*3115 1. Held, that the petitioner is not entitled to a deduction for obsolescence for intangible assets, including good will.
2. Where prior to enactment of war-time and permanent prohibition the petitioner had been engaged in the manufacture and sale of beer and "near beer" and after October 28, 1919, ceased to manufacture and sell beer but continued to make and sell "near beer," using the same machinery and process as had been previously used in the manufacture of beer with the exception of dealcoholization before bottling, held, that the petitioner is not entitled to a deduction for obsolescence on such property.
3. Evidence held insufficient to determine the amount of obsolescence sustained by the petitioner as a result of having abandoned the lower floor of one of its buildings as a result of having ceased to make beer.
4. Losses claimed as a result of the decrease in value of tangible assets continued in use denied.
*1040 This is a proceeding for the redetermination of deficiencies in income*3116 and profits taxes of $20,975.05 for 1918 and income tax of $5,013.65 for 1919. The deficiencies result principally from the respondent's having disallowed for 1918 a deduction of $110,047.52 and for 1919 a deduction of $57,139.99. The deductions were taken by the petitioner in its returns for the respective years as obsolescence on tangible assets resulting from the enactment of war-time prohibition legislation and the ratification of the Eighteenth Amendment. It was admitted by the respondent at the hearing that he had failed to allow as a deduction an amount of $5,000 representing a part of a loss sustained on the sale of certain property in 1918. From the pleadings, a stipulation, documentary evidence and depositions, we make the following -
FINDINGS OF FACT.
The petitioner, a New York corporation, was organized February 26, 1902, and had its office and place of business at Niagara Falls.
The business of the petitioner prior to the incidence of the Eighteenth Amendment to the Constitution of the United States and the Acts of Congress in the enforcement thereof, was the manufacture, production, distribution and sale of a malt and spirituous *1041 liquor known as*3117 beer, containing more than one-half of one per cent of alcohol by volume. The petitioner's business and good will were created by the manufacture and sale of such beverage. In 1902 the petitioner purchased the buildings and equipment of the Niagara Falls Brewing Co., a joint stock association existing in Niagara Falls, N.Y., and assumed the current liabilities of the association.
The petitioner thereafter constructed some new buildings and purchased and installed some additional machinery, fixtures and equipment, all of which were specially constructed, designed or adapted to the petitioner's business of manufacturing beer, and were not available or practicably or readily adaptable to other uses. This property and equipment were devoted solely to the business of the petitioner in making beer and "Pep" beer, containing less than one-half of one per cent of alcohol by volume prior to the incidence of war-time prohibition and the Eighteenth Amendment and the statutes in enforcement thereof.
About July 1, 1918, the petitioner commenced the manufacture of soft drinks in a separate building, with machinery distinct from that used in the manufacture of beer or cereal beverages and*3118 which was carried in a separate account on petitioner's books.
The making and sale of beer and malt and spirituous liquors was discontinued because of the incidence of the Eighteenth Amendment and the statutes in enforcement thereof, but the making and sale of soft drinks and of beer of an alcoholic content of less than one-half of one per cent continued after the incidence of such amendment and statutes. Petitioner continued to make "near beer" after it had discontinued the manufacture of beer, in order to see if the plant could be made to pay by making this product, and also to keep the plant in action and save the machinery.
No part of the obsolescence or extraordinary depreciation taken by the petitioner for the years in question was computed upon or taken on account of the depreciation of buildings, machinery and equipment used for the manufacture of soft drinks other than dealcoholized beer.
