*1857 1. The petitioner executed a conditional contract for the sale of certain property in 1906. The purchase price was to be paid in installments to a trustee over a period of thirty-six years. At the end of the period, if the petitioner complied with certain conditions, it was to receive from the trustee the monies so paid by the purchaser. Held, the amounts so paid to the trustee annually did not constitute income to the petitioner before the incumbent conditions had been fulfilled.
2. Reasonable allowances for wear, tear and exhaustion, including obsolescence, of petitioner's properties determined.
3. Respondent's action in including in income the proceeds realized from the salvage of certain abandoned and discarded properties sustained because of insufficiency of evidence to show error.
4. Upon the evidence, the 1924 statutory net loss determined and allowed as a deduction in computing net income for 1925.
*543 These proceedings, which were consolidated for hearing and decision, are for the redetermination*1858 of deficiencies in income taxes asserted by the respondent for 1924, 1925 and 1926 in the amounts of $3,809.12, $4,271.27 and $4,143.38, respectively. The petitioner charges that the respondent erred in his determination as follows: (1) In including in income for each year the sum of $15,495.97 as income from leased properties; (2) in failing to allow adequate *544 deductions for wear, tear and exhaustion, including obsolescence, of petitioner's properties; (3) in including in income for 1924 and 1925 sums of $5,129.07 and $11,933.50, respectively, representing the proceeds realized from the salvage of certain abandoned and discarded properties; and (4) in failing to allow net losses sustained for 1924 and 1925, as deductions in computing net income for 1925 and 1926, respectively.
FINDINGS OF FACT.
The petitioner is a corporation located and operating an electric street railway in Mobile, Ala. It was organized in 1901, and is a consolidation of the Mobile Street Railway Company, organized in 1893, and the original Mobile Light & Railroad Company, organized in 1897.
In 1906 the petitioner and the Mobile Illuminating Company entered into a contract, by the terms of*1859 which the petitioner "let, leased and demised" and agreed to "sell and convey" to the Illuminating Company certain specified property, together with franchises granted by the city of Mobile. In consideration therefor the Illuminating Company agreed to and did pay over to a designated trustee $100,000 in cash and bonds, and it further agreed to pay to said trustee semiannually $11,464.40 for a period of 36 years. These payments have been made up to and through 1924, 1925 and 1926. The Illuminating Company also covenanted that:
* * * at its own cost and expense it will, so far as it lawfully can, except as herein otherwise provided, do and cause to be done all things necessary to preserve and keep in full repair and efficiency, all of said demised property, and to keep in full force and effect the rights, privileges and franchises, and will do all things necessary to preserve and keep valid and intact the liens and incumbrances created by the deeds of trust executed by the Mobile Light and Railroad Company to the New York Security and Trust Company, as trustee on the 2nd day of September, 1901, and to the Farmers Loan and Trust Company, dated July 1st, 1897, so far as the same covers*1860 the demised property and additions thereto, and that it shall and will diligently preserve all rights and privileges to it granted and confirmed by law, or otherwise, in connection with said property, * * *.
* * * it will, at all times, keep the demised premises in good order and repair, that it will make all necessary replacements of the demised property so as to keep the same in such order and condition as is usual to wellconducted electric light companies, and that it will, from time to time, make all such improvements as may be necessary, or reasonably required, to enable said company to carry on a business producing the gross income hereinafter set forth.
The Illuminating Company further agrees that during the period of this lease, it shall and will, from time to time, promptly pay and discharge, or cause to be paid and discharged, all taxes, licenses, rates, levies or assessments, *545 ordinary and extraordinary, hereafter levied, or imposed upon the said leased premises, and the renewals or extensions thereof, or any part thereof, * * *
The contract also provided that the trustee should invest the cash payments from time to time, and pay over to the petitioner*1861 the interest derived from such investments; that at the end of the 36-year period, or sooner if it had discharged certain mortgage liens, the petitioner should convey to the Illuminating Company the property involved in the contract, by good and sufficient conveyance, free from mortgages or liens; and that, "should the lease herein provided for be terminated before the expiration of the term herein stipulated by default of either party hereto, then the Trustee shall pay to the party not in default all the sums of money and securities then held by it as Trustee hereunder." Neither party has defaulted.
The petitioner kept its books of account upon an accrual basis. It has not received any of the money or bonds paid to the trustee by the Illuminating Company, nor has the latter or the trustee paid any moneys to the petitioner on account of the principal sum mentioned in the contract. In its income-tax return for each of the years in controversy, petitioner reported $15,495.97 income from the sale of its properties to the Illuminating Company, computed upon the installment basis. The respondent made no adjustment with respect to the amounts so reported by the petitioner.
