19 T.C. 305 (1952), 13993, Hens & Kelly, Inc. v. C.I.R.

Docket Nº:13993.
Citation:19 T.C. 305
Opinion Judge:TURNER, Judge:
Attorney:Fred R. Tansill, Esq., and Richard L. Shook, Esq., for the petitioner. Clay C. Holmes, Esq., for the respondent.
Judge Panel:ARUNDELL, J., dissenting: OPPER, J., agrees with this dissent.
Case Date:November 25, 1952
Court:United States Tax Court

Page 305

19 T.C. 305 (1952)




No. 13993.

United States Tax Court.

November 25, 1952

Fred R. Tansill, Esq., and Richard L. Shook, Esq., for the petitioner.

Clay C. Holmes, Esq., for the respondent.

1. Petitioner owns and operates a department store. It acquired the business, including good will, on April 1, 1940, in a reorganization within the meaning of section 112(g)(1) of the Internal Revenue Code. Hens & Kelly Company, one of the corporations consolidated to form the petitioner, acquired the business, including good will, on December 31, 1909, and in exchange for its common stock and a part of its preferred stock, from a predecessor corporation. Held, that the good will so acquired is includible in petitioner's equity invested capital, under section 718(a)(2) of the Code, as its basis for determining loss upon sale or exchange; that such basis to petitioner was its loss basis to petitioner was its loss basis to Hens & Kelly Company, which basis was its cost; and, on the facts, that the cost of the good will to Hens & Kelly Company when acquired on December 31, 1909, was $100,000.

2. Petitioner's predecessor, Hens & Kelly Company, on May 1, 1922, entered into leases for the various properties on which its business was located. Under the provisions of the leases, that company made certain improvements, and thereafter amortized such costs over the term of the lease, plus two 20-year renewal periods, which periods extended to May 1, 1982. In order to effect the consolidation of April 1, 1940, a single lease for the properties was substituted for the 1922 leases, to extend from April 1, 1940, to May 1, 1962, with an option to renew for 20 years. The new lease eliminated a provisions which had provided for an increase in minimum rentals each 5 years and substituted therefor a fixed minimum rental for the entire term, the minimum rental so fixed being less than the the rental then being paid under the 1922 leases. The new lease further provided for a reappraisal of the leased property prior to the renewal date. During the process of consolidation Hens & Kelly Company, pursuant to T.D. 4957, issued December 6, 1939, filed Form 969 with the Commissioner of Internal Revenue on March 12, 1940, nineteen days before the consolidation, in which it elected to continue its amortization of the leasehold improvements over the primary lease period, plus the renewal periods to May 1, 1982. After the consolidation, petitioner continued such amortization through the years involved but now contends that it is entitled to amortize such leasehold improvement costs over the term of the lease without regard to the renewal period. In the taxable years it was reasonably certain that petitioner would exercise its option to renew the lease to May 1, 1982. Held, that the proper period over which petitioner's basis for leasehold improvements should be amortized is the lease period plus the renewal period to May 1, 1982.

The respondent determined deficiencies in excess profits taxes against petitioner for the fiscal years ended January 31, 1943, and January 31, 1944, in the respective amounts of $9,195.15 and $76,321.36.

Page 306

The petitioner claims it is entitled to a refund. Issues presented are: (1) Is petitioner entitled, in determining equity invested capital for the years ended January 31, 1941, 1942, 1943, and 1944, to an inclusion of $400,000 representing good will? (2) Is petitioner, for the years ended January 31, 1941, 1942, 1943, and 1944, entitled to amortize the unrecovered cost of leasehold improvements under the terms of the lease executed April 1, 1940, for the lease term alone and without regard to the renewal period? The years ended January 31, 1941, and January 31, 1942, are involved by reason of an adjustment in the unused excess profits credits to be carried over to the subsequent years. Certain other issues raised by the petitioner appear to have been conceded by it.


Some of the facts have been stipulated and are found as stipulated.

Petitioner is a New York corporation, with its principal office and place of business at Buffalo, New York. It filed its income and excess profits tax returns for the years involved with the collector of internal revenue for the twenty-eighth district of New York. It kept its books and filed its returns on an accrual basis.

The petitioner owns and operates a department store. The business was started in 1892 by Matthias J. Hens and Patrick J. Kelly, who formed a partnership known as Hens & Kelly Company. Early in 1906 the business was incorporated under the name of The Hens-Kelly Company. At or as of January 1, 1910, the business was acquired by a new corporation by the name of Hens & Kelly Company. On April 1, 1940, Hens & Kelly Company was consolidated with S H Company, Inc., to form the petitioner, Hens & Kelly, Inc.

