*3715 1. The Commissioner's determination, under the provisions of section 331 of the Revenue Act of 1918, of the invested capital of the petitioner, which, in exchange for stock, acquired certain assets from an individual, is approved.
2. Value of a leasehold acquired on January 7, 1918 for stock, determined for the purpose of deductions for exhaustion thereof.
*796 This proceeding is for the redetermination of deficiencies in income and profits taxes for the calendar years 1919 and 1920, in the amounts of $4,997.12 and $3,214.38, respectively. The petitioner alleges that, in determining the deficiencies, the Commissioner erred in the following particulars:
In excluding from invested capital the value of a leasehold for which in January, 1918, $70,000 of capital stock was issued, which amount, it is alleged, represented its value at the time of acquisition.
In disallowing deductions in the amount of $7,000 for each of the years in question, for the exhaustion of the leasehold acquired in January, 1918.
FINDINGS OF FACT.
*3716 The petitioner is an Ohio corporation. It is and was during the years in question engaged in operating a hotel in the City of Akron.
On September 26, 1914, an agreement to lease certain property which is now known as the old part of the Hotel Akron, was entered into between Thomas J. Holden, now deceased, and C. J. *797 Snyder, also now deceased. The lease contract, which was subsequently executed, provided that it was to expire in January, 1925, and also provided for an annual rental of $6,000. No bonus was paid by Holden to Snyder for either the agreement or the lease.
During the spring of 1916, C. J. Snyder was constructing an addition to the Hotel Akron, and at that time entered into an oral agreement with Holden to rent to him the new building or addition when it was completed. On December 28, 1916, there was an agreement executed by Holden and the C. J. Snyder Building Co., providing for the execution of a lease between the parties upon completion of the building at an annual rental of $20,700, payable monthly in installments of $1,725, the term of the lease to extend for ten years from the completion of the building. This agreement to lease, as is shown*3717 by its terms, provided for the execution of a lease between the two parties of property, part of which, the old part of the Hotel Akron, was then occupied by Holden, and part of which, the addition to the hotel, was then under construction. It was also agreed that Holden would surrender his lease on the old part of the Hotel Akron which he had obtained in September, 1914, and would also surrender a lobby on the ground floor of the old building, there being a lobby equally as valuable provided in the addition to the building. No bonus was paid by Holden for the agreement of December 28, 1916.
On September 4, 1917, Holden and the C. J. Snyder Building Co. entered into a lease covering the old building and addition thereto, with the exception of the lobby in the old building, effective September 19, 1917, and providing for an annual rental of $20,700, payable in monthly installments of $1,725. On September 28, 1917, Holden assigned to the C. J. Snyder Building Co. the lease on the old building, acquired in September, 1914.
On November 28, 1917, the petitioner was incorporated with an authorized capital of $100,000 divided into 1,000 shares, each of the par value of $100, and*3718 on December 20, 1917, subscriptions to its capital stock were made by six individuals, among them being Holden. On December 20, 1917, there was a meeting of the directors of the petitioner, at which time there was submitted by Holden a proposition for the sale to petitioner of the fixtures, equipment, stock in trade, lease, etc., and all property of whatever description owned and used by him in connection with the Hotel Akron, being the property under lease to him, for a consideration of 995 shares of the stock of petitioner. On that date a resolution was passed by the board of directors providing, in part:
Whereas it appears that the equipment of said hotel is desirable for the purpose of this company and is reasonably worth the sum of $40,000, and whereas it appears that the lease of said Thomas H. Holden is desirable for *798 the purpose of this company and is reasonably worth the sum of $75,000, and whereas said hotel is a going concern and is doing a good hotel business and that it will be to the interest of this company and all its stockholders to accept this proposition; * * *
The resolution further provided for the acceptance of the proposition and authorized the*3719 officers of the petitioner to accept delivery of the property and to issue the stock to Holden. On January 7, 1918, petitioner's officers were directed to issue to Holden 995 shares of the capital stock, Holden having theretofore transferred the property described in his offer. Thereupon the stock was issued to Holden and the transaction completed.
Before entering into the agreement of December 28, 1916, with Holden, Pierce A. Snyder, who was an officer of the C. J. Snyder Building Co., had received an offer to lease the property covered by that agreement, at a monthly rental of $2,200, or $475 more rental per month than that afterwards provided in the agreement and lease to Holden. However, Holden at that time had a lease on the old part of the building and, consequently, Snyder was unable to accept the higher offer.