The investment in equipment for the manufacture of soft drinks other than dealcoholized beer, and the depreciation accrued thereon were as follows:
| Year | Investment | Depreciation |
| 1918 | $5,033.09 | |
| 1919 | 8,175.98 | $553.31 |
| 1920 | 9,027.54 | 1,448.49 |
| 1921 | 9,200.79 | 1,448.49 |
*3119 The buildings, machinery and equipment for the manufacture of beer and malt and spirituous liquors were acquired for the most *1042 part prior to March 1, 1913, and the cost, accrued depreciation, and depreciated cost thereof on March 1, 1913, were:
| Cost | Accrued depreciation | Depreciated cost | |
| Land | $100,000.00 | $100,000.00 | |
| Buildings | 196,667.97 | $48,475.79 | 148,192.18 |
| Machinery | 71,769.68 | 11,111.33 | 60,658.35 |
| Casks and tanks | 27,643.00 | 6,668.54 | 20,974.46 |
| Horses, wagons, etc | 8,988.50 | 948.87 | 8,039.63 |
| Office furniture and fixtures | 2,238.90 | 302.25 | 1,936.65 |
| Auto trucks | 4,900.00 | 703.00 | 4,197.00 |
| Signs | 500.00 | 125.00 | 375.00 |
| Small cooperage | 2,576.50 | 2,576.50 | |
| Saloon furniture and fixtures | 22,852.06 | 6,961.52 | 15,890.54 |
| Outside property | 38,128.55 | 38,128.55 | |
| Total | 476,265.16 | 75,296.30 | 400,968.86 |
On March 1, 1913, the plant and buildings had a value equal to the amount at which they were set up on the books.
The cost, accrued depreciation and depreciated cost of the buildings, machinery and equipment on December 31, 1917, were as follows:
| Cost | Accrued depreciation | Depreciated cost | |
| Land | $100,000.00 | $100,000.00 | |
| Buildings | 229,999.32 | $80,851.25 | 149,148.07 |
| Machinery | 117,618.07 | 23,524.58 | 94,093.49 |
| Casks and tanks | 40,399.35 | 7,855.76 | 32,543.59 |
| Horses, wagons, etc | 8,643.50 | 1,391.76 | 7,251.74 |
| Office furniture and fixtures | 3,091.24 | 878.50 | 2,212.74 |
| Auto trucks | 13,073.94 | 5,934.10 | 7,139.84 |
| Small cooperage | 18,497.78 | 17,595.56 | 902.22 |
| Saloon furniture and fixtures | 27,758.14 | 19,414.98 | 8,343.16 |
| Outside property | 76,719.59 | 1,299.84 | 75,419.75 |
| Total | 635,800.93 | 158,746.33 | 477,054.60 |
*3120 At the end of 1917 petitioner's buildings and machinery had a value fully equal to that at which they were carried on its books.
The book cost and net depreciated book cost of the fixed assets of the petitioner at December 31, 1918, and December 31, 1919, were:
| Dec. 31, 1918 | Dec. 31, 1919 | |||
| Book cost | Net depreciated cost | Book cost | Net depreciated cost | |
| Land | $100,000.00 | $100,000.00 | $100,000.00 | $100,000.00 |
| Buildings | 229,999.32 | 108,057.31 | 229,999.32 | 63,008.03 |
| Machinery: | ||||
| Beer | 131,675.21 | 32,500.00 | 134,542.63 | 19,966.71 |
| Soft drink | 4,533.09 | 4,533.09 | 7,400.18 | 6,946.87 |
| Casks and tanks | 40,399.35 | 5,000.00 | 40,399.35 | 2,000.00 |
| Horses, wagons, etc | 8,638.50 | 1,000.00 | 8,570.50 | 932.00 |
| Office furniture and fixtures | 3,101.74 | 600.00 | 3,173.87 | 400.00 |
| Auto trucks: | ||||
| Beer | 15,283.85 | 3,000.00 | 15,568.60 | 3,284.75 |
| Soft drink | 500.00 | 500.00 | 775.80 | 675.80 |
| Small cooperage | 2,632.71 | 500.00 | 2,232.71 | 100.00 |
| Saloon furniture and fixtures | 28,383.06 | 100.00 | 28,733.06 | 0 |
| Outside property | 38,128.55 | 38,128.55 | 38,147.27 | 32,500.00 |
| Total | 603,275.38 | 293,918.95 | 609,543.29 | 229,814.16 |
*1043 The above items of cost, accrued*3121 depreciation, nd depreciated cost were determined by the respondent and accepted by the petitioner. In determining the depreciated cost there has been used a rate of depreciation fixed by the respondent.
During 1917 and 1918 the petitioner's officers and directors were aware, through brewers' associations and other agencies, of the enactment of state and national legislation affecting its business as well as of the proposal and progress toward ratification of the Eighteenth Amendment. At different times during these years recently enacted or pending legislation regarding the brewing of malted liquors and the future prospects of the business as well as the future of the petitioner were discussed or considered by the executive committee of the board of directors, the board of directors, and the stockholders.