Petitioner's store is located in downtown Buffalo. It extends for an entire block, 231 feet, on West Mohawk Street, from Main Street to Pearl Street, and 90 feet on Main and Pearl Streets. The property was occupied by petitioner under leases, and was originally comprised of five separate properties, known as the Miller Block; No. 8 West Mohawk Block, consisting of Nos. 10 to 16, inclusive, on West Mohawk Street; the Snow properties, on the corner of West Mohawk and Pearl Streets; and the Manchester properties, which adjoined the Snow property and fronted on Pearl Street. Originally the store of Hens & Kelly Company occupied a part of the Miller Block. It fronted on Main Street, a short distance from the corner of Mohawk and Main Streets, and was 20 feet wide by 104 feet deep. In 1903 the partnership leased all of the Miller Block, four floors in height; all three floors of No. 8 West Mohawk Street; and the ground floors of Nos. 10, 12, and 14 in the Mohawk Block.

Page 307

This lease ran to April 30, 1913. On January 1, 1906, the partnership leased No. 16 West Mohawk Street, four floors, and the remaining three upper floors of Nos. 10, 12, and 14 of the Mohawk Block. This lease likewise ran to April 30, 1913. A lease to the Manchester property was acquired on February 1, 1906, to end on May 1, 1913. This property had four floors. On May 1, 1906, a lease was obtained to the Snow property, consisting of four floors, from May 1, 1906, to April 30, 1913. On January 6, 1910, shortly after the organization of Hens & Kelly Company, successor to The Hens-Kelly Company, new leases were obtained to the above properties. The said properties were leased by three separate leases, from three separate owners: (1) the entire Miller Block of four floors, Mohawk Block of four floors, and No. 8 West Mohawk Street, of three floors; (b) the Snow properties of four floors; and (c) the Manchester properties of four floors. The term of each lease was from May 1, 1913, to April 30, 1928. The reserved rent as set forth in the leases was as follows:

(a) Miller and Mohawk Blocks and No. 8 West Mohawk Street

May 1, 1913-April 30, 1918 $3,583.33 per month

May 1, 1918-April 30, 1923 $3,916.66 per month

May 1, 1923-April 30, 1928 $4,275.00 per month

(b) Snow properties

May 1, 1913-April 30, 1918 $483.33 per month

May 1, 1918-April 30, 1923 $533.33 per month

May 1, 1923-April 30, 1928 $575.00 per month

(c) Manchester properties

May 1, 1913-April 30, 1918 $266.66 per month

May 1, 1918-April 30, 1923 $300.00 per month

May 1, 1923-April 30, 1928 $316.66 per month

Beginning late in 1905, and ending in 1910, the buildings occupied by the store were extensively remodeled. The work of remodeling was almost continuously carried on between 1908 and the beginning of 1910. The buildings had originally been tenements and small stores, and in the course of the remodeling, they were practically reduced to shells, consisting of floors and the outside walls. Partitions were taken out, walls and foundations were strengthened and the floors were leveled. New entrances and exits in the various departments were necessary, as were the opening and closing of entrances through the old walls of the different buildings. Some interference with normal business operations was occasioned by the remodeling operations. Individually, Hens and Kelly were both active in the management and operation of the store. Hens, after looking over the mail in the morning, would proceed through the store, where he would greet and talk to department managers and employees. He would also greet and talk to customers, many of whom he knew personally. He supervised Page 308 the buying in the millinery department and looked after the employment of help. He had a more affable personality than Kelly. His policy was to sell at a smaller margin of profit than his competitors. Kelly looked after the widow trimming and store displays. He supervised the buying in the ladies' ready-to-wear department. Seymour Knox was a director of Clawson & Wilson Company, a wholesale dry goods concern in Buffalo, which sold merchandise to The Hens-Kelly Company. He controlled S. H. Knox 5 & 10 Cent Syndicate, a predecessor of Woolworth Company. He was very wealthy and influential. John L. Clawson was president of Clawson & Wilson Company. He was fairly wealthy, although not as wealthy as Knox. He was also a director of Columbia National Bank in Buffalo. Knox and Clawson became interested in The Hens-Kelly Company by guaranteeing a line of credit of $125,000 with the Columbia National Bank, to provide additional working capital for the business. The guarantee became effective on June 1, 1908...

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