*3707 1. Loss sustained in 1919 from the disposition of capital assets which were acquired for use in petitioner's regular business and which were disposed of during the continuation of this business and not in suspension thereof, held to be a loss sustained in the operation of a business and, therefore, to be included as a part of petitioner's "net loss" for 1919.
2. It does not necessarily follow, from the mere fact that the foregoing assets were not used during the period when held, that no depreciation was sustained thereon during this period.
*862 The Commissioner determined a deficiency in income and profits tax for the calendar year 1920 in the amount of $4,065.73. Petitioner contends that the Commissioner erred in holding (a) that a loss *863 arising out of transactions with respect to a sand plant and equipment was sustained in the year 1919, rather than in the year 1920; (b) that this loss was no part of the net losses as contemplated by the provisions of section 204 of the 1918 Act; and (c) *3708 that depreciation should not be computed for prior years in the computation of such loss.
FINDINGS OF FACT.
Petitioner is a New Jersey corporation with principal office at Trenton.
May 2, 1913, the Cable Excavator Co. wrote a letter to petitioner, the pertinent parts of which are as follows:
We propose to furnish you all the labor and material required to install ready for operation one (1) of our type "D" - #3 CABLE EXCAVATORS with main cable - 700 ft. long.
This plant is GUARANTEED TO dig, screen and wash fifty (50) tons of sand and gravel per hour, and to crush the oversize down to 1 1/2" material suitable for marketing. The operating unit costs of production on this plant including labor, fuel and supplies is guaranteed not to exceed Six ($.06) cents per ton under average conditions.
* * *
We propose to furnish all the above as specified, GUARANTEE installation and material; for the sum of:
TWENTY-TWO THOUSAND DOLLARS --- ($22,000.00) payments to be agreed upon later, but to be practically 60% of contract price upon presentation of bills-of-lading for material and as work progresses.
Subsequently, the petitioner replied in a letter which read in part as*3709 follows:
We herewith accept your proposition to furnish all labor and material required to install ready for operation, one complete cable excavator together with screening and washing plant, electric conveying car, trestle, etc., as set forth in your proposal of May 2nd, 1913.
We wish you would furnish us with an approximate schedule of about the time payments would be due on this proposition (time and amounts) so that we may govern ourselves accordingly.
On May 9, 1913, the Cable Excavator Co. replied to the above letter as follows:
In reference to Mr. J. Walter Miller's letter of acceptance of May 27th (7th), which we are pleased to acknowledge, we would expect the payments to be made as follows:
| On arrival of tower lumber and completion of tower foundations | $3,200 |
| which would probably be about the 26th of May. | |
| On arrival of boiler, stationary engine and crusher | 1,800 |
| which would probably be about June 9th. | |
| On arrival of hoisting engines | 1,500 |
| which would probably be about June 16th. | |
| On arrival of bucket and cables | 1,000 |
| which would probably be about June 20th. | |
| On arrival of screen | 400 |
| which would probably be about June 25th. | |
| Upon completion of tower construction | $1,000 |
| which would probably be about June 30th. | |
| Upon the arrival of the lumber for the trestle and the foundations being put in for the trestle | 1,500 |
| which would probably be about July 7th. | |
| Upon arrival of the pump, pipe and Railroad rails | 1,800 |
| which would probably be about July 21st. | |
| Upon the arrival of the electric car | 1,000 |
| which would probably be about Aug. 4th. | |
| The balance to be paid within thirty (3) days from the time the plant is ready for operation. |
*3710 *864 The plant was completed in the latter part of 1913, and a test run was made that fall.
On December 16, 1913, the petitioner wrote the following letter to the Cable Excavator Co.:
With further reference to our final acceptance of the Gravel Plant which you erected for us at Fieldsboro, N.J., would say that after taking the matter up with our Board of Directors they have instructed me to write you as follows:
Under the Contract which we entered into with you under date of May 2nd, you guaranteed the plant to dig, screen, wash, and load 50 tons of sand and gravel per hour. The operating cost of production including labor, fuel, and supplies was guaranteed not to exceed .06 per ton.
The plant as at present constituted will not do this and we are under the impression that the plant is 50% too small for the capacity expected of it.
They have instructed me to advise you that the plant is now yours to demonstrate that same will dig, wash, screen, and load 500 tons per day of 10 hours, at a cost not to exceed .06 per ton.
We have done our best at a great expense to pur plant into thorough working condition, which should have been done by you, and the best we can*3711 do with it is not more than 200 tons per day.
