*2774 1. Value of leasehold at March 1, 1913, determined for exhaustion purposes.
2. Special assessment denied where no abnormality affecting capital or income is shown to have existed.
*891 These proceedings are for the redetermination of deficiencies in income tax for the years 1920 to 1925, inclusive, in the respective amounts of $17,760.82, $38,205.99, $4,687.50, $4,687.50, $4,687.50, and $4,875. The issues are the March 1, 1913, value of a certain leasehold owned by the petitioner, which issue is common to all of the years and is the only issue for 1922 and subsequent years, and whether the petitioner is entitled to special assessment for the years 1920 and 1921. These proceedings were consolidated for hearing and decision.
*892 FINDINGS OF FACT.
Petitioner is a New York corporation with its principal office at 250 Fifth Avenue, New York City. It was organized in 1911 for the purpose of taking over and operating a certain leasehold, hereinafter described. *2775 All of its capital stock was issued in exchange for an agreement to make the lease.
In May, 1911, Charles Hirschhorn, Nathaniel J. Hess, and Edwin H. Hess entered into an agreement with Ogden Mills, whereby Mills agreed to grant to the others a lease on a certain plot of ground at the southwest corner of Fourth Avenue and 26th Street, New York City. The lease was executed June 26, 1911, by Ogden Mills, landlord, Hess Building Co., tenant, and Charles Hirschhorn, Nathaniel J. Hess, and Edwin H. Hess, guarantors. It contained, among others, the following provisions:
(1) Term of leasehold 21 years, beginning May 1, 1912, at annual rental of $55,000.
(2) Renewal at option of tenant for two consecutive 21-year periods at rental of 5 1/2 per cent of the then value of the land.
(3) Taxes, assessments, water rents, and all other charges relating to said premises to be paid by tenant.
(4) Tenant to build and complete by May 1, 1913, a first class 20-story fireproof building, costing not less than $1,000,000, said building to be purchased by landlord at end of tenancy at the then market value.
(5) Tenant to deposit securities of the value of $150,000 as security for the erection*2776 and completion of the building.
(6) Landlord to make building loan to tenant in an amount up to 70 per cent of cost of building but not in excess of $800,000 at 5 1/2 per cent interest per annum for term of tenancy, $50,000 of the principal to be paid off every 5 years.
(7) Tenant to bear all costs and liabilities, if any, incurred in demolition and removal of old buildings on the site.
The site covered by the lease was in the heart of what is known as the Fourth Avenue District, which may roughly be defined as beginning at 17th Street and extending north on Fourth Avenue to 32nd Street. At the time the lease was executed Fourth Avenue was not developed as a high-grade commercial center. Within the district designated both sides of the avenue were built up principally with second-rate hotels, boarding houses, and a few old residences. From the period 1911 to March 1, 1913, the district changed from residential to commercial. The transition was at its height early in 1913. In 1911 a leading silk business had moved from lower New York to 17th Street and Fourth Avenue. There followed other silk, woolen, notions, toy, lace, and other such businesses, as well as several commission*2777 houses and factors who did the banking *893 for those concerns. By March 1, 1913, the nature of the Fourth Avenue district had completely changed and had become the center of the above-named trades, as well as of advertising and publishing trades.
The site of petitioner's leasehold was well situated in the upper part of the Fourth Avenue district. It had a northern exposure of 200 feet facing Madison Square Garden. This was a particularly desirable feature, since the textile trades, especially woolens and silks, preferred north light for inspecting materials. The south light with the sun rays mixed the colors and rendered them less distinguishable. A north exposure of this width was uncommon in the district.
The building provided for in the lease as above was completed and ready for occupancy on February 1, 1913. It was what is known as a first-class loft building. It was well planned and constructed and was especially adapted to the requirements of the trades above mentioned. It had space for offices, showrooms and stock rooms, and was equipped with both freight and passenger elevators.
On March 1, 1913, one month after the building was ready for occupancy, *2778 52.4 per cent of its space had been rented at gross annual rentals of approximately $144,800. By the end of the year 1913 additional leases had been made, bringing the rented space up to 68.3 per cent and the gross annual rentals up to $185,230. The tenants were for the most part very high class. Among the tenants at March 1, 1913, were the Silk Association of America; Fleitman & Co., silk factors, who had taken four floors; Funk & Wagnalls, publishers, who had taken two floors; C. A. Auffmondt & Co., who had taken three floors; and A. & M. Karaghensian, a rug concern, which had taken an entire floor.
The petitioner sustained net losses in operating the Hess building during the years 1913 and 1914. New buildings of this type ordinarily operate at losses for several years. Over the entire period from February 1, 1913, to December 31, 1927, petitioner's net profit was $1,500,882.88. Profits and losses for the entire period were as follows:
| Period | Profit or loss from operations |
| Feb. 1, 1913-Jan. 31, 1914 | 1 $73,982.36 |
| Feb. 1, 1914-Jan. 31, 1915 | 1 19,304.45 |
| Feb. 1, 1915-Jan. 31, 1916 | 16,833.53 |
| Feb. 1, 1916-Jan. 31, 1917 | 45,700.14 |
| Feb. 1, 1917-Jan. 31, 1918 | 41,024.85 |
| Feb. 1, 1918-Jan. 31, 1919 | 45,701.30 |
| Feb. 1, 1919-Dec. 31, 1919 (11 months) | 44,437.86 |
| Jan. 1, 1920-Dec. 31, 1920 | 50,630.77 |
| Jan. 1, 1921-Dec. 31, 1921 | 141,510.13 |
| Jan. 1, 1922-Dec. 31, 1922 | $159,446.75 |
| Jan. 1, 1923-Dec. 31, 1923 | 209,222.98 |
| Jan. 1, 1924-Dec. 31, 1924 | 232,231.65 |
| Jan. 1, 1925-Dec. 31, 1925 | 226,686.24 |
| Jan. 1, 1926-Dec. 31, 1926 | 198,986.86 |
| Jan. 1, 1927-Dec. 31, 1927 | 181,756.63 |
| Net profit | 1,500,882.88 |
*894 The petitioner had no income during the years in question except from the operation of the Hess building.
