*115 Decision will be entered under Rule 50.
Petitioner operated a newspaper establishment under the terms of written leases. It made expenditures for plant equipment and furniture which it claims to be deductible in the entirety in the year paid. Assets acquired by such expenditures had a useful life of more than 1 year. Held, expenditures were made for capital assets and must, therefore, be recovered on a depreciation basis over the useful life of the assets acquired or the remaining term of the leases, whichever is the lesser.
*654 The respondent determined a deficiency of $ 4,785.19 in the petitioner's income tax for the fiscal year ended October 31, 1948. The issues presented are whether the respondent erred (1) in disallowing certain amounts deducted by petitioner as ordinary and necessary business expenses and determining that they should be capitalized and allowances for depreciation be taken with respect thereto, and (2) in determining that petitioner realized capital gain of $ 1,400 during the year. Respondent concedes error as to issue (2), thus*116 leaving for determination only issue (1). Respondent also concedes that $ 45.19 of the amount capitalized should be deducted as an ordinary and necessary business expense.
FINDINGS OF FACT.
Petitioner is an Iowa corporation and has its principal office and place of business in Sioux City, Iowa. It filed its income tax return *655 for the fiscal year ended October 31, 1948, with the collector of internal revenue at Des Moines, Iowa. Petitioner kept its books and filed its return on the accrual basis of accounting.
Beginning December 1, 1941, and at all times pertinent herein, petitioner engaged in the business of printing, publishing, and circulating a morning and evening daily newspaper, known as the "Sioux City Journal" and "Sioux City Journal-Tribune," respectively, and a Sunday paper, known as the "Sioux City Sunday Journal." The Journal was founded in 1870 by George D. Perkins who published it in Sioux City in a morning, evening, and Sunday edition. In 1941 it was published by Perkins Brothers Company. The Tribune was founded by John C. Kelly who published it in Sioux City as an evening paper. In 1941 it was published by The Tribune Company. The two papers were the*117 only ones published in Sioux City and had been in competition with each other since 1924. On November 26, 1941, after about 4 years of negotiating and bargaining, the two publishers effectuated an agreement. The agreement between Perkins Brothers Company and The Tribune Company provided that a new corporation to be known as "Journal-Tribune Publishing Company," the petitioner herein, would be formed and that its capital stock would be subscribed to by stockholders of Perkins Brothers Company and The Tribune Company in the proportion of 60 per cent by the former and 40 per cent by the latter. The agreement further provided that Perkins Brothers Company and The Tribune Company would lease their respective newspaper establishments to the petitioner for a period of 99 years at an annual rental of $ 30,000 to Perkins Brothers Company and $ 20,000 to The Tribune Company, payable only out of the net earnings of petitioner. The agreement excluded from the properties to be leased all other businesses then conducted by Perkins Brothers Company and The Tribune Company, respectively. The agreement provided, inter alia:
2e. At the conclusion of the term of the leases, the Journal-Tribune*118 Publishing Co. shall have the option to purchase the right, title and interest of the lessors in and to the leased property by paying therefor the fair market price at that time, to be determined through appraisal by three disinterested persons, one to be appointed by the lessor whose interest is being purchased, one to be appointed by the lessee, and one to be appointed by the two appraisers selected previously. The Journal-Tribune Publishing Co. shall have the right at any time to sell or otherwise dispose of any of the physical equipment covered by the leases, accounting for the proceeds thereof to the respective lessors at the termination of the leases.
On November 28, 1941, petitioner was incorporated. Sixty per cent of its capital stock of $ 50,000 was subscribed to and paid for by stockholders of Perkins Brothers Company and the balance of 40 per cent was subscribed to and paid for by stockholders of The Tribune Company. The following day, The Tribune Company executed a *656 lease to petitioner for a period of 99 years, beginning December 1, 1941, for:
the possession and use of the newspapers of the lessor, known as the Sioux City Tribune, and all editions thereof*119 heretofore published by lessor, and of which it is the owner and proprietor, including the subscriptions, good will, publishing and engraving equipment, machinery, contracts, franchises and all other property, tangible and intangible, (excepting the real estate in which said property is housed), which at the time of the execution hereof has heretofore been possessed and enjoyed by the lessor in or about the publication of its said newspapers, and the conduct of its newspaper business; * * *
The annual rental provided was $ 20,000 per year, payable out of net earnings of petitioner in the operation of its business. The lease contemplated that rental certificates would be issued to the lessors, or, in the event of liquidation or dissolution, to stockholders of the lessors in amounts proportionate in face value to the annual rental provided of $ 20,000. These rental certificates were to be assignable and represented a proportionate interest in the rentals and in the reversionary interest in the property covered by the lease.
