Hotel Kingkade v. Commissioner of Internal Rev.

• Decision Date: 10 February 1950
• Docket Number: No. 3968.,3968.
• Citation: 180 F.2d 310
• Parties: HOTEL KINGKADE v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Tenth Circuit

180 F.2d 310 (1950)

HOTEL KINGKADE v. COMMISSIONER OF INTERNAL REVENUE.

No. 3968.

United States Court of Appeals Tenth Circuit.

February 10, 1950.

John E. Marshal, Oklahoma City, Okl., for petitioner.

Carlton Fox, Sp. Asst. to Atty. Gen. (Theron Lamar Caudle, Asst. Atty. Gen., and Ellis N. Slack and A. F. Prescott, Sp. Assts. to Atty. Gen., on the brief), for respondent.

Before BRATTON, HUXMAN and PICKETT, Circuit Judges.

BRATTON, Circuit Judge.

This petition to review a decision of the Tax Court presents the question whether in determining the liability of Hotel Kingkade Company for income and declared value excess-profits taxes certain expenditures were deductible from gross income as ordinary and necessary expenses in carrying on a trade or business.

Section 23(a) of the Internal Revenue Code, 26 U.S.C.A. § 23(a), provides in presently material part that in computing net income there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. And section 29.23(a)-4 of Treasury Regulation III provides in substance that the cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life but keep it in ordinary efficient operating condition may be deducted as expense, provided the plant or property account is not increased by the amount of such expenditures; and that repairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the life of the property, should be charged against the depreciation reserve if such account is kept.

In 1910, Andrew Kingkade leased to L. Rardin and C. T. Williams for a term of ten years a hotel building then under construction in Oklahoma City, Oklahoma, and afterwards known as the Kingkade Hotel. The construction of the building was completed in 1911; the lessees furnished and equipped it for a hotel; and they opened it for business. In 1912, Kingkade Hotel Company, hereinafter referred to as the owning company, was organized to acquire and during that year did acquire from Andrew Kingkade the building and the lease covering it. The lessees failed in business, and in 1914 the owning company acquired the furnishings and equipment which the lessees had installed in the hotel. In 1923, the owning company acquired the Bristol Hotel in Oklahoma City, completely furnished; in 1933, the owning company acquired the Ewell Hotel in Oklahoma City, unfurnished, with garage and parking lot; and since such dates the owning company has owned the three properties. In 1914, Hotel Kingkade Company, hereinafter referred to as the taxpayer, was organized for the purpose of operating the Hotel Kingkade. On April 28, 1914, the lessees assigned to the taxpayer the lease covering the hotel; and since that time, the taxpayer has operated the hotel. At all times after the lease expired in 1920, the taxpayer operated the hotel pursuant to an oral understanding with the owning company that the rental would be in accordance with the ability of the taxpayer to pay rent, depending on the amount of its profits. Since 1923, the taxpayer also operated the Bristol Hotel in accordance with such arrangement. And since 1933, it has operated the Ewell Hotel, garage, and parking lot under similar arrangement, all subject to an understanding however that the taxpayer would pay the cost of repairs and maintenance and pay the balance of its income to the owning company as rent. Pursuant to such understanding, the taxpayer currently paid its profits to the owning company as rental unless some portion thereof was retained as a reserve to meet some anticipated expense. In 1942, the owning company was out of debt and permitted the taxpayer to retain some of its profits to create a cash reserve to meet operating requirements in later years. The controlling stock interest in the owning company and in the taxpayer was held by Andrew Kingkade and his wife, their son, and the son's wife and daughter.

In 1944, 1945, and 1946, the taxpayer expended $9,310.48, $5,497.16, and $3,959.66, respectively, for carpets, rugs, padding under carpets, refrigerator with ice maker, reflue and repair heating and water boilers, closet tanks, bowls, pipe, toilet covers, cloth material, dishwasher, adding machine, fire hose and appliances, electric fans, roofing and sheet metal contracts, cooking ranges, potato peeler and trays, and tile work on kitchen walls and showers. Virtually all of the equipment thus purchased was to replace like equipment which had become worn out and had to be discarded. All of the expenditures were treated on the books of the taxpayer as current repairs, replacements, and maintenance, and were charged to expense. In its income and declared value excess-profits tax returns, the taxpayer treated such expenditures as expenses deductible from gross income under the provisions of section 23(a) (1) (A), supra. The Commissioner determined that the amounts claimed as deductions for repairs and maintenance constituted capital expenditures and therefore were not deductible as business expenses. The Tax Court sustained the action of the Commissioner, and the taxpayer seasonably sought review. The taxpayer does not complain of the decision of the Tax Court in respect to the expenditure for repair of the roof, but in all other respects the decision is challenged.

It is not always easy to draw the boundary line between capital outlays and current expenses. The problem sometimes presents difficulty. In some instances an expenditure should be classified as one or the other depending upon the exercise of judgment in the light of the pertinent circumstances and the application of good accounting principles. Generally, an expenditure should be treated as of a capital nature if it brings about the acquisition of an asset having a period of useful life in excess of one year or if it secures a like advantage to the taxpayer which has a life of more than one year. And in order to constitute an...