*2962 1. Value of leases at date of acquisition by petitioner determined.
2. Where a deduction for depreciation has been allowed upon the basis of a composite rate for a building and its appurtenances, no error is shown by proving that certain parts depreciate at a greater rate, without establishing that the composite rate is erroneous.
*1310 The Commissioner determined deficiencies in income and profits taxes of $2,406.08, $3,169.99, and $284.04 for the respective fiscal years ended January 31, 1921, January 31, 1923, and January 31, 1924. The petitioner instituted this proceeding for the purpose of securing a redetermination of its liability. It alleged several errors, one of which was withdrawn, leaving for consideration the following:
(a) The failure of the Comissioner to allow as an item of invested capital for the fiscal years ended January 31, 1921, and January 31, 1922, the value of two certain leases acquired by the taxpayer as at the date of its organization, July 1, 1913, from the predecessor partnership.
(b) *2963 The failure of the Commissioner to allow as a deduction from gross income, in all years, depreciation upon the leasehold so acquired by the taxpayer from its predecessor.
(c) The failure of the Commissioner to allow as a deduction from gross income, in all years, depreciation actually sustained upon the furniture and fixtures of the taxpayer.
(d) The failure of the Commissioner to allow as a deduction from gross income, in the years 1923 and 1924, depreciation upon component parts of the equipment of a new building erected by the taxpayer, at rates sufficient to return to the taxpayer over the normal useful life of that equipment, its cost.
(e) The failure of the Commissioner to allow as a deduction from gross income in the years 1923 and 1924, depreciation upon the new building of the taxpayer, at the rate of three per cent per annum.
FINDINGS OF FACT.
The petitioner is a corporation organized July 1, 1913, under the laws of Ohio.
*1311 In 1894 Solomon M. Levy established at the northwest corner of Long and High Streets, in the City of Columbus, Ohio, a retail establishment, operating as a sole proprietorship and dealing in men's and women's clothing. In*2964 January, 1906, one Weiler became associated with Levy as an equal partner and the business formerly conducted by Levy was thereafter continued as a partnership under the name "The Union Clothing Company." In June, 1913, Weiler's interest was repurchased by Levy. Levy paid Weiler one-half of the book value of the business and, in addition, $10,000. Levy immediately organized the petitioner and submitted an offer to sell the business in its entirety to petitioner in exchange for all of its capital stock, being of a par value of $300,000, one-half preferred stock and the other one-half common stock. Included among the assets transferred by Levy to petitioner were two leases, expiring March 31, 1924, upon the premises in which the business of the petitioner was conducted. These leases were assigned to the petitioner by Levy on July 7, 1913, at which date they had a fair market value of $35,000. In computing invested capital for the fiscal year ended in 1921, the Commissioner refused to allow any value for such leases and, in computing petitioner's taxable net income for its fiscal years ended in 1921, 1923, and 1924, the Commissioner refused to allow any deduction for the exhaustion*2965 of such leaseholds.
At its organization on July 7, 1913, the petitioner acquired furniture and fixtures of an actual cash value of $50,862.14. Such assets were set up on its books of account in a furniture and fixtures account at $50,862.14. From July 7, 1913, to January 31, 1916, there were additions to such account of $7,000.72. During such period there was charged off against such account as depreciation, $5,166.77. During such period there were other purchases of furniture and fixtures which were not charged to such account but charged off as expense. The amounts so charged off as depreciation, together with the cost of furniture and fixtures charged off as expense, were equivalent in amount to the depreciation sustained upon the petitioner's furniture and fixtures. In computing invested capital for the fiscal year ended in 1921, the Commissioner has reduced the furniture and fixtures account, as shown on the books of the petitioner as of January 31, 1916, by additional depreciation claimed to have been sustained between July 7, 1913, and January 31, 1916, and not written off the books.