The leasehold above described had a value at March 1, 1913, of $500,000.
Nathaniel J. Hess and Edwin H. Hess, two of the petitioner's three stockholders, were members of the partnership of M. & L. Hess, which had the exclusive management of the Hess building. M. & L. Hess were also builders. They did most of the work of constructing the Hess building, including the excavating, the concrete work, the masonry, and the plastering work. They purchased all of the materials, hired the labor, and had general supervision of the entire construction. The work of installing elevators, electric wiring, etc., was let to subcontractors.
Hirschhorn, the third stockholder in the petitioner corporation, furnished, without consideration, his personal securities to the value of $150,000, as the guaranty for the completion of the building called for in the lease.
In computing the petitioner's tax liability for the years 1920 to 1925, inclusive, the respondent did not allow any deduction on account of exhaustion of the leasehold, and did not include in*2780 invested capital any amount representing leasehold value.
OPINION.
SMITH: For each of the years 1920 to 1925, inclusive, the petitioner is claiming a deduction for depreciation of the above described leasehold on the basis of a value at March 1, 1913, of not less than $750,000. The respondent denies that the leasehold in question had any value at that date. For the years 1920 and 1921 the petitioner is claiming the right to special assessment under the provisions of section 327 of the Revenue Acts of 1918 and 1921. In its petitions for the years 1920 and 1921 petitioner alleges as further errors that the respondent failed to make any allowance for leasehold value in its invested capital for those years, and failed to reflect in invested capital the proper adjustment of taxes for prior years. In its brief petitioner states that it does not press the issue relating to statutory invested capital.
The evidence before us fairly supports the petitioner's contention that the leasehold had a substantial value at March 1, 1913. This was attested by witnesses who were familiar with real estate matters generally in New York City and who had particular knowledge of conditions in*2781 the immediate vicinity of the leasehold site. These witnesses pointed out, especially, the unusual and favorable features of the lease itself. The more important of these are stated in the *895 above findings of fact. The ground rental of $55,000 per year was said to be comparatively low and apparently based upon an undervaluation of the land. There was a liberal building loan to be made by the lessor at a comparatively low interest rate and with an easy plan for the repayment of the principal, that is, at the rate of $50,000 every five years. The amount of the securities, $150,000, required to be deposited by the lessee as a guaranty for the completion of the building was comparatively small.
During the interval from 1911, the time the lease was made, until March 1, 1913, the Fourth Avenue district had been undergoing a complete change in character and was fast becoming one of the leading business districts of the city. Prior to March 1, 1913, many of the leaders in the silk, woolen, and other trades were permanently established within the district. At that time the petitioner had already rented more than half of the space in the Hess building at gross annual rentals*2782 of nearly three times the annual rent it was obligated under the terms of the lease to pay. Some of its tenants were large and highly reputable concerns. The evidence clearly shows, we believe, that at March 1, 1913, the petitioner was practically assured of a substantial profit from the operation of the Hess building. The evidence does not, however, afford us any very satisfactory means of determining in dollars and cents the capital value of the leasehold. The petitioner contends that the fair market value of the leasehold was $750,000, and a witness, well qualified to give an opinion as to the value on March 1, 1913, placed it at approximately $1,000,000, or a minimum of $700,000. It appears to us, however, that this estimate is prompted in part by hindsight and is not based upon facts existing on March 1, 1913. Opinion evidence is only a factor to be taken into consideration in determining the value of the leasehold. . The large profits from the operation of the building arising in years subsequent to 1920 appear to us to be based in part at least upon the general increase in rents in the City of New York subsequent*2783 to the war period. It is hardly possible that this general increase could have been foreseen at March 1, 1913. Upon careful consideration of all of the evidence, we are of the opinion that the leasehold had a fair market value at March 1, 1913, of $500,000. Deductions for exhaustion during the tax years involved should be computed on that basis.
In respect of its claim for special assessments for the years 1920 and 1921, the petitioner relies upon the facts that no allowance was made in its invested capital on account of the value of the leasehold, and that the stockholders made valuable contributions to the business for which they received no consideration.
*896 We are unable to find from the evidence that the leasehold had any material value at the time it was paid in to the corporation. That point was raised in the issue above referred to relating to statutory invested capital. The evidence does show that Nathaniel J. Hess and Edwin H. Hess, two of the petitioner's stockholders, who also composed the partnership of M. & L. Hess, performed the greater part of the work of constructing the Hess building and that Hirschhorn, the third stockholder, deposited his personal*2784 securities, the value of $150,000, as a guaranty for the completion of the building, and also that the three stockholders joined in the lease as guarantors for the petitioner. We do not see, however, that these facts bring the petitioner within the purview of section 327 of the Revenue Acts of 1918 and 1921. We do not know what was the actual value of the services performed, gratis, by the stockholders, or what would have been the cost of the same services performed by others for the usual and ordinary considerations. It has not been shown that the respondent was unable to determine the petitioner's invested capital, or that the facts stated were productive of an abnormality affecting, to any appreciable extent, the petitioner's capital or income during the years 1920 and 1921. The respondent is therefore sustained upon this point.
Judgment will be entered under Rule 50.
Footnotes
1. Loss. ↩