The lease provided, inter alia:
3. As a further consideration for the leasing and demising aforesaid, the lessee further covenants, promises and agrees *120 to bear, pay and discharge, in addition to the said rent reserved, all rents, taxes, charges for revenue and otherwise, assessments and levies, general and special, ordinary and extraordinary, of every name, nature and kind whatsoever, which may be taxed, charged or assessed, levied or imposed upon said demised property, and upon the reversionary estate therein during the term hereby granted, and so long thereafter as said lessee, its successors and assigns shall use or possess the same. And it is further understood and agreed by and between the parties hereto that the first annual taxes to be paid by the lessee shall be those which shall become due and payable in the year 1942.
4. The lessee further covenants and agrees to and with the lessor, its successors and assigns, as aforesaid, that during the term of this lease it will at all times use the demised property and the rights and privileges so demised by the lessor, in the publication of the newspaper herein referred to, and in every respect will exert its best endeavor in the upkeep and publication of said newspaper. To that end, lessee shall have the right at all times to sell or otherwise dispose of any of the physical property*121 now or hereafter used in connection with the operation of said newspaper plant, or to remove or install the same in such quarters in the city of Sioux City, Iowa, as in its judgment may from time to time be deemed advisable or expedient, and to add thereto such new or additional machinery or equipment as from time to time it may be deemed advisable, provided, however, that any and all such additions shall be considered and treated as demised jointly under this lease and a lease being contemporaneously executed by the lessee and the Perkins Bros. Company in the proportion of forty per cent under this lease and sixty per cent under the lease between the lessee and the Perkins Bros. Company and all and every of the obligations on the part of the lessor herein provided shall be deemed to extend to all the physical property hereafter acquired by the lessee, and used by it in the operation of its said business.
* * * *
*657 8. It is further convenanted and agreed by and between the parties hereto that in the event of the termination of this lease at any time before the expiration of said demised term of ninety-nine years, for the breach of any of the covenants herein contained, then*122 and in such case all the property demised hereby, and a forty per cent interest in all choses in action, rights, privileges and franchises whatsoever, which may up to said time have been acquired by the said lessee in or about the operation of its said business, shall be forfeited to the said lessor, its successors and assigns, as aforesaid, and shall become its or their property, and no compensation therefor shall be allowed or paid to the lessee.
9. At the termination of the term of this lease the lessee shall have the option to purchase the right, title and interest of the lessor and its assigns, as hereinbefore provided, in and to the leased property, provided it shall notify it or them in writing of its said election at least one year before the end of the term, and by paying therefor the fair market price at that time, to be determined through appraisal by three disinterested persons; one to be appointed by the lessor; or a majority in interest of its assigns; one to be appointed by the lessee; and one to be appointed by the two appraisers so selected. In the event the lessee shall not elect so to purchase and pay the purchase price so fixed and determined as aforesaid, the*123 said demised property with forty per cent of all the rights, privileges and franchises then possessed, used or enjoyed by the said lessee and more particularly hereinbefore described, shall revert to the said assigns of the lessor, and shall be delivered to and held by them in the proportions to which each shall be entitled.