The board of directors of the petitioner at a meeting held November 26, 1918, authorized the president and auditor of the company to investigate and make a report on the question of lawful depreciation to be taken on the plant, property and equipment of the company, in view of the pending prohibition legislation, in an amount which in the judgment of the president and auditor*3122 was just, lawful and proper.
The charges against earnings for the year 1918 for depreciation and obsolescence as recorded on the petitioner's books and deducted in its return for that year were as follows:
| Regular depreciation | Obsolescence | |
| Buildings | $4,597.63 | $27,014.33 |
| Machinery | 5,389.93 | 59,430.22 |
| Casks and tanks | 2,019.81 | 16,912.87 |
| Horses, wagons, etc | 862.98 | 1,268.56 |
| Office furniture and fixtures | 152.48 | 532.42 |
| Autos and trucks | $2,611.26 | $2,204.40 |
| Small cooperage | 650.00 | 2,132.71 |
| Saloon furniture and fixtures | 833.21 | 522.01 |
| Total | 17,117.30 | 110,047.52 |
The amount of the deduction for obsolescence was determined after discussions between the president, secretary, auditor, and brewmaster of the petitioner and after they had made surveys of the plant and machinery. The obsolescence taken was only on property that had been used to brew beer. The deduction for obsolescence represented the amount necessary to be written off the assets to bring them down to an amount which the petitioner's directors thought could be realized on them at a forced or liquidaion sale after the imminent prohibition legislation should become effective. The amount*3123 of the deduction taken was determined after inquiries by the president of the petitioner as to what the brewing machinery would bring in the case of prohibition. The deductions for depreciation and obsolescence were approved by the board of directors on February 5, 1919, and by the stockholders of the petitioner on February 11, 1919.
*1044 During 1919 in addition to regular depreciation there were written off on petitioner's books additional amounts for obsolescence of property for which deductions for obsolescence had been taken for the prior year. The amounts written off in 1919 were based, among other things, on the fact that the assets of a similarly situated brewing company at Niagara Falls which had taken greater deductions for obsolescence than the petitioner had been sold in 1919 for only a fractional part of the amount at which the assets remained on the books. Other considerations were that the petitioner had to curtail the brewing of beer considerably more than theretofore, and that in the event that it attempted to dispose of its machinery it would not find any market because of so much of that kind of machinery being offered for sale.
The charges against*3124 earnings of the year 1919 for depreciation and obsolescene as recorded on the books of the petitioner and deducted in its return for that year were:
| Regular depreciation | Obsolescence | |
| Buildings | 5,049.28 | $40,000.00 |
| Machinery | 5,854.02 | 10,000.00 |
| Casks and tanks | 2,071.52 | 928.48 |
| Office furniture and fixtures | 157.89 | 114.24 |
| Auto trucks | 100.00 | 0 |
| Small cooperate | $400.00 | 0 |
| Saloon furniture and fixtures | 0 | $450.00 |
| Outside property | 0 | 5,647.27 |
| Total | 13,632.71 | 57,139.99 |
In a determination of the deficiencies herein involved the respondent disallowed the deductions taken by the petitioner for obsolescence and allowed deductions for depreciation and losses as follows:
| Claimed on original return | Allowed by respondent | Difference | |
| 1918 | |||
| Regular depreciation | $17,117.30 | $20,552.05 | $+3,434.75 |
| Obsolescence | 110,047.52 | -110,047.52 | |
| Loss, casks and tanks | 18,210.16 | +18,210.16 | |
| 127,164.82 | 38,762.21 | -88,402.61 | |
| 1919 | |||
| Regular depreciation | 13,632.71 | 20,983.05 | +7,350.34 |
| Obsolescence | 57,139.99 | -57,139.99 | |
| 70,772.70 | 20,983.05 | -49,789.65 |
The petitioner gave up and abandoned the manufacture and sale of beer in 1919*3125 on account of the restrictions imposed by statute.
