Hunter v. Hunter, Docket No. 5666-64.
| Decision Date | 30 June 1966 |
| Docket Number | Docket No. 5666-64. |
| Citation | 46 T.C. 477 |
| Parties | ROBERT L. HUNTER AND MAE V. HUNTER, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Oakley Wade, for the petitioners.
J. C. Linge, for the respondent.
Petitioners owned and operated an irrigated farm in Colorado, which they acquired in 1955, together with 300 shares of Highland Irrigation Co., a nonprofit mutual assessment corporation which owned the irrigation system serving their farm. The diversion dam in the river built in 1909 or 1911 and owned by Highland was washed out by a flood in 1955. Highland borrowed money from a bank to build a new dam in 1956 and assessed its member-stockholders to meet the payments thereon as well as to pay its operating expenses. Petitioners were assessed and paid to Highland the amounts of $900 in 1960, and $750 in each of 1961 and 1962, of which amounts Highland used $190.71, $206.50, and $207.73 in each of those years, respectively, to make payments on the bank loan and on stock of the bank Highland was required to purchase to obtain the loan. Held:
1. Petitioners are not entitled to deduct as ordinary and necessary business expenses under section 162, I.R.C. 1954, that portion of their assessments applied by Highland to make payments on that portion of the bank loan used to build the dam and to buy the bank stock.
2. Petitioners are not entitled to deduct such amounts as soil and water conservation expenditures under section 175, I.R.C. 1954.
3. Petitioners are not entitled to a deduction for depreciation under section 167, I.R.C. 1954, with respect to the new dam.
4. Petitioners are not entitled to a deduction in the years here involved for a casualty loss with respect to the old dam which was partially destroyed in 1955.
Respondent determined deficiencies in petitioners' income tax for the taxable years 1960, 1961, and 1962 in the amounts of $52.88, $42.82, and $39.98, respectively.
The issues for our consideration are:
(1) Whether petitioners are entitled to deduct as an ordinary and necessary business expense under section 162, I.R.C. 1954,1 that portion of each annual assessment paid by them to Highland Irrigation Co. which was used by that company to repay funds borrowed and used by it to construct a diversion dam for irrigation purposes and to purchase capital stock of the bank for cooperatives which loaned it the money.
(2) If petitioners are not so entitled, whether they are entitled to deduct as a soil and water conservation expense under section 175(a) that portion of each annual assessment paid to Highland Irrigation Co. for the aforementioned purposes.
(3) In the alternative, whether petitioners are entitled to reasonable deductions in each taxable year involved for depreciation with respect to said dam.
(4) Also in the alternative, whether petitioners are entitled to a casualty loss deduction under section 165(a) with respect to the original dam owned by Highland Irrigation Co. that was either damaged or destroyed in 1955.
Some of the facts are stipulated and are so found and incorporated herein by this reference.
Petitioners Robert L. and Mae V. Hunter are husband and wife living in Las Animas, Colo. They filed joint Federal income tax returns for the taxable years 1960, 1961, and 1962 with the district director of internal revenue, Denver, Colo. Mae V. Hunter is a petitioner herein only because she filed joint returns for the aforesaid years, and hereinafter Robert L. Hunter will be referred to as petitioner.
During the taxable years 1960, 1961, and 1962 petitioner was engaged in the business of farming. In January 1955, petitioner purchased a farm near Las Animas, Colo. This farm is located in a semiarid area where the average annual rainfall is about 12 inches, and where the productivity of an irrigated farm as compared to a nonirrigated farm is in the ratio of approximately 4 to 1. Petitioner's farm is irrigated with water diverted from the Purgatoire River in Bent County, Colo., through the Highland Irrigation Co. diversion works and canal. In connection with the purchase of the farm petitioner also required 300 shares of the capital stock of Highland Irrigation Co.
Highland Irrigation Co. (hereinafter referred to as Highland or the company) is a mutual assessment corporation incorporated under the laws of the State of Colorado in 1914 and has been actively engaged in the business of furnishing water for irrigation to its stockholders since that time. Available water is prorated to the stockholders according to stock ownership.