The lease recites that it was being executed simultaneously with a lease by Perkins Brothers Company of its newspaper publication properties and contemplated that both properties would be operated jointly in the publication of such editions of both newspapers as the lessee might elect. The lease also contemplated a joint valuation of the properties on expiration of the leases with a division of three-fifths to Perkins Brothers Company as lessor, or its successors in interest, and two-fifths to The Tribune Company as lessor, or to its successors in interest. The lessee also agreed that upon the request of the lessor, or successors in interest, it would furnish a detailed statement of plant additions. Perkins Brothers Company executed a lease identical in all respects with the above-described Tribune Company lease, with variations only as to properties leased, *124 the annual rental of $ 30,000, and in names and proportionate interests in the rental and properties covered. The proportionate interest of the Perkins Brothers Company, or its successors, was fixed at 60 per cent in lieu of the 40 per cent provided in The Tribune Company lease. Early in 1942, petitioner issued rental certificates with a face value of $ 30,000 to Perkins Brothers Company and $ 20,000 to The Tribune Company as contemplated by the leases. The Tribune Company went into voluntary liquidation and its rental certificates were distributed pro rata among its individual stockholders. The combined physical assets of the two newspapers at the date of leasing had a value of $ 353,000, and the circulation structure, good will, franchises, and other intangibles had a value of from $ 10 to $ 15 per paid daily subscriber. On March 21, *658 1942, the total daily circulation was 84,712 and the Sunday circulation was 56,505. The value of the circulation structure and of other intangibles therefore was between $ 847,120 and $ 1,370,680, giving an aggregate value for the leased properties ranging from $ 1,200,120 to $ 1,723,680.
Upon execution of the lease, some of The Tribune*125 Company's machinery and equipment was taken over immediately into the petitioner's plant, some of it was taken over in a year's time, and the remainder was sold or junked. The remaining useful life of the leased property was 20 years from the date of the leases. From time to time, up to October 31, 1946, petitioner made sales of various items of machinery, equipment, and furniture and fixtures under the leases, realizing a total of $ 19,748.97, which was credited to an account called "Reserve for Machinery and Equipment Replacement." No sales of machinery and equipment or of furniture and fixtures were made during the fiscal year ended October 31, 1947. From time to time, following the leases, petitioner purchased various items of machinery, equipment, and furniture and fixtures in the following amounts:
| Machinery and | Furniture and | ||
| Years | equipment | fixtures | Total for year |
| 11 months ending Oct. 31, 1942 | $ 1,971.54 | $ 2,838.46 | $ 4,810.00 |
| Oct. 31, 1943 | 97.84 | 179.64 | 277.48 |
| Oct. 31, 1944 | 2,155.57 | 64.77 | 2,220.34 |
| Oct. 31, 1945 | 709.09 | 27.54 | 736.63 |
| Oct. 31, 1946 | 6,392.72 | 591.56 | 6,984.28 |
| Oct. 31, 1947 | 1,645.90 | 816.29 | 2,462.19 |
| $ 12,972.66 | $ 4,518.26 | $ 17,490.92 |
*126 At the beginning of its taxable year, ending October 31, 1948, petitioner had a balance in the above-mentioned "Reserve" account of $ 2,258.05 available for replacement of machinery, equipment, furniture and fixtures. During the year it sold one additional item of equipment for $ 1,400 so that the total sales proceeds then available for application against purchases was $ 3,658.05. During the taxable year, ending October 31, 1948, petitioner purchased various items of machinery, equipment, furniture, and fixtures as follows:
| (a) 4 items of machinery and equipment, which were | |
| charged directly to the Reserve above described | $ 988.94 |
| (b) 10 unrelated items of machinery and equipment | 2,173.67 |
| (c) Down payment, freight, installation, and purchase | |
| price of a casting machine in the stereotype department | 10,081.53 |
| (d) 7 unrelated items of furniture and fixtures | 628.91 |
| (e) Motion picture camera and related equipment | 2,024.75 |
| Total | $ 15,897.80 |
*659 All of the above-listed items of purchase had a useful life in excess of 1 year. The motion picture camera and related equipment was purchased in order to furnish national advertising representatives of petitioner*127 pictures of Sioux City enterprises and industries. No such equipment was included in property transferred to petitioner on the date of execution of the leases.
The useful life of the stereotype machine was 15 years, the useful life of all other machinery and equipment was 10 years, the useful life of the furniture and fixtures was 20 years, and the useful life of the motion picture camera and related equipment was 10 years. These purchases included an expenditure of $ 45.19 for repairs to machinery and equipment, which on petitioner's books was charged to machinery and equipment purchases. The purchases of $ 15,942.99 exceed the "Reserve" account balance of $ 3,658.05 by $ 12,284.94. Petitioner deducted the amount of $ 12,284.94 in its income tax return for the fiscal year ended October 31, 1948, as "Maintenance of Leased Plant."
Petitioner was not reimbursed by the lessors on account of these expenditures. No rental or other income was reported by the lessors, or their successors in interest, on account of such expenditures.