The petitioner's officers considdered selling or converting its buildings and machinery into a plant for a dairy, cold storage, ice cream manufacturing, dry storage, ice manufacturing, fruit storage, semicold storage, machine shop and chemical plant. The president of the petitioner, who was familiar with the use of buildings for industrial *1045 purposes, could find no use for the buildings and machinery except for the purpose of brewing beer or making cereal beverages. Because of the buildings being damp, the floor levels uneven, and there being no elevators and but few openings for light, they were not readily adaptable for storage, manufacturing or industrial purposes.
The buildings were zoned under the city zoning law in an industrial or manufacturing zone.
Much of the brewing machinery could not be removed from the buildings without tearing out the walls of the buildings or dismantling the machinery, and some of the machinery could not be dismantled to the extent that it could be removed without tearing out a side of the building.
Sales of the petitioner's products for the years 1912 to 1921, inclusive, were*3126 as follows:
| Barrels | |||
| Beer | Cereal beverage | Soft drinks | |
| 1912 | 33,177 | ||
| 1913 | 37,581 | ||
| 1914 | 32,756 | ||
| 1915 | 30,681 | ||
| 1916 | 38,388 | ||
| 1917 | 37,196 | 16 | |
| 1918 | 30,204 | 327 | $6,092.35 |
| 1919 | 17,823 | 8 | 22,451.35 |
| 1920 | 0 | 7,921 | 21,507.43 |
| 1921 | 0 | 2,852 | 15,343.77 |
The sale of beer was discontinued October 29, 1919. The first sale of cereal beverage, dealcoholized beer, was November 27, 1917, under he name of "Pep." The first sale of soft drinks was July 1, 1918. After the Eighteenth Amendment became effective the petitioner's sales of soft drinks and "near beer" declined, although the petitioner used as great effort to sell "near beer" and soft drinks as it had done theretofore.
Up to the time of the hearing, the petitioner had used its best efforts to sell the premises and the highest offer was $35,000 cash, made by the president of a paper company which owns the adjoining premises. About December 27, 1921, the petitioner sold to the paper company whose premises adjoined those of the petitioner 1.39 acres of the 3.53 acres of its land for $20,000. The land, which was sold free of buildings, had a frontage of 197 feet and depth varying from 282 to 334 feet.
*3127 The petitioner's lands, buildings, machinery and equipment were at all times mentioned herein owned by it absolutely and without encumbrances.
*1046 The value of the property of the petitioner as determined by the city assessor of Niagara Falls for the assessment of property tax for the years indicated was as follows:
| Land value, exclusive of buildings | Full value of property less exemption, if any | |
| 1917 | $47,900 | $223,460 |
| 1918 | 47,990 | 223,460 |
| 1919 | 47,990 | 183,460 |
| 1920 | 29,360 | 164,830 |
| (18,630) | (18,630) | |
| 1921 | $29,360 | $129,760 |
| (18,630) | (18,630) | |
| 1924 | 29,360 | 104,760 |
| (18,630) | (18,630) |
The amounts shown in parenthesis for the years 1920, 1921, and 1924 represent the values placed by the assessor on the property sold by the petitioner in 1921 to the paper company.
The reduction in the values for the years 1919, 1921, and 1923 was made by the city assessor because the petitioner's buildings which had been constructed and used for brewing beer could no longer be used for that purpose on account of prohibition and because of the unsuitableness of the buildings for manufacturing purposes. Assessments on nonbrewery property generally*3128 were increased during the same period.
The reductioin in the value was not made entirely prior to the year 1923 for the reason that prior thereto the city assessor had not as thoroughly gone into the question of the value of the property as he had at that time.
When the petitioner ceased manufacturing beer on October 28, 1919, it abandoned the lower floor, consisting of storage space in a building on its premises designated in the evidence as Building No. 4. The space so abandoned had been used for the storage and aging of beer, but its use was not required in making the beverage containing less than one-half of one per cent of alcohol by volume. The cost of Building No. 4 to December 31, 1917, was $67,913.74, and the depreciation accrued to that date was $23,875.37, making a depreciated cost of $44,038.37. The cost of Building No. 4 to March 1, 1913, was $67,913.74, and depreciation accrued to that date amounted to $16,538.70, making a depreciated cost of $51,375.04.
