*3453 In November, 1916, the petitioner acquired a certain leasehold and issued its capital stock of the par value of $300,000 in payment therefor. Under the evidence, held that the leasehold at the time it was acquired by the petitioner, had a fair market value of $300,000, and that the petitioner is entitled to include said leasehold in its invested capital at $300,000, and to compute the annual allowances for the exhaustion of the leasehold on that basis.
*827 This proceeding is for the redetermination of deficiencies in income and profits taxes asserted by the respondent in the amounts of $2,390.28 for the year 1920, and $10,919.42 for the year 1921. The petitioner alleges that the respondent erred: (1) In excluding from the petitioner's invested capital the amount of $300,000 which the *828 petitioner claims as the cost of a certain leasehold acquired by it in 1917; (2) in computing allowances for depreciation of the petitioner's building at the rate of 2 per cent instead of at the rate of 2 1/2 per cent; (3) in excluding from*3454 the petitioner's invested capital as paid-in surplus for the year 1921 certain amounts paid in to the petitioner by its stockholders.
The petitioner is a corporation organized under the laws of the State of Illinois with its principal office at Chicago.
In the latter part of 1916 one A. H. Woods conceived the idea of obtaining a leasehold and erecting a theatre building at the northwest corner of Randolph Street and Dearborn Street, in the City of Chicago. That property consisted of two pieces, one of which belonged to the Borden Estate and the other to the Wells Estate. The property belonging to the Borden Estate had a frontage of 80 feet on Randolph Street and 90 feet on Dearborn Street, and the property belonging to the Wells Estate adjoined the Borden property on the north and had a frontage of 90 feet on Dearborn Street and a depth of 80 feet. Woods, through his broker, brought this property to the attention of the trustees of the Marshall Field Estate. The broker represented to the Marshall Field trustees that he had a client, a Mr. Woods, who was desirous of obtaining a location for a downtown Chicago theatre, and that he had in contemplation the acquisition of a leasehold*3455 on the property at the northwest corner of Dearborn and Randolph Streets, in Chicago, at that time separately owned in two ownerships, the south half belonging to the Borden Estate and the north half to the Wells Estate. The broker represented that he could get the Borden Estate and the Wells Estate to sell these properties at a reasonable price; that Woods had his capital tied up in the operation of theatres and was seeking to finance his acquisition of the leasehold through the purchase of the fees on this property by the Marshall Field Estate with a ground lease simultaneously to be made to Woods, and that Woods would obligate himself to put a new building on the property. The terms of the offer to take the leasehold involved the payment of a rental which would yield approximately a return of 5 per cent to the Marshall Field Estate on the money that was required to be expended by the estate to acquire the fee to the properties. On that basis a three-cornered deal was entered into whereby the Field Estate agreed to acquire the two parcels of property and at the same time to make a lease of the ground to Woods. The Field Estate was not interested in this property until the proposition*3456 was brought to it by the broker on behalf of Woods.
In November, 1916, the Field Estate acquired the two pieces of property mentioned, paying $607,500 for the Borden property and $450,000 for the Wells property, or $1,057,500 for the two pieces, and *829 at the same time a lease was entered into between the trustees of the Field Estate and A. H. Woods, demising to Woods the two pieces of property for a term of 99 years, beginning on the first day of January, 1917, and ending on the 31st day of December, 2015. The rental reserved by this lease was $45,000 for the first year, $50,000 for the next five years, and $55,000 per year for the remaining 93 years. The lessee covenanted to construct on the leased property a first-class modern, fireproof building suitable for mercantile, hotel, theatre or office purposes, to cost not less than $400,000, and to cover substantially the whole area of the leased premises. It was further agreed that the lessee, upon the deposit of $150,000 in securities with the Field Estate, might tear down and wreck the buildings then standing on the premises. Under the sixth paragraph of the lease the lessee was required immediately to make a deposit*3457 of $100,000 in cash or securities, the remaining $50,000 to be deposited before the old buildings were torn down. The amount of $100,000 was deposited by Woods at the time of the making of the lease.
On December 29, 1916, the petitioner was organized under the laws of the State of Illinois with a capital stock of $500,000 divided into 5,000 shares of the par value of $100 each. On January 10, 1917, Woods assigned to the petitioner the leasehold mentioned, together with cash and securities of the value of $100,000, and the petitioner issued to him therefor 4,000 shares of its capital stock. The remainder of the capital stock of the corporation was issued for cash.