Previous to 1946 petitioner had a sufficient balance in its "Reserve" account to purchase any and all machinery purchased. After the reserve was exhausted*128 a disagreement arose between petitioner's lawyers and accountant, inter sese, as well as with the respondent, as to the proper treatment to be given the sale and purchase of machinery. Petitioner decided to obtain a judicial construction of the leases. On December 4, 1950, it filed a petition for a declaratory judgment in the District Court of Iowa for Woodbury County. It joined as defendants all of the rental certificate holders as lessors or successors in interest to lessors under the leases.
Petitioner notified all of the rental certificate holders as lessors regarding the suit over the construction of the leases and asked each one of them to decide what he wished to do in the matter, that is, whether to contest it or take other action. Perkins Brothers Company and its individual stockholders filed an answer on December 27, 1950, in which they admitted the truth of the material statements of fact in the petition and then stated:
2. * * * that it was at all times and now is their understanding that the rent reserved by the lessor, Perkins Bros. Co., should be apportioned to them in proportion to their respective holdings of stock in the said Perkins Bros. Co., without deductions*129 for upkeep or replacement of the demised property; that the said lessee should be obligated to pay all taxes, insurance and other items more particularly set out in said lease and should at all times preserve said property in a proper condition of efficiency; that it should have the right to sell any part of said equipment and devote the proceeds thereof to additions and replacements; *660 that at the termination of said lease the said newspaper plant would revert to these defendants and their respective successors and assigns in efficient and proper condition and to the end that the net rent reserved in said lease should inure to the benefit of these defendants and their successors and assigns respectively without outlay of any kind whatsoever for upkeep or other expenses in the operation thereof.
3. That for their future security and their respective successors and assigns, and to remove all doubt as to their rights and responsibilities with respect to the leased property and the said lease thereof these defendants agree that said matter should be clarified.
An answer was filed on behalf of the Kelly family on December 28, 1950, in which the allegations of the petition were*130 admitted. A third answer was filed by a guardian on behalf of an incompetent, in which she asked that the "rights and interests of said incompetent be duly protected by the court."
On December 29, 1950, the District Court of Iowa for Woodbury County entered findings of fact, conclusions of law, judgment, and decree to the following effect:
7. That each of the said leases simultaneously entered into and executed by this plaintiff as lessee and the said Perkins Bros. Co., and The Tribune Co., respectively, contained the provisions as to future disposition of the physical property and equipment then existing and thereafter to be added thereto substantially as is set out in said petition, and that thereby it was understood and agreed between the parties hereto that the efficiency of said newspaper plants should not be impaired and that this plaintiff should be liable for maintaining and replacing the leased equipment in a condition of efficiency and suitability for publishing daily and Sunday newspapers in said city of Sioux City at the sole expense of the lessee and for the entire term of said leases and without cost to the said lessors or their successors in interest. Further, that*131 the plaintiff throughout the term of said lease would exert its best endeavor in the upkeep and publication of said newspapers and to that end and purpose that it should have the right at all times to sell or otherwise dispose of any of the leased physical property as well as that thereafter acquired and used in connection with the operation of said newspaper plant as in its judgment from time to time might be deemed advisable or expedient, applying the proceeds of any such sales to the purchase of new or additional equipment and returning to the lessors, or their successors in interest, all such machinery and equipment as might remain at the termination of said leases.
* * * *
CONCLUSIONS OF LAW.
* * * *
2. That the said leases and in particular the right and duty of the plaintiff to sell and dispose of the physical property covered thereby and to use the proceeds thereof and to expend such additional monies from its own funds as from time to time during the term of said leases may be necessary to keep the said property in proper condition to efficiency operate the said newspaper plant as by said leases contemplated and agreed is the sole obligation of this plaintiff and no part *132 thereof need be borne by these defendants individually or collectively.
*661 The court then entered its declaratory judgment in the following terms:
1. IT IS, THEREFORE, HEREBY ORDERED, ADJUDGED and DECREED that the leases referred to in the above and foregoing Findings of Fact and Conclusions of Law executed simultaneously by the above named Perkins Bros. Co., and The Tribune Co., as lessors respectively to the said plaintiff as lessee, effective December 1st, 1941 and continuing for the term of ninety-nine years thereafter, understood and interpreted in the manner recited in the Findings of Fact and Conclusions of Law above set out, and which by this reference are made part hereof, constitute the contracts between lessors and lessee, define their respective rights, duties and obligations and is binding upon all parties to this suit.