We shall now expect you to demonstrate to us that the plant will produce 500 tons of marketable material and load on cars at a cost not to exceed .06 per ton.
The day after this letter was sent the petitioner against started the plant on a test run.
During the winter, on account of freezing conditions, the plant and equipment remained in a state of rest until spring, when another test was made. Thereupon the Cable Excavator Co. conducted a test of its own and then demanded the balance due on the contract in the amount of $8,840.59. The petitioner refused to pay the money and the Cable Excavator Co. brought suit in the District Court of the United States on September 2, 1914.
After the completion of the tests conducted by the Cable Excavator Co., but before suit was brought, the petitioner made some further experiments and spent $5,419.37 in an unsuccessful endeavor to make the plant serviceable.
In making the tests the plant was operated for a period of days under approximated operating conditions to determine whether or not the material could be dug, washed and screened and the oversize *865 reduced to 1 1/2 inches*3712 at the guaranteed cost. In each of these tests the plant failed to produce the guaranteed results. The plant was never in regular operation and from the time the tests were completed until the time suit was brought the plant was never used. It was not used thereafter. The product obtained from the test runs was marketed.
The outlay of the petitioner respecting the sand plant and equipment was as follows:
| Contract price, plus extras and less allowances | $22,208.47 |
| Balance of said amount never paid by taxpayer | 8,840.59 |
| Amount paid the Cable Excavator Co | 13,367.88 |
| Additional amounts expended to make plant serviceable | 5,419.37 |
| Total outlay | 18,787.25 |
The petitioner filed an answer and counter claim in the suit brought against it, denying that the plant was completed in accordance with the agreement and demanding damages of $37,637.52 occasioned by a loss of contracts made in reliance on the Cable Excavator Co.'s fulfillment of its agreement.
This suit was pending for about three years and on December 12, 1917, an order of discontinuance was entered pursuant to a settlement between the parties. The agreement was as follows:
MEMORANDUM OF AGREEMENT, *3713 made this sixteenth day of November, A.D. one thousand nine hundred and seventeen, by and between Jones Phillips, John C. Lawrence and Alvah D. Hadsel, doing business under the name of The Cable Excavator Company, of the first part, and Independent Brick Company, of the second part;
WHEREAS, the party of the first part heretofore installed in a certain apparatus for the party of the second part; and
WHEREAS, action has been brought in the United States District Court for the District of New Jersey by the party of the first part against the party of the second part to recover the sum of Eight thousand, eight hundred forty dollars and fifty-nine cents ($8,840.59), claimed as the balance due for said installation; and
WHEREAS, the parties hereto are desirous of discontinuing the said action and adjusting the matters as hereinafter set forth;
NOW THEREFORE, THIS AGREEMENT WITNESSETH, that in consideration of the premises, of the covenants herein contained, and of the sum of One dollar each to the other well and truly paid, the parties hereto have agreed as follows:
FIRST: The action instituted by the party of the first part against the party of the second part in the United States*3714 District Court for the District of New Jersey shall be discontinued without payment of costs by either party to the other.
SECOND: The party of the first part is to endeavor to dispose of the plant installed by them upon the land of the party of the second part, and to that end the party of the second part gives to the party of the first part permission to take the plant in its present condition, to make such repairs as may be necessary, to dispose of the same at a figure satisfactory to them, and after deducting *866 from the money realized the sum of Eight thousand, eight hundred forty dollars and fifty-nine cents, to divide the balance received for the sale of said apparatus equally between the parties hereto, and to all of this the party of the first part agrees in settlement and satisfaction of the differences heretofore existing between the parties.
THIRD: The party of the second part consents that the plant may remain upon its property pending such sale.
This agreement is executed in duplicate.
IN WITNESS WHEREOF, the parties hereto have hereunto by their duly constituted agents, set their hands and seals the day and year first above written.
This agreement*3715 was carried out as executed and on November 25, 1919, the Cable Excavator Co. wrote the following letter to the petitioner:
In reply to your letter of the 20th, we have prepared and are enclosing herewith a statement showing amount received for sale of machinery and equipment at Fieldsboro, N.J., and also our expense in getting this matterial out, from which you will note our net receipts were $6,220.60.
We note from agreement entered into between your Company and ourselves dated Nov. 16, 1917, that any amount we received over $8840.59 we were to divide equally with you.
We trust you will find this statement correct.
Attached thereto was a list of the various items sold, their selling price, and the dates of sale, ranging from December 19, 1917, to September 29, 1919.
