United States v. Ekberg

• Decision Date: 21 June 1961
• Docket Number: No. 16539.,16539.
• Citation: 291 F.2d 913
• Parties: UNITED STATES of America, Appellant, v. Harold M. EKBERG and Secrie Ekberg, Appellees.
• Court: U.S. Court of Appeals — Eighth Circuit

291 F.2d 913 (1961)

UNITED STATES of America, Appellant, v. Harold M. EKBERG and Secrie Ekberg, Appellees.

No. 16539.

United States Court of Appeals Eighth Circuit.

June 21, 1961.

Kenneth E. Levin, Atty., Tax Div., Dept. of Justice, Washington, D. C., for appellant. Howard A. Heffron and Abbott M. Sellers, Acting Asst. Attys. Gen., Lee A. Jackson and Melva M. Graney, Attys., Dept. of Justice, Washington, D. C., on the brief.

Thomas H. Foye, Rapid City, S. D., for appellees. Donn Bennett, Buffalo, S. D., and Bangs, McCullen, Butler & Foye, Rapid City, S. D., on the brief.

Before JOHNSEN, Chief Judge, and VOGEL and BLACKMUN, Circuit Judges.

BLACKMUN, Circuit Judge.

This case involves questions of federal income tax accounting and return treatment of a rancher's breeding cattle for the calendar years 1954, 1955 and 1956.¹ In the center of the controversy are (a) the 1954 Internal Revenue Code's § 1231 (b) (3), 26 U.S.C.A. § 1231 (b) (3), defining breeding livestock held 12 months or more as "property used in the trade or business", and (b) § 1.471-6(f) of the Code's Regulations providing:

"A taxpayer who elects to use the `unit-livestock-price method\' must apply it to all livestock raised, whether for sale or for draft, breeding, or dairy purposes. * * *"

Two questions are presented:

1. Was this taxpayer, under Regs. § 1.471-6(f), improperly required to subject his raised breeding livestock to the unit-livestock-price method?

2. May the taxpayer recover his breeding stock's unit values through amortization deductions?

The taxpayers are husband and wife.² They timely filed joint federal income tax returns for each of the three taxable years involved. They reside in Harding County, South Dakota. There Mr. Ekberg owns and operates a ranch of substantial acreage. For some years he has been engaged in the business of raising high quality purebred Aberdeen Angus cattle. For that purpose he constantly has maintained a breeding herd in addition to his other cattle. Additions to this herd are made only with heifers which he has raised; no additions are made through purchase. All heifer calves born in the breeding herd are held for breeding purposes until designated otherwise.

The taxpayer has kept his books and records on the accrual basis of accounting; because of this, he has been required by the applicable Regulations,³ § 1.61-4(b), to use inventories to determine gross income. He has also employed the "unit-livestock-price method" of valuing his livestock inventory; because of this, he has been required by the applicable Regulations, § 1.471-6(f), to apply that method to his breeding livestock as well as to his cattle held for sale. Specifically, he has assigned, in the taxable year of birth, a full unit price of $70 to each new heifer. Evidently this unit evaluation has met with the approval of the District Director of Internal Revenue for it is not now questioned.

This addition to inventory at the unit price of each new heifer in the breeding herd results in an increase in the taxpayer's ordinary income for the taxable year and in a reduction in the gain, if any, upon the animal's subsequent disposition. If, in contrast, the taxpayer could carry each breeding animal at a zero basis, as would be the case if he used the cash receipts and disbursements method, its birth would not create ordinary income, its net disposition price would constitute gain in its entirety rather than in part, and, with all other qualifying factors satisfied, that gain would be afforded capital gains treatment rather than ordinary income treatment. The taxpayer presumably, as is the case for each of the three taxable years here, would then enjoy a lower income tax.

Mr. Ekberg endeavored to obtain this tax benefit. He encountered opposition, however, from the tax authorities because of his use of the accrual-inventory method of accounting and of the unit-livestock-price method of evaluation. In 1951 and again in 1952 he was not permitted to remove his breeding cattle in its entirety from inventory and to reduce in one year each head's $70 unit value to zero. He then adopted another approach. In 1954 he removed from inventory only his yearling heifers in the breeding herd and, instead, included and expressly described them among other assets in his return's depreciation schedule. A deduction for "depreciation" upon the heifers, computed so as to recover the existing unit valuations over a six-year period, was taken. He did the same thing in 1955 and 1956. The Internal Revenue Service disallowed these deductions.⁴ Deficiency assessments resulted and were paid.