In 1922*1862 one Harry Barker, a consulting engineer, was employed by the petitioner to inventory and appraise all of its railroad properties, as of December 31, 1921, and prepare a report showing the original and reproduction costs, and depreciation, for the information of the Alabama Public Service Commission for rate-making purposes. In his report, Barker set forth the minimum rate of depreciation applicable to each class of petitioner's street railroad properties, and from those several rates he computed an average or composite rate of 3.4 per cent per annum. The depreciation rates set up in the report were based by Barker solely upon wear, tear and physical life of materials, as nearly as such factors could be determined from the testimony of subordinate employees of the petitioner and without reference to the petitioner's records, and without regard to obsolescence and other factors which would tend to materially shorten the useful life of the properties. In the preliminary statement of his report, Barker called attention to several reasons why a higher rate of depreciation than 3.4 per cent might be advisable and concluded by stating that because of the reasons advanced a composite rate*1863 of 5 per cent would not be excessive.
Subsequent to the Barker appraisal, a revenue agent was sent to Mobile to examine petitioner's accounts for 1918, 1919, and 1920. *546 The only authority he could find, with regard to the matter of depreciation, was the Barker report, which he accepted and recomputed the depreciation allowances for those years by the use of the composite rate of 3.4 per cent. Believing the action of the revenue agent, subsequently approved by the respondent, to be binding upon it, the petitioner claimed depreciation deductions in its returns for the taxable years in controversy which were computed by the use of the same composite rate of 3.4 per cent.
The depreciation deductions claimed by the petitioner in its returns for the years in controversy, and allowed by the respondent, are as follows:
| 1924 | $103,454.03 |
| 1925 | 104,866.12 |
| 1926 | 104,572.37 |
The following is a statement of the several classifications of petitioner's depreciable properties; and the rate per cent set opposite each is indicative of the average useful life of the items of property included in the classification:
| Classification | Rate per cent based on average useful life |
| Tracks, including ballast, ties, rails, special work, track and roadway labor and paving | 5.00 |
| Roadway machinery and tools | 7.50 |
| Bridges, trestles, and culverts | 5.00 |
| Crossings, fences, and signs | 5.00 |
| Poles and fixtures | 8.92 |
| Underground conduits | 3.00 |
| Distribution system (trolley lines) | 8.92 |
| Shops and car houses | 3.70 |
| Stations and miscellaneous buildings | 3.70 |
| Park and resort property | 5.00 |
| Passenger cars | 5.70 |
| Service equipment | 7.89 |
| Electric equipment of cars | 5.90 |
| Shop equipment | 5.00 |
| Furniture and office equipment | 7.50 |
| Miscellaneous equipment, including automobiles and auto trucks | 20.00 |
| Power-plant building | 3.00 |
| Power-plant equipment | 5.10 |
*1864 In its returns for 1924 and 1925, the petitioner claimed loss deductions of $65,285.92 and $22,632.22, respectively, on account of abandoning and discarding certain properties for various causes, and included in income for those years the sums of $5,129.07 and $11,953.50, respectively, representing the proceeds realized from the salvaging of abandoned properties. The respondent disallowed the claimed loss deductions, but did not eliminate from income the amount reported in each year as income from salvage.
In its amended return for 1924, which is the basis of the respondent's deficiency determination for that year, the petitioner reported a net loss of $13,764.13. In Schedule "L" of the same return, the petitioner reported the receipt of nontaxable income, representing "Interest on obligations of a State, Territory, or any political subdivision thereof, or the District of Columbia," of $3,540.46. In its return for 1925 the petitioner claimed a deduction of $10,223.67 in *547 computing net income, representing the amount of the statutory net loss alleged to have been sustained for 1924. In the deficiency notice, the respondent determined that the petitioner realized*1865 a net income for 1924, and, accordingly, he disallowed the deduction claimed in the 1925 return.
OPINION.
MARQUETTE: The petitioner contends that the written agreement made by and between it and the Mobile Illuminating Company in 1906 was either a contract to sell in 1942, or a conditional sale made at the time of the execution of the written instrument, and that in either event no part of the money paid to the trustee in 1924, 1925 and 1926 pursuant to said agreement constituted income to it. The respondent contends that the payments made to the trustee by the Illuminating Company were lease rentals and that they were constructively received by and constituted income to the petitioner when paid to the trustee. Although the written instrument is denominated a lease, the words employed can not have the effect of changing its true nature, which is to be determined by the real intention of the parties. .
The facts are that the Illuminating Company agreed to pay a trustee $100,000 down, in bonds and cash, and a fixed amount every six months thereafter for 36 years; to maintain the property in full repair*1866 and efficiency; to keep alive the franchises; and to pay all taxes, assessments, etc., levied against the property. Compliance with these and other conditions in the contract will entitle the Illuminating Company to a deed to the property, clear of encumbrances, at the end of the 36-year term. In our opinion the contracting parties did not enter into a lease, but a conditional contract of sale, and the payments made to the trustee were not rentals, but installments of the purchase price. .
