as fact that its timber was of a higher quality than the average in the Puget Sound district; that logs produced therefrom sold at premiums that averaged $2 per 1,000 board measure feet; that it was located on the main line of a railway and was distant only 35 miles from market; that the timber stand per acre averaged nearly double that of the district tributary to the Puget Sound market; that all but 16 per cent of the timber stand consisted of the most valuable species found in that territory; that about 75 per cent of the fir, spruce and cedar cut into the better grades of lumber; that the prices for the products of the petitioner averaged $1 more per 1,000 board measure feet on the Puget Sound lumber market than were paid for similar grades of lumber in the *1115 Columbia River market; and that between 1907 and 1913 stumpage in the Puget Sound district increased in value from 50 to 75 cents per 1,000 board measure feet.
In further support of its contention, the petitioner introduced a number of experienced lumber and timber operators as expert witnesses. All were familiar with*4303 lumbering conditions in the State of Washington, well acquainted with the tract and timber in question and conversant with the processes of logging, manufacturing and marketing timber. The expert opinions of value of the petioner's timber at March 1, 1913, varied from $4.75 to $5.25 per 1,000 board measure feet.
The respondent proved some sales of alleged similar timber lands at prices that support his contention of an average unit value of $3.25 at March 1, 1913. Upon cross-examination it appeared, however, that such sales were of small and isolated tracts and that the prices obtained were not a fair measure of the value of large timber areas easily accessible for logging and located on lines of transportation to nearby markets. In his brief, counsel for the respondent calls attention to the weakness of opinion evidence, although it is obvious that his determination of these deficiencies and the record that he made at the hearing rest almost entirely on such evidence.
A careful study of all the evidence adduced by the parties convinces us that the petitioner has sustained the burden of proving that the average unit value of the standing timber in which it owned an interest*4304 at March 1, 1913, was greater than cost and was $4.75 per 1,000 board measure feet. Inasmuch as the record discloses that approximately 72 per cent of such timber was subject to a royalty charge of 70 cents per 1,000 board measure feet, it is obvious that the total value and the corresponding unit value of all the timber in question must be reduced by the amount of such royalty charge before the value of the petitioner's interest therein can be ascertained.
The evidence shows that the petitioner owned 960 acres of the tract in question in fee, the right to cut and remove without further payment all the timber on 1.680 acres owned by various persons, and the right to cut and remove all the timber on 6,840 acres owned by the Northern Pacific Railway subject to a royalty charge of 70 cents per 1,000 board measure feet. It is also established by proof that the average stand of timber throughout the tract was uniform. We conclude that the royalty due the Northern Pacific Railway for cutting the timber on its lands, if applied to the entire tract, would result in an average charge of 60 cents per 1,000 board measure feet. We are of the opinion, therefore, that the average unit value*4305 of the petitioner's interest in the standing timber in question at March 1, 1913, was $4.15 per 1,000 board measure feet, which we hold is a reasonable basis for the computation of the annual deduction from gross income *1116 to which the petitioner is entitled on account of depletion. Cf. ; .
In addition to the royalty charge of 70 cents per 1,000 board measure feet, the Northern Pacific contract imposes a considerable body of obligations on each of the parties thereto. We assume that their reciprocal undertakings were mutually advantageous and so have no bearing on the value of the timber. Since the parties are in substantial agreement that the land owned by the petitioner has no market value after the removal of the timber we do not regard such land as a factor in determining the reasonable deductions for depletion to which the petitioner is entitled. A part of the purchase price of the property in the amount of $94,548.47 was payable without interest as the timber was cut. We regard this amount as part of the original capital investment and not as a royalty*4306 charge. It is not a factor in the determination of the value of the petitioner's interest in the standing timber at March 1, 1913. Having decided that the March 1, 1913, value of the petitioner's interest in the standing timber was greater than cost thereof, it is not necessary to decide the question of law upon which the parties disagree.
Judgment will be entered on 20 days' notice, under Rule 50.
Considered by STERNHAGEN, GREEN, and ARUNDELL.