A ten-story office and theatre building was erected by the petitioner on the leased property and a bond issue of $400,000 was placed on the leasehold and building to secure the repayment of a loan in that amount made to the petitioner by the American Bond & Mortgage Co. The building was constructed of steel, brick and concrete, and its foundations were sufficient to carry two additional stories. The theatre in the building had a seating capacity of 1,148. The theatre will probably become out of date in about 25*3458 years from the time of its construction, and due to the rapid increase in taxes and rising ground values the ten-story building probably can not be operated profitably for more than 30 years from the date of construction. The physical life of the building is at least 50 years.
The leasehold mentioned had a fair market value of $300,000 when it was acquired by the petitioner. The respondent, upon audit of the petitioner's income and profits-tax returns for the years 1920 and 1921 refused to allow the petitioner to include in its invested capital any amount on account of the leasehold, and he computed the allowances for depreciation of the petitioner's building at the rate of 2 per cent instead of 2 1/2 per cent as claimed by the petitioner.
*830 OPINION.
MARQUETTE: The first question raised by the record in this proceeding is, what was the value at the date of acquisition, of the leasehold which the petitioner acquired from Woods in January, 1917? The petitioner contends that the leasehold in question had a value at that time of $300,000; that it issued in exchange therefor its stock of the par value of $300,000, and that it is entitled to include the leasehold in*3459 its invested capital at that amount, and to compute the annual allowances for exhaustion on that basis.
Upon consideration of the evidence we are of the opinion that it sustains the petitioner's contention. The transaction between Woods and the trustees of the Field Estate, whereby Woods acquired the leasehold which we are considering, was not the ordinary transaction consummated at arm's length by the owner of property desiring to lease it and a prospective lessee. The evidence shows that Woods, who desired to build a theatre in Chicago, found a suitable site consisting of two pieces of property owned by two different estates. Not being in position to finance the acquisition of the property himself, he took the matter up with the Field Estate through a broker. The Field Estate at that time was seeking longterm investments at a comparatively low rate of return. Upon the representations of the broker that the two pieces of property could be acquired at a reasonable price, and merged into a single fee and leased to Woods for a long term at a fair return on the purchase price, the Field Estate purchased the property and did lease it to Woods. One of the trustees of the Field*3460 Estate testified that the rental value of the combined tracts, or parcels of property, was at least $75,000 per year and that Woods was able to obtain the leasehold for the consideration stated in the lease only on account of the exceptional circumstances surrounding the transaction. The Field Estate was in reality only financing Woods in the enterprise. Several other witnesses who were familiar with the property covered by the lease, and with other property in the vicinity, also testified that it had a rental value of from $72,000 to $75,000 per year, and that the leasehold was actually worth at least $300,000 in January, 1917. One of these witnesses offered Woods $300,000 for the lease early in the year 1917, but Woods refused to accept it. In 1923 the witness purchased the lease and the building on the property for $1,000,000, and he testified that at that time he considered the leasehold alone worth more than $400,000. We are of the opinion that the leasehold was worth at least $300,000 when it was acquired by the petitioner.
*831 Leaseholds are tangible property under the Revenue Acts of 1918 and 1921. The leasehold under consideration having been actually worth*3461 at least $300,000 when acquired by the petitioner, and the petitioner having issued its capital stock in the amount of $300,000 therefor, it is entitled to include the lease in its invested capital at that amount and to deduct annually an aliquot part thereof for the exhaustion of the lease. ; ; .
As to the rate which should be used in computing the annual allowance for the depreciation of the petitioner's building, we are of the opinion that the evidence produced is not sufficient to warrant us in disturbing the respondent's determination. The building was well constructed of steel, concrete and brick, and therefore not subject to rapid deterioration. Owing to changes in styles of theatre construction, the theatre part of the building may become out of date in twenty years, and if the taxes on the land continue to increase, the ten-story office building may become less profitable, but it is also quite possible that the office might be made to return a higher rental and the theatre conducted at some, though reduced, profit, even though*3462 it be somewhat out of date. Moreover, the theatre might be remodeled. There is no evidence before us on either of these points. We are not informed as to the amount of income the building has so far earned, or whether it is increasing, decreasing, or remaining stationary in its ratio to taxes and operating expenses. Upon the state of the record as to this point, we think that the respondent's determination should be approved, and we so hold.
No evidence was introduced by the petitioner in support of the other assignment of error.
Judgment will be entered under Rule 50.