The officers of the petitioner expected that it would receive something from the sale of the plant and when the above letter was received they went over the matter with the general superintendent. A check-up showed that some things had not been disposed of. However, there remained merely odds and ends consisting of cables, sheave wheels, one or two buckets and some other miscellaneous materials for which*3716 there was not much demand. The principal items had all been disposed of. The petitioner had some communication with the Cable Excavator Co. after the receipt of the above letter and in 1920 asked for some modification of the statement contained in the letter, but in June, 1920, the petitioner conceded that under the agreement of November 25, 1919, as carried out by the subsequent sale of the property, it was not entitled to receive any money from the sale of the property and no further accounting was ever asked for.
Exclusive of the loss sustained respecting the sand plant and equipment, the petitioner sustained a net loss from operations during 1919 in the amount of $3,137.26, all of which the Commissioner applied against 1920 income, and now makes no contention that he did so erroneously.
The Commissioner in his final determination for the year 1920 added $18,787.25 to the petitioner's net income as shown by its books, on account of the sand plant and equipment, which addition he *867 explained in these words: "Inasmuch as the plant bacame obsolete in 1919, the loss has been applied in that year."
For 1919, the Commissioner's statement is in part as follows:
| Net loss reported | $465.64 |
| Add: | |
| (1) Loss sand plant and equipment | 9,393.62 |
| (2) Reserve for taxes | 996.17 |
| (3) Additional depreciation | 2,185.29 |
| Total | 13,040.72 |
| Less: | |
| (4) Depletion disallowed | 509.84 |
| Adjusted net loss | 12,530.88 |
| Less: | |
| (5) Capital loss, sand plant, and equipment | 9,393.62 |
| Net loss to be applied 1920 | 3,137.26 |
| EXPLANATIONS. | |
| (1) Loss on sand plant and equipment is computed as follows: | |
| Cost | $18,787.25 |
| Less depreciation from 1914 to 1918, inclusive | 9,393.63 |
| Net loss | 9,393.62 |
* * *
(5) This office holds that this loss is not an operating loss and, therefore, cannot be applied against the net income for 1920. (Section 204 of the Revenue Act of 1916.)
OPINION.
LITTLETON: Petitioner claims a loss of $18,878.25 was sustained in the year 1920. The Commissioner allowed it for the year 1919, but deducted depreciation. All but a small portion of the plant and equipment had been disposed of by the last of November, 1919. The amount realized from this sale was $2,619.99 less than the amount which, if realized, was to go exclusively to the Cable Excavator Co. Although a few odds and ends remained the disposition of them did not reduce the amount of the loss and apparently it was known in 1919 that it would not. Petitioner, after November 25, 1919, was seeking some further adjustment with the Cable Excavator Co., but on what basis we do not know. It may have had some hope of saving something from the wreck, but optimism can not delay the date when a loss is sustained. *3718 ; . The Commissioner has allowed the loss in 1919, and we have no reason to change his determination in this respect.
The next question is whether the loss sustained with respect to the aforementioned sand plant and equipment may be added to the agreed loss from operations and thus arrive at a total "net loss" resulting *868 from the operation of a business regularly carried on by the petitioner, as provided in section 204 of the Revenue Act of 1918. The Commissioner denied the petitioner the benefit of the loss on the sand plant and equipment as a part of its "net loss" on the ground that it was a loss from the sale of capital assets and, therefore, not an operating loss, whereas petitioner contends that since the cause of the loss resulted from a transaction entered into in furtherance of its business, the loss was in connection with the operations of its business and, therefore, should be included in its "net loss" for 1919. While we do not have the most satisfactory evidence as to the exact character of petitioner's business, *3719 we do have the fact that this is a brick company and that the greater part of the losses which were assigned as the basis of the counterclaim which petitioner set up, when suit was brought against it for the balance of the purchase price of the sand plant, was on account of losses alleged to have been sustained on contracts for supplying sand and gravel in various building operations. The machine in question was purchased "to dig, screen, wash and load" sand and gravel. To the extent that marketable sand was produced in the test operations, this sand was sold by the petitioner. No question is raised by the Commissioner that the asset in question was not purchased for use in petitioner's regular business. In view of the foregoing facts, when considered in the light of the entire record in this case, the Board is of the opinion that this was not a new or unrelated venture in which the petitioner sought to engage outside of its regular business, but rather an acquisition of an asset which was to be used in the business which the petitioner was regularly engaged in carrying on.