The present action is to recover those payments. The case was tried to the court sitting without a jury and resulted in judgment for the plaintiffs. The government has appealed.

The trial court found as a fact that the taxpayer "without the consent of the Commissioner of Internal Revenue, changed the `accrual method' of reporting * * * income, but only to the extent of transferring breeding livestock * * carried in inventory under the `unit-price method' to the depreciation schedule". It also found that the Commissioner's consent for this was not required. It concluded, largely upon the authority of Scofield v. Lewis, 5 Cir., 251 F.2d 128, that the taxpayer had the right unilaterally to make this change and to claim the "depreciation" deductions, that this did not amount to a change in accounting method, and that the taxpayer, by the deductions, "achieved" capital gains treatment approximating that accorded breeders on a cash basis.

Two things merit initial mention:

(a) We are not concerned here with the question whether the taxpayer's net gains realized upon the disposition of breeding cattle and other property "used in the trade or business", and held for the required period of time, are entitled to capital gains treatment. The government concedes this. Among the many cases so holding are Albright v. United States, 8 Cir., 173 F.2d 339, and United States v. Cook, 8 Cir., 270 F.2d 725. This is so even though the taxpayer has included his breeding stock in inventory. Fawn Lake Ranch Co., 12 T.C. 1139, 1144, appeal dismissed, 8 Cir., 180 F.2d 749; SoRelle, 22 T.C. 459, 473-474; Estate of C. A. Smith, 23 T.C. 690, 705; Scofield v. Lewis, supra; Carter v. Commissioner of Internal Revenue, 5 Cir., 257 F.2d 595; Herbert A. Nieman & Co., 33 T.C. 451, 462.

(b) The case is rendered somewhat confusing by the taxpayer's questionable use of the word "depreciation" to describe his claimed amortization of unit evaluations and by his inclusion of breeding cattle in his returns' depreciation schedules. The deductions claimed as "depreciation" are actually items asserted, with respect to animals which had not reached maturity, in order to counteract, by amortization, the prior inclusion in inventory and ordinary income of breeding animals at birth at the unit evaluations. We therefore are not dealing with the usual income tax concept of depreciation related to exhaustion and wear and tear of trade or business or income producing property provided for under § 167(a), 26 U.S.C.A. § 167(a). True depreciation of that kind is not assertable on inventory livestock. Regs. § 1.167(a)-6(b); SoRelle, supra, at p. 474 of 22 T.C.; Frost, 28 T.C. 1118.

The government's position is that this taxpayer has freely selected and uses the accrual-inventory method of accounting and the unit-livestock-price method of evaluation; that his breeding livestock is raised, not purchased; that it has been carried in inventory; that it cannot now be removed from inventory without the Commissioner's consent because this involves a change of accounting method; and that the Commissioner has not given his consent.

The taxpayer's position is that he is entitled to remove his raised breeding livestock from inventory and to achieve a zero income tax basis for it because of the policy behind § 1231 (b) (3) to provide broad tax benefit for breeding livestock raisers; that his livestock was placed in inventory because Regs. § 1.471-6(f) requires it; that this requirement was rendered obsolete with the statutory change effected in § 1231's predecessor by the Revenue Act of 1951 and is now improper; that he may amortize his improperly-required inventory valuations by appropriate annual deductions; and that so doing does not effect a change in accounting method which needs the Commissioner's consent.

Because the case concerns involved farm accounting problems, it is desirable to review the applicable provisions of the 1954 Code and of its accompanying Regulations and then to emphasize some features of their relevant history. We do this in the margin.⁵

The Code and Regulations in summary provide that:

a. A farmer or rancher may use either a cash receipts and disbursements method or an accrual method of accounting.

b. Once having selected his accounting method, it is binding upon him for income tax purposes for subsequent years unless the Commissioner consents to a change.

c. If he uses an accrual method, he must use inventories.

d. If he uses inventories and if he raises livestock, he must value that livestock for the inventory either by the farm-price method or by the unit-livestock-price method e. If he uses inventories and if he raises livestock and if he uses the unit-livestock-price method of evaluation, he must apply that method to all livestock raised, including breeders, but as to breeding livestock purchased he has the option of including it in inventory or of treating it as a capital asset subject to depreciation after maturity.

f. His breeding livestock held a year or more qualifies as property used in the trade or business.

The history of the Code and Regulations shows that:

a. Regs. § 1.471-6(f), with its emphasis on raised breeding livestock and on the compulsory extension to it of the unit-livestock-price method, when that method has once been selected by the rancher, orginated in 1944.

b....