The evidence discloses that of the amounts thus far paid to the trustee by the Illuminating Company, no part has been received by the petitioner, and that the petitioner's right to receive such payments is not vested and absolute, but is dependent upon certain conditions which may never be fulfilled. A somewhat similar situation arose in , where the court held that an insurance agent's commissions on renewal premiums were taxable only in the year in which received, because his right to the commissions was entirely contingent upon the payment of premiums by the policyholders, and*1867 that a contingent right of that character was *548 not income within the meaning of the income-tax statutes. To the same effect is our decision in , where it was held that:
Amounts withheld by municipalities under paving contracts as funds to guarantee maintenance of the paving for a period of years and which funds the municipalities might themselves expend for maintenance and repairs (are) not accruable as income to the contractor during the withholding period.
We are of opinion that the present case falls within the principle laid down in the above cited cases, namely, that a taxpayer on the accrual basis need not include as income amounts to be received in the future where such receipt is dependent upon a substantial contingency. Therefore, there should be eliminated from the petitioner's taxable income for each of the years in controversy, as determined by the respondent in the deficiency notices, the amount of $15,495.97.
The next complaint of the petitioner is that the deductions allowed by the respondent for wear, tear and exhaustion, including obsolescence, of its properties, are inadequate to take*1868 care of the consequences of those factors and, therefore, are not the reasonable allowances contemplated by the taxing statutes. The petitioner concedes that the respondent has used a proper valuation basis for the purpose of computing the allowances, but contends that a wrongful determination has resulted through the application to that basis of a composite rate which is based upon a longer life than the actual useful life of the property. After considering all of the evidence presented in connection with this matter, we are of the opinion that the determination of reasonable allowances for depreciation, including obsolescence, requires the use of a much higher rate than the composite rate of 3.40 per cent used by the respondent, and that such allowances can be better determined by the use of a separate rate for each classification of depreciable property, based upon the average useful life of the items included in the classification. Accordingly, we have set out in the findings of fact a rate for each classification which the evidence establishes is indicative of the average useful life of items included therein. These rates are based upon the evidence of the two witnesses called*1869 by the petitioner, whose qualifications and experience entitle their opinions to great weight and respect, and whose testimony was unweakened by cross-examination and stands unrebutted.
On the evidence we conclude that the petitioner is entitled to deductions for wear, tear and exhaustion, including obsolescence, of its properties, for 1924, 1925 and 1926, of $167,003.20, $166,497.07 and $164,425.35, respectively; and since the respondent has made allowances of $103,454.03, $104,866.12 and $104,572.37, respectively, the net *549 income for 1924, 1925 and 1926, as determined by the respondent in the deficiency notices, should be reduced by $63,549.17, $61,630.95 and $59,852.98, respectively. The allowances which we have determined are based upon the same valuation bases as used by the respondent and the rates set forth in our findings of fact. The petitioner is not entitled to any allowance in respect of the office building, since that structure was not completed until after the taxable years in controversy. Also, we conclude that the petitioner is not entitled to any allowance in respect of the properties which are the subject of the agreement with the Illuminating Company, *1870 since it appears that under the terms of that agreement all losses due to wear, tear and exhaustion, including obsolescence, of those properties is being and will be sustained by the Illuminating Company and not by the petitioner.
The next contention of the petitioner is that, the respondent having disallowed the loss deductions claimed in the returns for 1924 and 1925 in respect of the properties abandoned and discarded in those years, he should have eliminated from income the amounts reported as the proceeds realized from the salvaging of such properties. We find it necessary to decide this matter adversely to the petitioner, since the evidence does not show that the salvage realized did not exceed the estimated salvage taken into consideration in the determination of reasonable depreciation allowances, plus the aggregate of amounts previously charged for depreciation of these properties.
The respondent determined that the petitioner realized a net income for 1924 of $51,521.79. We have held that this should be reduced by $63,549.17 for additional depreciation, and by the amount of $15,495.97, erroneously included in income. The petitioner received nontaxable income in 1924*1871 of $3,540.46, representing interest on obligations of a State, Territory, or political subdivisions thereof, or of the District of Columbia. Upon these facts, we find that the petitioner sustained a net loss for 1924, within the meaning of section 206(e) of the Revenue Act of 1926, of $23,982.89, and, accordingly, net income for 1925, as determined by the respondent in the deficiency notice, should be reduced by that amount.
The adjustment which we have directed to be made in the net income for 1925 for additional depreciation will leave a substantial net income for that year, and, consequently, the petitioner did not sustain any net loss for that year which can be deducted in computing net income for 1926.
Judgment will be entered under Rule 50.