*1987 Value of a lease for invested capital purposes and amounts of annual deduction for exhaustion of the lease determined.
*968 This proceeding was brought for the redetermination of deficiencies in income and profits taxes for the years 1919 and 1920 in the amounts of $35,647.84 and $30,772.39, respectively.
The issues are (1) at what valuation, if any, a certain leasehold acquired by petitioner at the time of its organization should be included in petitioner's invested capital; (2) what amount, if any, petitioner is entitled to deduct annually from income on account of the exhaustion of its equity in the leasehold; (3) whether in the determination of the deficiencies in tax petitioner is entitled to a credit on account of taxes previously assessed and paid.
In its petition petitioner claimed the right to special assessment under the provisions of sections 327 and 328 of the Revenue Act of 1918, but has abandoned this claim.
FINDINGS OF FACT.
The petitioner was incorporated on or about December 15, 1915, under the laws of the State of New*1988 Jersey, for the purpose of leasing and operating a hotel in Newark, N.J. It was capitalized in the sum of $150,000 of preferred capital stock and $150,000 of common capital stock, each share having a par value of $100.
On or about December 24, 1912, the Fidelity Trust Co. of Newark, N.J., as executor and trustee under the last will and testament of Philip N. Jackson, deceased, gave an option to John Monteith, Waldo C. Genung, and Herman C. Schneider to purchase the premises known as 48-50 Park Place, Newark, N.J., which were owned *969 by the estate of Philip N. Jackson, deceased. Monteith was a lawyer of ability, Genung was the head of a concern dealing in builders' supplies, and Schneider was a builder. The instrument granting the option provided that for and in consideration of $7,500 paid by Monteith, Genung, and Schneider, the trust company, if requested in writing so to do, would within a period of sixty days from date of the agreement, but not afterward, and upon the further payment of $2,500, enter into a contract of sale of the property with the three said individuals. It was agreed that the contract of sale would provide that the trust company would sell and*1989 convey by an executor's deed to the three individuals the said premises for the purchase price of $192,500, of which amount the above mentioned $2,500 should be in part payment. It was agreed that within a certain specified time Monteith, Genung, and Schneider would erect on the premises a building of a style and character to be approved by the trust company and to cost not less than $200,000. It was agreed further that the contract of sale should provide that the deed to the premises should be delivered only after the completion of the proposed building to the satisfaction of the trust company and after proof that the entire cost thereof had been paid. The option agreement also provided that upon delivery of the deed by the trust company the three said individuals would execute and deliver to the trust company their bond for $200,000 to be secured by a purchase money mortgage on the premises, to carry interest at the rate of 5 per cent per annum and to contain the usual tax, insurance and interest clauses, whereupon the trust company would, in addition to the delivery of the deed, pay to the three individuals the sum of $10,000, less the interest on $190,000 at 5 per cent per annum*1990 from the date Monteith, Genung, and Schneider went into possession of the premises.
On or about February 24, 1913, Monteith, Genung, and Schneider paid to the trust company the sum of $2,500 referred to in the option agreement and thereupon an agreement of sale was entered into between the said individuals and the trust company in accordance with the provisions therefor contained in the option agreement. The agreement of sale provided specifically that if the purchasers failed to perform any of the covenants by them to be performed at the time appointed therefor then, at the option of the trust company, the rights of the said three individuals in the premises would terminate and they would deliver up possession thereof to the trust company on demand. It was also agreed that Monteith, Genung, and Schneider would build a hotel on the said premises at 48-50 Park Place, Newark, N.J., in accordance with the provisions of the agreement of sale.
*970 Thereafter Monteith, Genung, and Schneider proceeded to erect a hotel building. They partially completed it to the extent that the framework and walls were up, the cement floors were in, the roof ready for tar paper and the tiling, *1991 the window frames in place, much of the rough plumbing completed and the elevator shafts installed. At this stage of completion, early in 1915, Monteith, Genung, and Schneider neglected to reimburse the trust company for taxes on the premises, as required by their agreement. Builders' and mechanics' liens of $104,444.96 and $4,594.15, respectively, had been filed against the property. The trust company, as trustee of the estate of Philip N. Jackson, therefore, pursuant to the terms of the agreement of sale, entered upon and took possession of the premises, including the incompleted building.
