THE DAVIDSON BUILDING COMPANY v. Commissioner
| Decision Date | 31 August 1961 |
| Docket Number | Docket No. 78475. |
| Citation | 20 TCM (CCH) 1291,1961 TC Memo 247 |
| Parties | The Davidson Building Company, a Corporation v. Commissioner. |
| Court | U.S. Tax Court |
Elmer J. Babin, Esq., Carnegie Hall, Cleveland, Ohio, for the petitioner. Vernon R. Balmes, Esq., for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioner's income tax for the taxable years 1954, 1955, and 1956, in the respective amounts of $9,514.58, $6,742.40, $7,188.22. The issues are (1) whether respondent correctly disallowed a portion of the deductions for depreciation for the taxable years 1954, 1955, and 1956, and (2) whether petitioner is entitled to deduct as business expense amounts attributable to discount on debentures determined by respondent to be contributions to capital rather than indebtedness.
The stipulated facts are hereby found accordingly.
Petitioner is a corporation organized and existing under the laws of the State of Iowa. Petitioner maintains its principal office at 910 Carnegie Hall, Cleveland, Ohio. Federal income tax returns for the taxable years 1954, 1955, and 1956 were filed by petitioner, on an accrual method of accounting, with the district director of internal revenue, Cleveland, Ohio.
Petitioner was organized to acquire the real estate and building described as "Lots Six (6), Seven (7), and Eight (8), Block Three (3), Sioux City," hereinafter called the building.
The building was built on the northeast corner lot of Sixth Street and Pierce Street, running 150 feet north on Sixth and 150 feet east on Pierce, in 1914. It is an L-shaped building, with a small parking lot in the rear. It houses numerous stores on the ground floor, including one of the most popular drug stores in town, while the upper floors have offices primarily occupied by attorneys, accountants and doctors.
The building is located in the center of the financial and business district of Sioux City. It is two blocks north of the best retail area and is near the City Hall, the County Court House, and many banks.
The building is run-down and obsolete in many respects. There are two manual elevators that are old but in good running condition. It has been 20 years since their last remodelling and they are run by direct current which eventually must be changed to alternating. There is no freight elevator. The building tips slightly so that it is periodically necessary to adjust the guide lines of the elevators. The ceilings in the building are 10 to 15 percent higher than more modern buildings and the windows are double-hung, large, and antique in style, with the result that the building is difficult to air-condition. In addition, there is insufficient power capacity and sewerage to air-condition more than the present 30 percent of the building. Many of the design and construction features of the building are similarly outdated.
The foregoing conditions have affected the vacancy rate of the building. Despite the reasonably good physical condition, the antique features have led to a present vacancy rate of 10 percent as compared to less than 1 percent prior to 1954.
It would be uneconomic to erect a new office building or to use the land for a parking lot. A 1-story building would be the best possible use for the land in the present market.
In 1954, the assessed valuation for tax purposes was $68,725 for the land and $149,000 for the building. This assessment was made in 1941 and there have been many changes since. The movement of business and the expansion of the community have caused the tax assessments to be irregular. The Davidson plot has increased in value 25 percent from 1941 to 1954. The economic value of buildings in this area, as opposed to the physical value, has generally decreased, while building construction costs have increased over 200 percent during this same period.
In 1954, the cost of constructing a building duplicating the Davidson Building would have been $1,778,094. On February 1, 1954, $820,000 of fire insurance at 80 percent co-insurance was carried on the Davidson Building. This coverage was increased to $1,215,000 in 1956 to cover 100 percent of the insurable replacement cost.