In 1922 the petitioner started construction work upon a new building. In the construction*2966 of such building there was expended, among other amounts, $25,134.08 for plumbing and heating, $5,646.85 for a lighting system, and $36,863.24 for elevators. Such items had an average life of from 10 to 12 years. In computing taxable net *1312 income the Commissioner allowed petitioner a composite rate of depreciation upon said new building of 3 per cent per annum.
OPINION.
PHILLIPS: The first question with which we are concerned is the value on July 7, 1913, of two leaseholds which constituted a part of the assets assigned to petitioner in exchange for its capital stock. Under the provisions of section 326 of the Revenue Act of 1921, petitioner is entitled to include the actual cash value thereof in the computation of its invested capital, and under the provisions of section 214(a)(8) is entitled, in computing taxable net income, to deduct a reasonable allowance for the exhaustion of such assets. ; . For the purpose of proving the value of such leaseholds petitioner adduced by deposition the evidence of two real estate dealers. The first of these witnesses expressed*2967 the opinion that these leaseholds had a value of from $75,000 to $85,000 at the basic date. His testimony was based upon his recollection of the results of certain computations which he had made at a previous time, which computations had been lost and the basis of which he was unable to recall. It does not appear that in making such computations he had the leases before him or was familiar with all of their terms. The question put to him, in answer to which he stated his opinion of the value of these leases, failed to state the terms of the leases. Without the lost computation he was unable to state the basis upon which he arrived at the value which he assigned to these leases.
The second witness expressed his opinion that the leaseholds had a value at the basic date of $100,000, but his testimony was badly shaken upon cross-examination, and the value assigned does not appear to be supported by his testimony with reference to other leaseholds made about the same time and upon the basis of which he testified he arrived at his value. The weight to be attached to his testimony may perhaps be gained from the following statement made on cross-examination:
I told you I did not*2968 have any time to prepare anything this morning or last night. A fellow walks in on me at half past five or a quarter after five and calls me in here this morning, and I am liable to make some slight error in a complicated thing like this, not knowing the particular circumstances.
We are not satisfied to accept the valuation placed upon these leaseholds by either of these witnesses. We are satisfied, however, that these leases, executed several years prior to 1913, did have a substantial value in the latter year as shown by leases executed at or about that time on the other property in the neighborhood. Considering *1313 the testimony regarding such other leases and the fact that Levy, a week or two prior to the assignment of these leases to the petitioner, had purchased the one-half interest of his partner at its book value plus $10,000, we are of the opinion that on July 7, 1913, these leaseholds had an actual cash value of $35,000. Invested capital and taxable net income should be adjusted accordingly.
The next issue relates to the action of the Commissioner in reducing the petitioner's invested capital for the fiscal year ended in 1921 for depreciation claimed to*2969 have been sustained between July 7, 1913, and January 31, 1916, and not written off on the books. While the depreciation charged off on the petitioner's books during that period would appear to have been insufficient, the uncontradicted testimony is that there were additions made during that period which were never added to the account and which, together with the depreciation written off, were sufficient to maintain the assets at the figure carried on the books. In such circumstances we are of the opinion that the Commissioner erred in reducing invested capital for alleged insufficient depreciation. ; ; ; .
The petitioner also alleged that the Commissioner committed error in failing to allow depreciation upon plumbing, heating and lighting system, and elevators in its new building at the rate of 10 per cent per annum and upon the remaining cost at 3 per cent per annum. the Commissioner allowed a composite rate of 3 per cent upon the entire cost of the building, including the installations*2970 in question. The statute provides that a reasonable allowance shall be made for depreciation. Here the only testimony that we have is that during 1922 and 1923 certain sums were expended for the installations in question, and that these have a life of from 10 to 12 years. This is insufficient to establish any error on the part of the Commissioner in allowing a composite rate of 3 per cent upon the cost of the entire building. In attacking a composite rate of depreciation it is not sufficient that the petitioner may be able to pick out certain parts and prove that if such parts were considered separately a greater depreciation rate should be allowed. The composite rate is based upon an average life for all of the parts and until error in the average is shown there is no basis upon which it can be said that the amount allowed is not reasonable.
Decision will be entered under Rule 50.