During the taxable years involved herein Highland had issued an outstanding 3,800 shares of stock of which petitioner owned 300 shares. All of the stock issued by Highland was owned by 22 stockholders. Petitioner is vice president of Highland and a member of its board of directors.
With certain exceptions, such as the sale of assets or loans, Highland's only source of operating funds is from its stockholders. Such funds are obtained through assessments. Annual assessments are established by the member-stockholders at the annual meeting. The board of directors of Highland approve the expenditure of funds.
The failure of a member-stockholder to pay an assessment may cause Highland to sell the member's shares of stock thus making it impossible for such party to acquire water from Highland. The bylaws of Highland provide, inter alia, as follows:
No water shall be delivered or furnished to any stockholder who shall be in arrears in the payment of the annual maintenance charge or any assessment upon the shares of stock owned by him and no water shall be furnished by the Company to any person who is not a stockholder in the company, nor shall water ever be furnished to any stockholder except pro rata with all other stockholders in proportion to his ownership of said capital stock and without priority over all other stockholders except as permitted through the rotating or alternating system herein referred to.
The bylaws also provide for the forfeiture and sale of a stockholder's stock if he is in arrears for 3 months in the payment of any assessment.
Prior to 1955, Highland owned and had title to various assets used for the distribution of water to its stockholders, including a diversion dam on the Purgatoire River. Water was raised up from this river by the dam and diverted into irrigation canals and ditches through which water was delivered to the stockholders. At each stockholder's farm there was a headgate which delivered the water to the individual farm. The dam was constructed about 1909 or 1911. Title to all of the assets used by Highland in connection with the distribution of water for irrigation purposes was vested in Highland. The irrigation system which Highland owned was intact and operating in 1955 when Hunter purchased his farm.
In June 1955 the center of the dam was washed out by a flood and it became necessary to either repair such dam or construct a new dam in order to furnish water to Highland's stockholders. Use of the old dam, with repairs, was continued through the summer of 1955, but based on this experience the stockholders determined that it was inadequate for the purpose of diverting water and its maintenance was too expensive. The stockholders voted to construct a new diversion dam and work thereon was commenced in 1955.
During the latter part of 1955 and the early part of 1956, Highland built a diversion dam about 30 feet directly below the site of the former dam at a cost to it of $76,297.27. No labor cost was incurred in the construction of the new dam since the stockholders did the work themselves. The old dam was left in place and used as a retaining wall during construction of the new dam, and because it tended to strengthen the north abutment of the new dam. The design of the new dam was prepared by the U.S. Government and the dam was constructed in accordance with specifications provided by the U.S. Government.
The new dam is 306 feet long and approximately 30 feet high. The material used in constructing the dam included 300 tons of steel railing, 3,200 cubic yards of rock, and heavy timbers. The excavation for the new dam extended down about 25 feet to shale or bedrock. Vertical rails (steel piling) were set in the excavation and concrete was used to hold the rails in place. Then horizontal rails were bolted or welded laterally to the upright rails. This network or ‘crib’ extended across the length of the dam (about 300 feet), and was filled with sandstone and limestone rock. A facing consisting of a double row of timbers was applied to the upstream side of the crib.
The finished dam is about 30 feet in height but only 4 or 4 feet above the normal riverbed. There is a gate on one end to allow water to flow into the canal, and a spillway on the other end. The main canal carries the water which is ultimately used by the individual members of Highland. The new dam was in use at the time of the instant proceeding.
The source of the funds used to pay for the construction of the new dam was the amount of $23,135.79 paid by the U.S. Government and the amount of $76,297.27 borrowed from Wichita Bank for Cooperatives, Wichita, Kans., hereinafter called the bank.
On January 6, 1956, Highland and the bank entered into a loan agreement wherein it was agreed that the bank would loan Highland money to be used for the construction of the new dam, an additional amount to renew a loan, and an additional amount to purchase 19 shares of stock of that bank, which Highland was required to purchase in order to borrow money from the bank. The total amount of the loan was $102,000, evidenced by two promissory notes of Highland, one in the amount of $92,000 with interest at 4 1/4 percent and the other in the amount of $10,000 with interest at 3 1/4 percent. These notes were secured by a first mortgage on all of Highland's assets, including specifically its entire...
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