During the years 1916 and 1917, rentals in the City of Akron were constantly advancing. The population was increasing rapidly and there was during those years at least a rise of 50 per cent in rentals. The city was growing due to increased business and prices were 'skyrocketing."
During the year 1918 and prior to January 20, 1919, 128 shares of the stock*3720 acquired by Holden were sold at par. In April, 1919, three individuals, two of whom had experience in the hotel business, acquired the entire stock of petitioner. These individuals purchased the stock on the basis of book value after all surplus had been distributed. The amount paid for the stock was par - $100,000. The balance sheet on which the sale was based showed the lease as an asset at $63,000.
Upon audit of the returns for the years in question, the Commissioner excluded from invested capital the value of the leasehold, as set up on petitioner's books, which it had acquired from Holden, and he also disallowed for each of the years in question any deduction for exhaustion of the leasehold so acquired.
OPINION.
LOVE: The petitioner contends and the Commissioner denies that it is entitled to include in its invested capital for the years 1919 and 1920, the value of the lease at an amount equivalent to its value when acquired by Holden, less exhaustion to the beginning of each year. In this connection, it is urged that the lease had a value of *799 $70,000 when acquired by Holden in September, 1917, and the same value when acquired by it.
Assuming for the*3721 moment that the lease had the value claimed at the time it was acquired by petitioner, we are clearly of the opinion that, under the circumstances herein, the petitioner may not include any amount on account thereof in its invested capital.
It is clearly established by the evidence that the lease in question was acquired by Holden without any expenditure therefor. It is further shown that Holden did not give up or relinquish any valuable right when he surrendered the first lease in order to obtain the one under consideration. We must, therefore, agree with the Commissioner that the lease of September, 1917, cost Holden nothing.
Holden, in exchange for the lease and other property, received 955 of the 1,000 shares of petitioner's capital stock. Obviously, therefore, the computation of petitioner's invested capital is subject to the provisions of section 331 of the Revenue Act of 1918, which provides:
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*3722 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 then 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 of taxation. (Italics ours.)
The petitioner being entitled to include in invested capital only the sum representing the cost of the lease to Holden, it follows that, he having paid nothing or having relinquished no valuable right therefor, the petitioner may not include the value of the lease or any amount on account thereof in invested capital for the years in question. The Commissioner's*3723 action in this respect is, therefore, approved.
The petitioner's second contention is that the lease in question had a value at the time of its acquisition of $70,000 and that, as the term thereof was ten years, it is entitled to deduct annually for exhaustion one-tenth of its value, or $7,000. The Commissioner, on the other hand, denies that the petitioner is entitled to deduct for exhaustion of the lease the amount of $7,000 or any other amount.
We come, therefore, to the question as to the value, if any, of the lease at the time it was acquired by the petitioner in exchange for its *800 stock. The record contains a veriety of opinions respecting the value of the lease at the time it was acquired by Holden and at the time it was acquired by the petitioner.
Two witnesses, each in the real estate business in Akron, and each familiar with rentals in Akron during 1916 and 1917, testified that rentals had increased at least 50 per cent during these two years. It was also shown that the city was booming, due to business conditions, and that prices were rapidly rising.
A disinterested qualified real estate dealer, specializing in property in that vicinity, testified*3724 that at the time the lease was acquired by the petitioner, a fair rental for the property or "for the lease as it stands or written" would have been $30,000 a year, or about $10,000 more a year than the rental specified in the lease. Three of the five members of the board of directors who placed a value of $70,000 on the lease, were in the real estate business in Akron. Beginning three months after the acquisition of the lease by petitioner, and throughout 1918, stock of the corporation was sold at par, despite the fact that no dividends had been declared.
After carefully considering all of the evidence presented by the petitioner with respect to the value of the leasehold at the time of its acquisition and giving due consideration to the contention of the Commissioner that the lease was merely given a value in order to absorb the total par value of the stock authorized and that the subsequent sale of stock at par was based on going concern value, we conclude that the lease on January 7, 1918, had an actual cash value of at least $60,000. Accordingly, during the years in question petitioner should be allowed to deduct exhaustion upon the leasehold on the basis of a cost of $60,000*3725 to be prorated over the life of the lease from January 7, 1918.
Judgment will be entered on 15 days' notice, under Rule 50.