In order to protect the estate of Philip N. Jackson, deceased, the trust company advanced to it the sum of $52,500 and in consideration of this amount the estate settled the claims of the said lienors. Thereupon the trust company proceeded to organize a corporation, known as the Newark Hotel Investment Co., for the purpose of completing the building partially erected on the premises 48-50 Park Place. The Newark Hotel Investment Co. was organized with a capital of $500,000 and by agreement it issued to the trust company its mortgage on the incompleted building for the sum of $550,000. It*1992 reimbursed the trust company in the amount of the expenditures theretofore made on behalf of the estate of Philip N. Jackson in respect to the property and paid the balance of the purchase price of the land which the Jackson estate had not yet received from the original purchasers, namely, Monteith, Genung, and Schneider. The amount so paid by the investment company to the trust company was $263,808.24. Thereupon the Newark Hotel Investment Co. proceeded to complete the construction of the hotel at a cost to it of the sum of $729,797.82, making the total cost to the investment company of the land and completed hotel building the sum of $993,606.06. This total sum includes the amount of $52,500 which was advanced by the trust company to the estate of Philip N. Jackson to settle the builders' and mechanics' liens previously mentioned herein, but includes no other part of the cost of the building up to the time it was taken over by the trust company.
The hotel building was completed by the investment company about May 1, 1916.
On or about the 10th day of December, 1915, the Newark Hotel Investment Co. entered into an agreement with one Adam James Eckert by which the investment*1993 company leased to the said Eckert the premises 48-50 Park Place, Newark, N.J., together with the hotel being erected thereon, for a term of thirty years, beginning *971 May 1, 1916. The annual rental reserved in the lease was based upon the cost to the investment company of the land and completed hotel, viz., $993,606.06 and was at the following rates: 5 1/5 per cent of such cost for the first three years, 6 per cent for the next two years, and 7 per cent for each year of the term of the lease thereafter. The average annual rental for the 30-year term is $67,396.41. In addition to the cash rental reserved the tenant agreed to pay all taxes, water rates and charges, municipal assessments, light rates and charges, premiums for insurance and certain specified repairs. The tenant also agreed to furnish the hotel at a cost of not less than $125,000. Adam James Eckert, the tenant named in the lease, represented Frank A. Dudley, who was the president of the United Hotels Co. of America.
On or about December 20, 1915, Adam James Eckert assigned the said lease to the petitioner. The assignment agreement contained, among others, the following recitals and provisions:
Whereas, *1994 the said Company was formed for the purpose of developing and when developed to operate a first class fire proof hotel in the said City of Newark which would require an investment of about One Million Dollars, and
Whereas, said Eckert has heretofore submitted to this Company a proposition to sell, assign, transfer and set over to this Company the said lease from said Newark Hotel Investment Company to said Eckert together with all benefits and beneficial interests and opportunities for profit thereunder subject to the assumption by this company of all the liabilities assumed or enacted by said Eckert and his guarantor Frank A. Dudley thereby or thereunder, in consideration of the payment to said Eckert or his assigns of the sum of One Hundred Fifty Thousand Dollars on or before January 1, 1916 in cash or in fully paid and non assessable Common Capital stock of this Company, and
Whereas, the Company having fully considered the value of the said lease for its Corporate purposes and the value of the benefits and beneficial interest and the opportunities for profit therein and thereunder and having decided after investigation of said Eckert's as well as other propositions to secure*1995 the operation of a first class fire proof hotel in said City of Newark. And for this assignment of this lease and the consideration aforesaid the Robert Treat Hotel Company does hereby agree to pay to said Eckert or his assigns the sum of One Hundred and Fifty Thousand Dollars or at the option to issue and deliver to said Eckert or his assigns One Hundred and Fifty Thousand Dollars of the fully paid non assessable Common Capital Stock of this Company on or before January 1, 1916 and each party hereby agrees to do each and every other necessary act to fairly and completely carry out this agreement and the provisions thereof.