Improvements made to the building in general and for various tenants prior to February 1, 1954, were as follows:
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Feb. 1, 1954
Depreciated
Lease improvements: Cost Balance
Toller's Drug Store
(Store front, exterior of building, lobby) .......... $ 5,444.08 $ 4,840.91
Room 305-18
(Partitions and wiring. Lease expires 5/31/57.) ..... 2,434.56 1,899.97
Room 319-26
(Partitions and wiring. Lease expires 5/31/57.) ..... 5,321.38 4,152.92
Air conditioner, S & D ................................... 1,190.00 984.48
Building improvements — 1953 ............................. 2,030.00 1,853.50
Elevator and equipment ................................... 5,225.19 4,770.87
__________ __________
$21,645.21 $18,502.65
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Petitioner calculated the depreciation of the building for the years 1954 and 1955 on the basis of $800,000 for the building and improvements, leaving $150,000 for the land and assuming an estimated remaining useful life of the building of 15 years. Petitioner also based its depreciation of the improvements prior to the acquisition of the building upon the undepreciated balance of these improvements and the unexpired term of the present leases. In 1956, petitioner adjusted the estimated remaining useful life of the building to 18 years and depreciated the undepreciated balance, $681,639.36, accordingly.
Respondent increased by $105,000 the amount of the purchase price allocated to the land, thereby decreasing the amount allocated to the building to $676,497.35. Respondent also determined that the building, as well as the improvements to the building made prior to the date of acquisition, should be depreciated over a life of 30 years. These determinations by respondent reduced the claimed depreciation deductions for 1954, 1955, and 1956 of $51,034.47, $56,721.73, and $42,711.68 by $29,610.26, $32,301.97, and $18,070.99, respectively.
On July 1, 1953, Julius Epstein purchased the building from Arthur and Stella Sanford. The contract, hereinafter called the land contract, provided for a purchase price of $891,581.84, $241,581.84 to be paid upon execution of the agreement and the balance of $650,000 to be paid over the ensuing 20 years with interest at 3½ percent. Installments of $26,000 per year for the first 5 years and payments of $39,000 per year for the next 15 years were to be applied, first to interest and then to principal, and the balance to be paid on July 1, 1973. Epstein was entitled to the delivery of a warranty deed of the premises at any time after the principal of the debt was reduced to $450,000. A short form of this land contract was filed for record.
No personal liability was incurred by Epstein or any successors in interest on the land contract. The sellers' sole remedy, in the event of default, was the cancellation of the contract and recovery of the property.
On September 30, 1953, Elmer J. Babin, acting for himself and Epstein, purchased the land contract from Epstein, "as agent," for $926,000. Babin made a $10,000 down payment, agreeing to take title subject to the balance of the land contract due and to pay $266,000 upon delivery of an assignment of the land contract on January 31, 1954.
Babin filed the articles of incorporation for petitioner on October 12, 1953, and a charter was granted on the 15th of that month. The corporate life of petitioner was 20 years with a right of renewal as provided by law. The corporation was authorized to issue 600 no-par shares of nonassessable common stock for $100 per share in cash or property valued by the board of directors. In addition, petitioner had the power to borrow money and issue bonds or other evidence of indebtedness.
The first meeting of the directors of the Davidson Building Company was held on January 5, 1954. At this meeting the corporation accepted an assignment of the September 30 contract as full payment for 240 shares of no-par common stock subscribed for by Babin and Epstein. Babin and Epstein each received 120 shares of stock from this subscription with an assigned value of $100 per share. The remaining 360 shares were subscribed for by 15 individuals at a cash price of $100 per share, on the condition that for every 5 shares of stock purchased the subscriber would purchase 2 debentures to be issued by the corporation. Revenue stamps were attached for all shares issued.
A total of 144 debentures was issued, each with a face value of $1,800. The bonds had a fixed maturity, with two bonds to be retired each month for 6 years beginning March 10, 1954, and proceeding through February 10, 1960. The debentures did not pay interest, but were issued at a discount equivalent to 5 percent per annum from the issuing date to the maturity date of the individual debenture.
The stock was subscribed for in 15-share blocks with the corresponding purchase of 6 debentures. Out of each block of 6 debentures, one was to be retired on the same day every year for 6 years. The date of retirement for the 24 groups of bonds was determined by lot. All the debentures maturing from March 1954 through December 1956 were retired in accordance with the schedule...
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