One of the petitioner's buildings, designated in the evidence as Building No. 3, was divided into two parts - easterly and westerly. About 1917, the petitioner rebuilt the inside of the easterly part of the*3129 building and installed a storage cellar and new filtering and bottling machinery. The cost of Building No. 3 to December 31, 1917, was $70,938.89, and the depreciation accrued to that date was $24,934.52, leaving a depreciated cost of $46,004.37. The cost of Building No. 3 to March 1, 1913, was $53,083.13, and the depreciation accrued to that date was $13,088.46, leaving a depreciated cost of $39,994.67. *1047 The cost to December 31, 1917, of the machinery in Building No. 3 was $27,453.09, and the depreciated cost at that date was $24,707.79. After October 28, 1919, and until about January, 1922, the easterly part of Building No. 3, with the equipment therein, was used about once every two weeks in making "near beer" or cereal beverage, and aside from this it was not used for any other purpose. Prior to October 28 1919, the easterly part of the building and the equipment therein were used about three or four times a week in making and bottling beer.
Inasmuch as the petitioner could not operate its business at a profit after prohibition, it dissolved under voluntary consent of the stockholders by certificate to such effect filed with the Secretary of State of the State*3130 of New York on December 1, 1921, its affairs in dissolution being administered by its directors as trustees in dissolution.
Under a lease dated January 31, 1922, and effective from January 15, 1922, the petitioner leased all its buildings, plant, and equipment, including its soft-drink equipment, under a lease running for a period of three months renewable at three-month intervals at the option of the lessee, and this lease at the time of the hearing was still in operation at an annual rental of $5,000, plus taxes, insurance, and repairs. This was the highest and only rental offered at any time to officers and agents of the petitioner for the property. The lessee was not a stockholder or director of the petitioner and had no financial connection with the petitioner at the time the lease was made. Although he was never a stockholder of the petitioner, he formerly had been its secretary, resigning in February, 1922, and a number of years prior thereto had been a director for one year.
The value of petitioner's machinery in 1918 and 1919 after prohibition became reasonably certain was not in excess of $10,475, which was less than its book value either on December 31, 1918, or*3131 December 31, 1919, after deducting the amounts for obsolescence taken by the petitioner for the respective years.
At the end of 1918 and 1919, the petitioner's land had a value of about $46,000, whereas the buildings had a value of about $34,000. The value of the land and buildings at the end of the respective years was less than their book value after deducting for obsolescence the amounts taken by the petitioner for these years in its returns.
The difference between the value in 1918 and 1919 and depreciated cost of petitioner's machinery, buildings and land at December 31, 1917, was due to the imminence and incidence of war-time and permanent prohibition legislation. There was no material change in the value of land and buildings in the vicinity of those of the petitioner used for purposes other than brewing.
*1048 In making the cereal beverage containing less than one-half of one per cent of alcohol by volume manufactured and sold by the petitioner after October 28, 1919, the same machinery and the same process, except the dealcoholizing before bottling, was used as had been used in making beer. This cereal beverage had the same appearance as the beer manufactured*3132 by the petitioner prior to October 28, 1919, but did not resemble it in taste, nor did it have the same popularity.
In 1918, the petitioner sold certain property located at Main and Niagara Streets, Niagara Falls, N.Y., and the loss determined by the respondent was understated by $5,000 due to the respondent in his computation having overstated the amount of depreciation previously taken.
OPINION.
TRAMMELL: The errors assigned in the original petition were that the respondent failed to allow the petitioner as deductions in computing its net income, (1) "a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business of the taxpayer, including a reasonable allowance for obsolescence;" (2) "losses sustained during the taxable year and not compensated for by insurance or otherwise incurred in the trade or business of the taxpayer."
With respect to the first assignment of error, it does not appear from the record that there is any controversy concerning deductions for the exhaustion, wear and tear of the property, but only as to the allowance of deductions for obsolescence.
In its brief the petitioner states that the contention for an allowance*3133 of a deduction on account of the obsolescence of intangible assets, including good will, is not pressed in view of the Board's decisions following the case of Red Wing Malting Co. v. Willcuts, 15 Fed.(2d) 626. In view of the petitioner's statement and of our holding in Manhattan Brewing Co.,6 B.T.A. 952">6 B.T.A. 952, we must hold that the petitioner is not entitled to a deduction for either year on account of obsolescence of intangible property including good will. With respect to the assignment of error relating to obsolescence there remains to be considered the question of whether the petitioner is entitled to the deductions taken by it for obsolescence of tangible property as set out in our findings of fact.