There were no brokers' commissions or extra bonuses paid in connection with making the lease or in connection with its assignment.
The completed hotel building was made of pressed brick and steel framework. It had a partial stone front, metal window frames and cement floors; was twelve stories high and had a frontage of 80 feet and a depth of from 360 feet to 365 feet. Park Place, on which the hotel is located, is one of the main streets of Newark and faces Military *972 Park. The hotel is within a quarter of a block of the tube trains from Newark*1996 to New York; it is on the artery of traffic to the center of Newark, namely, Broad and Market Streets, and to the Public Service Trolley terminal in the same block. These conditions obtained in 1915 when the hotel was being erected, and when the lease of the premises was executed. At that time there was no other first-class hotel in Newark.
At the date of the lease of the premises the Fidelity Trust Co., through the Newark Hotel Investment Co., controlled by it, was desirous of leasing the property to a responsible organization which would operate it as a first-class hotel. In fixing the rate to be paid by the tenant the investment company calculated that 5 per cent of the sums actually spent by it would be a satisfactory net rate of return on its investment in the property and that all cash rent over and above such 5 per cent would be set aside to take care of the depreciation of the building.
Upon taking possession of the completed hotel petitioner issued $150,000 of its common capital stock to Adam James Eckert as payment of the assignment of the lease to it by him. Petitioner thereupon made entries in its books debiting the lease with $150,000 and crediting common capital*1997 stock with $150,000. With these entries was the following explanatory note: "Common capital stock paid for lease."
The net income of petitioner for the years following the start of its business up to and including the end of the year 1920 was as follows:
| Year | Net income |
| May to Dec. 1916 | $13,914.80 |
| 1017 | 36,445.94 |
| 1918 | 49,212.55 |
| 1919 | 97,026.58 |
| 1920 | 95,384.08 |
These earnings were net profits after all charges of every kind had been paid and they were available for dividends. The petitioner regularly paid 8 per cent dividend on its preferred stock up to the time of the retirement of such preferred stock, about a year before the hearing of this proceeding. It paid $20 a share per year dividend on its common stock from 1917 or 1918 up to the year 1928, when a dividend of 150 per cent was paid in addition to the regular dividend of $20 per share.
The taxes paid by the petitioner on the real estate in question for the 11-year period from 1918 to 1928, both inclusive, were as follows:
| 1918 | $18,516.50 |
| 1919 | 21,709.00 |
| 1920 | 25,200.00 |
| 1921 | 25,267.20 |
| 1922 | 25,401.60 |
| 1923 | 25,267.20 |
| 1924 | $27,631.80 |
| 1925 | 27,631.80 |
| 1926 | 28,665.00 |
| 1927 | 29,846.25 |
| 1928 | 30,161.25 |
*1998 *973 The personal-property tax covering the personal property contained in the Robert Treat Hotel which was paid by the petitioner for each of such years was as follows:
| 1918 | $1,160 |
| 1919 | 1,360 |
| 1920 | 1,500 |
| 1921 | 1,504 |
| 1922 | 1,512 |
| 1923 | 1,504 |
| 1924 | $1,512 |
| 1925 | 2,268 |
| 1926 | 2,184 |
| 1927 | 2,274 |
| 1928 | 2,298 |
The fair value of the leasehold over and above the amount of the stipulated rent was $150,000 on May 1, 1916, the beginning of the term granted. At the beginning of 1919 the unamortized portion of this valuation was the sum of $136,666.67, and at the beginning of 1920 the sum of $131,666.67.
In determining the deficiencies in question the respondent disallowed the inclusion in petitioner's invested capital of the value of the leasehold claimed by petitioner and allowed nothing for such value.
For the years 1919 and 1920, respectively, the United Hotels Co. of America filed consolidated reports for itself and certain other corporations claimed to be affiliated, including the petitioner. In Schedule No. 7 of the consolidated returns amounts of taxes were allocated to the various corporations alleged to be affiliated. The allocation to the petitioner*1999 was $11,607.20 for the year 1919 and $9,731.13 for the year 1920. Affiliation of the Robert Treat Hotel Co. was denied by the respondent. The amount of tax for the respective years 1919 and 1920 allocated to the petitioner on the said consolidated returns was not credited to petitioner by respondent in the statement of deficiencies in question in this proceeding.
