Bonwit Teller & Co. v. Commissioner of Internal Revenue

• Decision Date: 25 August 1931
• Docket Number: No. 246.,246.
• Citation: 53 F.2d 381
• Parties: BONWIT TELLER & CO., v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Second Circuit

53 F.2d 381 (1931)

BONWIT TELLER & CO., v. COMMISSIONER OF INTERNAL REVENUE.

No. 246.

Circuit Court of Appeals, Second Circuit.

August 25, 1931.

Arthur B. Hyman, of New York City, for petitioner.

G. A. Youngquist, Asst. Atty. Gen., Sewall Key and John MacC. Hudson, Sp. Assts. to Atty. Gen. (C. M. Charest, Gen. Counsel, Bureau of Internal Revenue, and Stanley Suydam, Sp. Atty., Bureau of Internal Revenue, both of Washington, D. C., of counsel), for respondent.

Before MANTON, SWAN, and CHASE, Circuit Judges.

SWAN, Circuit Judge.

The first question raised by this appeal relates to the valuation of a lease for the purpose of calculating deductions to be allowed for exhaustion. The taxpayer is the lessee of improved premises in New York City. The term ran for twenty-one years from October 1, 1911, and the rental was so favorable, according to the taxpayer's contentions, that on March 1, 1913, the lease had a fair market value of approximately $1,000,000. Pursuant to section 234(a)(7) of the Revenue Act of 1921 (42 Stat. 255) and sections 204(c) and 234(a)(7) of the Revenue Act of 1924 (43 Stat. 260, 284 26 USCA §§ 935 note, 986), the taxpayer claimed the right to deduct in each of the taxable years in question "a reasonable allowance for the exhaustion" of its leasehold. The Commissioner of Internal Revenue denied the taxpayer any deduction. The Board of Tax Appeals found the fair market value of the leasehold on March 1, 1913, to be $350,000, and held that this sum should be exhausted not only over the period of the original term, but also over an additional term of twenty-one years which the lessee had the option to obtain at a rental to be determined by an appraisal of the property to be made at the time of renewal. This gave an allowance for exhaustion of $8,850 for each of the years in question. It is the contention of the taxpayer that the Board erred both in adopting $350,000 as the 1913 value of the leasehold and in extending the exhaustion of that value beyond the original term.

The Board's finding of valuation is challenged as an arbitrary figure unsupported by the evidence. The taxpayer alone submitted evidence. Its valuation witness was well qualified as an expert and was thoroughly cross-examined. He expressed the opinion that the lease had a value of $982,952 on March 1, 1913, and then explained in detail how he arrived at this figure, namely, by taking the aggregate of the estimated annual rental values of the several floors of the building and deducting the estimated operating expenses, including rent under the lease. This resulted in an annual estimated profit of $88,000, which was capitalized at 6 per cent. for the remaining nineteen years of the lease to give the valuation the witness ascribed to the lease. The Board discounted his opinion because he made an error in assuming that the annual rental remained constant after reaching $110,000, whereas in fact it rose to $130,000 for the last eleven years of the term. But this error could not account for any such deduction from his estimate as the Board made. Indeed counsel for the Commissioner cannot point to anything in the record to sustain the figure of $350,000 rather than any other figure which might have been adopted. Counsel's argument rests solely upon the proposition that the Board is not bound to accept as conclusive the valuation placed upon the property by the taxpayer's expert witness. As a general proposition this statement of law is sound, and it would justify the Board in adopting some other valuation than that to which the expert testified, provided there were sufficient basis in the record for the value adopted. In the case at bar neither the Board's opinion nor counsel's argument suggests any basis for the value adopted.

In Pittsburgh Hotels Co. v. Commissioner, 43 F.(2d) 345 (C. C. A. 3) the court held that a finding of 2 per cent. depreciation in certain property, in the face of testimony by six experts that 4 per cent. was a fair figure, could not stand when there was nothing in the record to indicate that the Board's estimate was based on facts in the record or on the Board's personal knowledge or experience. Similarly the Board's estimate of the value of good will was upset where several business men had testified to a higher figure and there was no contrary evidence. Boggs & Buhl v. Commissioner, 34 F.(2d) 859 (C. C. A. 3). The court said, at page 861: "* * * While the board may, as a general principle, reject expert testimony and reach a conclusion in accordance with its own knowledge, experience, and judgment, yet it must have knowledge of and experience with the particular subject under consideration. There is no evidence that the board had any independent and personal knowledge whatever of the business, reputation, and good will of the petitioner. Therefore it could not set aside or disregard all the positive and affirmative evidence as to the value of the good will, and base its conclusion upon conjecture. Midland Valley R. R. Co. v. Fulgham (C. C. A.) 181 F. 91, 95; De Ford v. Commissioner (C. C. A.) 29 F.(2d) 532. Consequently it should not have disregarded the only positive and direct evidence as to the value of the good will of the petitioner. Its order will accordingly be modified, and good will allowed to the extent of $975,000."

On similar grounds a finding was set aside in Nichols v. Commissioner, 44 F.(2d) 157 (C. C. A. 3). In Dempster Mill Mfg. Co. v. Burnet (App. D. C.) 46 F.(2d) 604, there was only one expert witness, and it was held error to disregard his testimony. There the evidence was thought too inconclusive for the court to direct a finding, and the case was remanded. This we believe to be the proper course to pursue in the present case.

It was also error to extend beyond the term of the lease the period over which exhaustion of the leasehold is to be spread. The renewal privilege had not been exercised, and may never be. There was no evidence as to the value of this privilege as a separate element in the valuation of the leasehold. Indeed, the expert testified on direct and redirect that he had not taken it into consideration, and this was apparent from his explanation of how he arrived at his figure of approximately $1,000,000. It is true that on cross-examination he did say that in his appraisal he had considered the fact that the lease contained an option to renew, but it would seem that he must then have been referring to an estimated ground rental of the property if unimproved. However, the result should be the same irrespective of whether the option of renewal entered into the estimated value of the lease. The problem is to compute the amount of exhaustion during the taxable year of "property used in the business." The property here in question was a leasehold having nineteen years to run, and containing an option to renew for twenty-one years at a rental to be determined by an appraisal of the property to be made at the time of renewal. Despite the uncertainty of the rental to be paid during the extension, the option may give additional value to the lease, just as many other types of provisions might give the lease value. But it is still true that the property being used in the business (the leasehold) will be exhausted in nineteen years. If the option should be exercised at the end of the existing term, there will be created a new term (new property) to be thereafter used in the business. The new term, when created, may or may not have value; if it has, allowance for the exhaustion of such new term will be in order. Let it be supposed that the option contained in the lease in question were to purchase the property at the end of the term. Such an option might readily enhance the value of the lease, but it could hardly be supposed to change the period during which the lease will become exhausted. Similarly in the case at bar we see no basis for extending the period of exhaustion beyond the end of the term which was valued. See Appeal of Lenox Land Co., 5 B. T. A. 1206, 1210; Hinkel Dry Goods Co. v. Commissioner, 10 B. T. A. 228.

In respect to the taxable year 1922, the taxpayer claimed a deduction of a $20,000 fee paid to a real estate broker for negotiating a lease on behalf of the taxpayer as lessor. The taxpayer was lessee of a building, not the premises covered by the lease hereinbefore referred to on the subject of valuation, and in 1...