With respect to the point raised by the Commissioner that a loss on the sale of a capital asset can not, *3720 under any conditions, form a part of a "net loss," the Board has already held against such a position in . There capital stock of another corporation had been purchased in furtherance of the company's advertising business in which it was engaged. The stock became worthless in 1919 and the Board allowed the loss on account thereof as a part of the loss from the operation of the company's business for 1919, and, accordingly, an item to be included in determining its "net loss" for that year. The capital stock there in question was none the less a capital asset than the sand plant and equipment involved in this case. Both were purchased in furtherance of businesses regularly carried on, and were incident to the production of income in each instance. We think no different rule should be applied in the two cases and, consequently, we are of the opinion that the Commissioner's position on this point is not well taken.
*869 The foregoing view is distinguishable from the principle laid down in *3721 , and in , wherein the losses involved were losses which occurred on the sale of plant and equipment in the "suspension of business," rather than in the "operation of any business regularly carried on." Nor is our holding in this case inconsistent with the fact that two classes of losses are allowable as "net losses" under section 204, supra, one from operations and the other from the sale of capital assets purchased for the production of articles contributing to the prosecution of the war, for the reason that the production of articles contributing to the prosecution of the war often meant a new venture, outside of a taxpayer's regular business, which was terminated with the war. Had not specific provision been made for such losses, the considerations which led to the disallowance in the Auburn & Alton Coal Co. case would have prevented such an allowance in many cases. Losses in such instances would result more from the suspension of a business than from the operation of a business regularly carried on. In this case we are dealing with losses which*3722 occurred in the continuity of a taxpayer's regular business and where the loss on the sale of a capital asset may as properly be called an operating charge as any other expense incident to the operation of the business.
It remains only to determine whether, in computing the amount of the loss in 1919, depreciation on the sand plant and equipment from 1913 to 1919 should be taken into consideration. The Commissioner deducted depreciation from 1914 to 1919, inclusive, whereas the petitioner contends that no depreciation should be deducted. The only evidence introduced with respect to depreciation, and that on which the petitioner relies, is that these assets were not used other than in the test operations in 1913 and 1914, and from this we are asked to find that the entire expenditure should be allowed as a deduction when the plant and equipment were finally disposed of. We do not regard this as sufficient. Depreciation is a question of fact. When property is being subjected to use, the depreciation sustained may be greater than that which is sustained when the property is not being used, though many authorities contend that depreciation may be greater in the latter case. All*3723 are agreed, however, that the care of the property in both cases is an important factor. No evidence was here introduced as to how this property was cared for. We have held that this property was acquired for use in petitioner's business and was so held until finally disposed of under the compromise agreement. The Commissioner has found that depreciation was sustained and since we are unable to say, from the mere fact that the property was not being used, that no depreciation was sustained in *870 any of the years from 1914 to 1919, we must sustain the prima facie correctness of the Commissioner's determination.
Reviewed by the Board.
Judgment will be entered on 10 days' notice, under Rule 50.
MURDOCK, dissenting: I dissent from that part of the prevailing opinion which allows a loss sustained with respect to the sand plant and equipment as a part of the "net loss" under section 204(a)(1) of the Revenue Act of 1918. In case a petitioner claims a "net loss" under this section and the Commissioner denies the "net loss" for the reason that it is not an operating loss, it is incumbent upon the petitioner to show what its business was and to show*3724 the relation of the particular transaction in question to the business which it regularly carried on in that year so that we can determine whether or not it can be said that the loss resulted from the operation of that business.
In the present case we not only do not know how the transaction in question was related to any business regularly carried on by the petitioner during the taxable year, but we do not even know what the business was which the petitioner regularly carried on during the taxable year. The prevailing opinion infers from the name of the petitioner that the company was engaged in the brick business. That opinion also seems to draw some support from allegations made by the petitioner in a counterclaim in a suit brought against it for the balance of the purchase price of the sand plant. Even in that proceeding those allegations would have required proof and in this proceeding they are mere self-serving declarations having no probative value.
From all of the facts in evidence I am unable to form any opinion as to whether or not a loss on the sand plant and equipment was a "net loss." If additional facts had been proven they might well have shown that this was*3725 a "net loss," but, on the contrary, it is quite possible that, consistent with the facts already proven, other facts existed which would have shown that this was not a "net loss" because it did not result from the operation of any trade or business regularly carried on by the taxpayer. In the absence of proof of these facts, I am not willing to make any assumption in regard to them.
STERNHAGEN concurs in the dissent.