OPINION.
VAN FOSSAN: The evidence in this proceeding establishes that the rent reserved in the lease of the premises in question did not represent the full rental value. Therefore, when the petitioner issued and delivered its common capital stock of the par value of $150,000, in payment for the assignment of the lease, it acquired something of value for such payment which it was entitled to include in its invested capital. The problem which confronts us, therefore, is at *974 what amount to evaluate petitioner's equity in the leasehold at the beginning of the term granted by the lease. Petitioner claims this value to have been $270,000. Respondent allowed nothing.
The record of the hearing herein contains considerable opinion evidence, the purpose of which was to prove the value of the land and building*2000 at the time of their initial occupancy by the petitioner, namely, about May 1, 1916. The estimated values testified to by the opinion witnesses were considerably in excess of the sum of $993,606.06, which was the total cost of the premises to the lessor, the Newark Hotel Investment Co., and which was the amount on which the rental stipulated was based. These estimates of the value of the land and building as of May 1, 1916, were made in 1924 and 1925. In making a retrospective appraisal it is not easy to blot out of one's mind that which one knows as the subsequent history of the property and to visualize only the factors and conditions which existed some years before. For this reason such an appraisal is not generally to be taken as conclusive evidence of value. In this case certain factors made it especially difficult to ignore subsequent development. Thus, we are not satisfied to adopt the estimated values fixed by petitioner's witnesses. Neither does the evidence prove with precision the cost of the incompleted building which petitioner acquired.
There is, however, evidence of a satisfactory character substantiating a value of $150,000, the value placed on the leasehold*2001 by petitioner itself at the time of acquisition.
The assignment agreement recited that the Robert Treat Hotel Co. had considered the value of the lease for its corporate purposes and that it would, therefore, pay for the assignment $150,000 in cash or in fully paid, nonassessable common capital stock. The petitioner, the Robert Treat Hotel Co., issued said amount of common stock in consideration of the assignment of the lease to it and included the leasehold in its invested capital in the sum of $150,000. This appraisal of value made by the petitioner contemporaneously with its acquisition of the leasehold was, under the facts in evidence, a satisfactory determination of its fair value and in our opinion the evidence in this proceeding justifies this valuation.
We have found as a fact that the fair value of petitioner's equity in the leasehold on May 1, 1916, which was the beginning of the term granted, was $150,000, which sum should be included in invested capital as of May 1, 1916. This sum should be amortized at the rate of $5,000 annually for each of the thirty years of the life of the lease. Therefore, at the end of the year 1916 the unamortized value of said leasehold*2002 was $146,666.67. The unamortized portion of the value of the said leasehold to be included in invested capital for the *975 year 1919 is $136,666.67. The said sum of $5,000 is deductible from petitioner's income for each of the years 1919 and 1920 on account of the exhaustion of petitioner's equity in the leasehold. .
The remaining question for our determination is whether the amount of tax allocated to the petitioner on the consolidated returns for 1919 and 1920, respectively, which ware filed by the United Hotels Co., as stated in the findings of fact, should be credited to petitioner before the determination of any deficiency in tax for the years 1919 and 1920.
The term "deficiency" means the amount by which the tax imposed exceeds the amount of tax shown by the taxpayer on his return. Although the petitioner was denied affiliation with the United Hotels Co. for 1919 and 1920, we are of the opinion that the consolidated returns for 1919 and 1920, filed for and on behalf of the petitioner among other corporations, must be deemed to be petitioner's returns for those years within the meaning of the statute. Therefore, *2003 in accordance with decisions of this Board (; ; ) petitioner should be credited with the amount of tax shown by the consolidated returns for 1919 and 1920 to have been allocated to petitioner and paid, namely, for the year 1919 the sum of $11,607.20, and for the year 1920 the sum of $9,731.13.
Decision will be entered under Rule 50.