No evidence was offered in the proceeding, no arguments were made to the court, nor were briefs filed. At the time of the filing of the petition, all of the rental certificates and the shares of stock of the petitioner were held by members of the Kelly family and Perkins Brothers Company, or its stockholders. Some members of the Kelly family *133 owned rental certificates but owned no shares of stock of petitioner, while other members of the Kelly family owned shares of stock of petitioner but no rental certificates.
Respondent disallowed the deduction taken by petitioner in the amount of $ 12,284.94 and treated the expenditures as "the cost of fixed assets the cost of which is capitalized by this adjustment."
Petitioner is entitled to a depreciation deduction computed as follows:
| Depreciation | ||||
| Cost | rate | Period | Amount | |
| Stereotype machinery | $ 10,081.53 | 6 2/3% | 6 mos | $ 336.05 |
| Other machinery and equipment | $ 1,529.31 | 10% | 6 mos | 76.47 |
| Furniture and fixtures | 628.91 | 5% | 6 mos | 15.72 |
| Total | $ 12,239.75 | $ 428.24 |
OPINION.
Petitioner made expenditures for newspaper machinery, equipment, and office furniture during its fiscal year ending October 31, 1948, in the amount of $ 15,897.80. Of this amount, $ 3,658.05 is the proceeds from the sale of property originally demised under the leases wherein petitioner was lessee and Perkins Brothers Company and The Tribune Company were lessors. By the leases' terms petitioner was bound to account to the lessors for the proceeds from the sale of said originally demised*134 property, but it was permitted under those terms to use the proceeds from such sales of equipment in the purchase of replacements and additions and improvements. In its income tax return for said fiscal year petitioner deducted the difference between the two amounts, $ 12,284.94, as "Maintenance of Plant." The controversy arises because the Commissioner in his *662 determination of the deficiency here involved has disallowed this amount as an ordinary and necessary business expense and has in said deficiency determination capitalized the expenditures and permitted recovery thereof upon a depreciation basis only.
Relying on the rationale of ; ; ; and , petitioner contends that expenditures here involved should be held by us to be ordinary and necessary business expenses and deductible in their entirety in the year paid. Respondent contends that the amounts paid by *135 petitioner are capital expenditures and, therefore, must be recovered by way of depreciation over the life of the equipment and furniture thereby acquired or over the remaining term of the leases, whichever is the lesser period. Two of the cases cited by petitioner, , and , are railroad cases and involve the retirement system of accounting which is permissible in the case of railroads. See , affd. .
, is not a railroad case it is true, but it has no application to the facts at bar because the expenditure there involved was a lease-end expense which the taxpayer there elected to pay in its entirety prior to the expiration of the lease term. Decision there turned upon the proposition that the expenditure involved would represent no acquisition of or investment in a capital asset on the part of the taxpayer and that there was, therefore, no cost to be recovered by way of depreciation. ,*136 is distinguishable on the facts.
The assets acquired by the expenditures here involved, all of which have a useful life in excess of 1 year, must in their nature be held to be capital assets, the cost of acquisition of which may be recovered by petitioner only by way of depreciation over their useful life or the remaining term of the leases, whichever is the lesser. Having so held, it is unnecessary for us to determine whether or not the leases involved imposed an obligation upon the petitioner to make the expenditures here sought to be expensed. It is also unnecessary for us to determine the effect of the state court's decision with respect to petitioner's lease obligations.
In determining the deficiency the respondent capitalized $ 12,284.94 of the $ 15,942.99 expended by petitioner in acquiring newspaper machinery, equipment, and office furniture during the taxable year. However, the respondent allowed depreciation computed on a basis of $ 15,942.99 instead of $ 12,284.94. At the hearing the parties agreed that if the respondent's action in capitalizing the $ 12,284.94 was sustained the depreciation allowed by respondent would have to be *663 adjusted and the allowance*137 computed on the capitalized basis. The respondent has conceded that of the amount capitalized by him $ 45.19 represented repairs. The deficiency, when computed hereunder, owing to respondent's concession as to the second issue, will be within the total deficiency determined by him. Accordingly, depreciation is allowable as set out in our findings.
Decision will be entered under Rule 50.