GW Van Keppel Company v. CIR, 16748.

CourtUnited States Courts of Appeals. United States Court of Appeals (8th Circuit)
Writing for the CourtVOGEL, VAN OOSTERHOUT and BLACKMUN, Circuit
Citation295 F.2d 767
Docket NumberNo. 16748.,16748.
Decision Date30 November 1961

Donal D. Guffey, Kansas City, Mo., for petitioner. Albert F. Hillix, Richard H. Brown and Hillix, Hall, Hasburgh, Brown & Hoffhaus, Kansas City, Mo., on the brief.

Fred E. Youngman, Atty., Dept. of Justice, Washington, D. C., for respondent. Louis F. Oberdorfer, Asst. Atty. Gen., and Meyer Rothwacks, Atty., Dept. of Justice, Washington, D. C., on the brief.

Before VOGEL, VAN OOSTERHOUT and BLACKMUN, Circuit Judges.

VAN OOSTERHOUT, Circuit Judge.

This proceeding comes before this court upon a timely petition by taxpayer, The G. W. Van Keppel Company, for review of the decision of the Tax Court entered October 24, 1960 (T. C. Memo 1960-224 not officially reported) determining deficiencies in income tax for the fiscal years ending November 30, 1955, and November 30, 1956. Jurisdiction is established.

The question presented is whether the Tax Court erred in holding that the cost of improvements erected by the taxpayer on leased property should be depreciated over the useful life of such improvements as determined by the Commissioner, rather than over the remaining period of the lease as contended by the taxpayer. If the Tax Court was warranted in determining under the factual situation here presented that the lease, which in form was a ten year lease, was in substance a lease for an indefinite period, the decision of the Tax Court must be affirmed.

The facts are largely stipulated. There appears to be no dispute as to the basic facts. The controversy arises largely with relation to inferences to be drawn from the facts.

During the years here in question there was in existence a written lease of the business premises occupied by the taxpayer, wherein Elizabeth E. Van Keppel was lessor and the taxpayer, lessee. The lease is dated September 28, 1950, and runs for a term of ten years from October 1, 1950. The lessee agreed to pay as rent the sum of $250 per month, to pay all taxes and assessments, to insure buildings and pay insurance premiums, to pay for all repairs, and to return the property at the termination of the lease in good condition. The lease contains no renewal option and makes no provision for the extension of the lease beyond the ten-year period.

Taxpayer is a Missouri corporation, incorporated December 29, 1945. It sells and services heavy construction equipment in Kansas City, Missouri. It took over the business formerly conducted by G. W. Van Keppel as sole proprietor. The lessor, Mrs. Van Keppel, is the wife of G. W. Van Keppel. The taxpayer corporation issued 1500 shares of stock in 1945, of which Mr. Van Keppel received 1124 shares, Mrs. Van Keppel, 375 shares, and R. L. Mitchell, who served as vice president, 1 share.

Mr. Van Keppel has at all times served as president, treasurer and director of the company and was at all times the person in control of taxpayer's affairs. Mrs. Van Keppel served as one of three directors until 1951, and continued to own the 375 shares of stock issued to her until November 29, 1956, when all of her stock was cancelled. As a result of the cancellation of Mrs. Van Keppel's stock, the outstanding stock of the corporation was reduced to 1125 shares. The record contains no information as to what, if anything, Mrs. Van Keppel received for the surrender of her stock, and nothing appears relating to the circumstances leading up to her retirement as a director.

Taxpayer operated its business on the real estate leased from Mrs. Van Keppel, the first lease being for a ten-year period, executed in 1945, and surrendered in connection with the execution of the present ten-year lease here in controversy. The real estate included in the lease was acquired at various times, commencing in 1938. Title to the first tracts of real estate was taken in the name of Mr. and Mrs. Van Keppel. In 1945 Mr. Van Keppel transferred his interest in the land to his wife. Title to additional contiguous real estate covered by the lease was subsequently acquired in the name of Mrs. Van Keppel. The source of the funds for the acquisition of the real estate and the consideration, if any, for the transfer of Mr. Van Keppel's interest in part of the real estate to his wife, is not shown.

Taxpayer's board of directors, then consisting of Mr. and Mrs. Van Keppel and K. W. Cramp, at a meeting on August 18, 1950, authorized the execution of the ten-year lease here in controversy, and above described, and also authorized Mr. Van Keppel to construct a building of suitable size and design on the leased premises for a cost not to exceed $100,000. Such building was erected at a cost of $98,180, and between 1952 and 1956 other permanent improvements were made on the leased property costing $26,515. The depreciation and amortization issues arise in connection with such improvements. The cost and estimated life of the improvements made by taxpayer are stipulated and not in dispute. The useful life of the principal building was 37 years as of December 1, 1955.

At the end of the last taxable year here in controversy, Mr. Van Keppel owned 774 shares of the 1,125 shares of stock of the taxpayer outstanding, and he served as president, treasurer and director of the taxpayer.

Taxpayer challenges the Tax Court's determination that the cost of the improvements erected by the taxpayer upon the leased property can be recovered only through annual deductions for depreciation over the estimated useful life of the property.

The allowance of deductions from gross income is a matter of legislative grace, and statutory authority for such deductions must be found. The allowance of deductions from gross income is not governed by general, equitable considerations. Deputy v. Du Pont, 308 U.S. 488, 493, 60 S.Ct. 363, 84 L.Ed. 416; Northern Natural Gas Co. v. O'Malley, 8 Cir., 277 F.2d 128, 131.

The statute governing the allowance of the deduction here involved is § 167(a) of the Internal Revenue Code of 1954, 26 U.S.C.A. § 167(a), which with § 161 provides so far as material here that in computing net income for income tax purposes there shall be allowed as a deduction from gross income, among others, a reasonable allowance for exhaustion, wear and tear (depreciation) of property used in a trade or business of the taxpayer or property held by the taxpayer for the production of income. The purpose of the depreciation allowance is to afford the owner of a wasting asset used in any trade or business or held for production of income, a means of recouping, tax free, his investment in that property; and under the classic or straight line method, which is applicable here, the amount which may be deducted is an amount which should be set aside each year in order that, at the end of the useful life of the property, the total of the sums thus set aside plus any salvage value will equal the original cost. United States v. Ludey, 274 U.S. 295, 300-301, 47 S.Ct. 608, 71 L.Ed. 1054.

Section 162 relating to deductions for business expense and Section 167 relating to depreciation, now a part of the Internal Revenue Code of 1954, appeared in substantially the same form in Section 23 of the Internal Revenue Code of 1939. Regulations have been promulgated relating to such sections, including Regulations 118, § 39.23(a)-10(b) and Regulations 1.167(a)-4 and 1.162-11(b) (1) under the 1954 Code.

The taxpayer in his brief correctly draws the following conclusion from the statutes and the interpretative regulations:

"It would appear to be clear from a reading of the above noted regulations that the cost borne by a lessee in erecting buildings or making permanent improvements on grounds of which he is lessee, is to be treated as a `capital investment\' and is not `deductible as a business expense.\' It would further appear to be clear that a taxpayer is entitled to recover such a capital investment. The only question then is the period of time over which such recovery may be had. Is the return of capital to be effected over the remaining term of the lease or effected over the estimated useful life of the improvements?"

The Tax Court in its original opinion set out Regulation 118, § 39.23(a)-10(b). Upon motion for reconsideration by the Government, the Tax Court...

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