Prior to September 5, 1917, the petitioner's business was the manufacture, production, sale and distribution of beer containing more than one-half of one per cent of alcohol by volume. In November, 1917, the petitioner began to make and sell dealcoholized or "near beer." About the first of July, 1918, it began making and selling soft drinks. Since obsolescence is not claimed on assets used in the *1049 manufacture of soft drinks, no further*3134 consideration will be given to these. The petitioner continued to manufacture and sell these three products until October 28, 1919, when on account of wartime and permanent prohibition legislation and the ratification of the Eighteenth Amendment it ceased to manufacture beer. The petitioner continued until about the time of its dissolution in December, 1921, to manufacture and sell dealcoholized or "near beer," using the same machinery and the same process that were used in the manufacture of beer, with the exception of dealcoholization before bottling. Immediately after dissolution the petitioner's plant was rented to a former officer and continued in use for making "near beer." The assets used in the manufacture and sale of beer were continued in use in the manufacture of "near beer," except that the lower floor of Building No. 4 was no longer used. In manufacturing "near beer" the easterly part of Building No. 3, with the equipment therein, was used less frequently than in manufacturing beer.
We have heretofore considered the question of the allowance of deductions for obsolescence of tangible assets due to prohibition legislation where the assets were continued in use after*3135 prohibition became effective and have denied such deductions. Yough Brewing Co.,4 B.T.A. 612">4 B.T.A. 612; Star Brewing Co.,7 B.T.A. 377">7 B.T.A. 377. We think our decisions in those cases are applicable and controlling here.
With respect to Building No. 4, the petitioner contends that since in 1919 it abandoned the lower floor therein, it is entitled to a deduction for obsolescence of at least $17,125.01, representing one-third of the depreciated cost of the building on March 1, 1913, of $51,375.04. If we were disposed to hold that obsolescence were allowable on account of abandonment of a part of a building, we do not have sufficient evidence to determine whether the amount contended for by the petitioner is correct or what the allowance should be. The contention, therefore, must be denied.
The petitioner also contends that on account of the reduced use of the machinery in Building No. 3 as well as the reduced use of the building itself from an average of four times a week to once every two weeks after it had ceased making beer, it is entitled to a deduction of obsolescence of $59,398.22. The petitioner determines this amount by taking 84 per cen of $70,712.16, *3136 which was the total of the depreciated cost of $46,004.39 of the building and $24,707.79 of the machinery at December 31, 1917. This contention must be denied, in view of our holding that a deduction may not be taken for obsolescence where the assets were continued in use in the business.
The second error assigned in the original petition is that the respondent failed to allow deductions for losses sustained during the *1050 taxable year and not compensated for by insurance or otherwise incurred in the trade or business of the petitioner. With the exception of a loss to be considered presently, we are unable to tell from the record what losses if any this assignment of error relates to unless the petitioner intended to raise the issue that if the deductions taken for obsolescence on tangible property are not allowable as obsolescence, then the petitioner is entitled to deduct as losses the amounts representing the decline in value of property resulting from prohibition legislation. While the evidence shows that the value of the petitioner's assets during the years involved in this proceeding experienced a great decline on account of prohibition legislation, yet they were*3137 continued in use during succeeding years. In George Wiedemann Brewing Co.,9 B.T.A. 792">9 B.T.A. 792, we had occasion to consider the question of the allowance as losses of deductions representing decreases in value of assets which were used in subsequent years, and there held that such deductions are not allowable. We think our decision in that case is applicable here.
At the hearing the petitioner amended its petition to allege that the respondent in determining a loss from the sale of certain property in 1918 had understated the amount of the loss by $5,000 as a result of having determined that the petitioner had previously taken depreciation of $5,000 more than it actually had. Inasmuch as the respondent admitted the correctness of the petitioner's allegation, the petitioner is entitled to have its net income reduced by the amount of $5,000.
Judgment will be entered under Rule 50.