Appeal of Estate of Riggs

*670OPINION.

James:

The taxpayer claims an allowance for exhaustion of its leasehold and the improvements thereon of a capital sum of $178,500 over a period of 13‡-§ years, from March 1, 1913, to the expiration of the lease, or an annual deduction of $12,903.61 as against $5,000 allowed by the Commissioner.

We have decided that a leasehold is property subject to exhaustion. Appeal of Grosvenor Atterbury, 1 B. T. A. 169; Appeal of Hotel De France Co., 1 B. T. A. 28; Appeal of Royal Collieries Co., 1 B. T. A. 369. That a leasehold is property subject to exhaustion has been held in Lynch v. Alworth-Stephens Co., 267 U. S. 364.

The remaining question, then, is whether the taxpayer’s computation of the exhaustion is correct, that is, whether the actual value and the term are as alleged, and on this we have found it to be a fact that the value of the leasehold and improvements on March 1, 1913, was $178,500, the amount claimed by the taxpayer, and the period is 13 yf years, that i.s, the period from March 1, 1913, to-December 31, 1926. The deduction for exhaustion of the leasehold should, therefore, be increased by the amount of $7,903.61 as claimed by the taxpayer.

The taxpayer also claims the right to exhaust the value which it had expended in furniture and fixtures as of March 1, 1913, in the amount of $33,859.87, less a salvage value of 15 per cent thereof, or $5,078.97, the balance of $28,780.90 likewise to be exhausted over 13j4r years, or in the amount of $2,080.54 annually.

The Commissioner has refused to allow any deduction on account of this exhaustion, for the reason that the taxpayer admits having *671charged all replacements and repairs to expense and that the result of an allowance for exhaustion would, therefore, be a duplication of deduction.

In our opinion neither the position of the taxpayer nor that of the Commissioner is correct. The taxpayer, in effect, contends for the exhaustion of its initial value of furniture and fixtures over the term of the lease, although the life of a large portion of this equipment is less than the term of the lease, and the right in addition to charge off, year by year, all, replacements, renewals, and repairs to the expense of the year. By this process the taxpayer would find himself, at the termination of the lease, in possession of the full equipment of a restaurant in virtually new condition, which he would be able to dispose of at a much greater sum than the estimated 15 per cent residual value. The Commissioner, on the other hand, denies the taxpayer all deductions on account of exhaustion of the March 1, 1913, value of the equipment, upon the sole ground that the equipment is kept virtually in a new condition by means of rapid renewals, replacements, and repairs. This argument is manifestly unsound, since all property which is used at all is kept in good condition by the same process, and this argument would result necessarily in the disallowance of all deductions on account of exhaustion, contrary to the specific language of the statute. The correct method of accounting and of claiming the deductions in question should have been for the taxpayer, year by year, to have estimated his exhaustion allowance upon the various kinds of property separately and on the life of that property or the life of the lease, whichever was shorter, and to have set up a corresponding depreciation reserve. To that reserve should have been charged all renewals and replacements, while repairs should have been charged entirely to expense. Additions to the equipment under a correct method would have been capitalized. ^Replacement costs per unit in excess of the cost on March 1, 1913, would, as they occurred, have been capitalized. Since the taxpayer was constantly approaching the termination of the lease, the exhaustion period as to replacements would also be constantly shortening, so that to a greater and greater extent the exhaustion of property acquired would be based upon the life of the lease instead of the life of the property. Neither the taxpayer nor the Commissioner, however, has suggested such a method, and we are not able to determine from the evidence submitted by the taxpayer the extent to which he has recovered by deduction the original value of furniture and fixtures as of March 1, 1913. It is in evidence, however, as to the item of linen, that at some time prior to the taxable year in question the. taxpayer ceased to employ linens owned by him and adopted a plan *672of rental, so that, at least as to these items, a complete loss was ascertained at some time between March 1, 1913, and the beginning of the taxable year here in question. Evidence was also’ introduced as to the breakage of crockery, one specified item of bread plates being mentioned upon which the replacement was alleged to have been 50 dozen per month. No doubt substantially all of the original value on March 1, 1913, was replaced and charged to expense long prior to the beginning of the taxable year. Even chairs and tables in restaurants are subject to severe usage, although we are without specific evidence as to the life of this class of equipment in the restaurant here in question. Upon the entire record, however, we are of the opinion that the taxpayer has failed to prove himself entitled to the deduction for exhaustion of equipment in the amount claimed, of $2,080.54, and the action of the Commissioner in respect of this item is confirmed.

ARUNdell not participating.