Westvaco Corp. v. United States, 152-73.

• Decision Date: 03 December 1980
• Docket Number: No. 152-73.,152-73.
• Citation: 639 F.2d 700
• Parties: WESTVACO CORPORATION (Formerly West Virginia Pulp and Paper Company) v. The UNITED STATES.
• Court: U.S. Claims Court

639 F.2d 700

WESTVACO CORPORATION (Formerly West Virginia Pulp and Paper Company) v. The UNITED STATES.

No. 152-73.

United States Court of Claims.

December 3, 1980.

COPYRIGHT MATERIAL OMITTED

Mark Stone, New York City, attorney of record, for plaintiff. Thomas R. Long and John Franco, New York City, of counsel.

William C. Rapp, Washington, D. C., with whom was Asst. Atty. Gen. M. Carr Ferguson, Washington, D. C., for defendant. Theodore D. Peyser, Jr., and Donald H. Olson, Washington, D. C., of counsel.

Before DAVIS, BENNETT and SMITH, Judges.

ON DEFENDANT'S MOTION FOR SUMMARY JUDGMENT AND PLAINTIFF'S CROSS-MOTION FOR PARTIAL SUMMARY JUDGMENT

SMITH, Judge:^*

Plaintiff seeks refund of federal income taxes paid for the taxable fiscal years ended October 31, 1959, 1960, 1961, 1962, and 1963. In dispute is the proper method of determining the limitation on the amount of the deduction from gross income that will be allowed under section 165 of the Internal Revenue Code (code)¹ for losses sustained to timber as a result of casualty. After having carefully considered the submissions and having heard oral argument, we deny defendant's motion for summary judgment. Plaintiff's cross-motion for partial summary judgment is granted in part and denied in part and the case is remanded to the trial division for further proceedings consistent with our conclusions herein.

The parties agree with each other with respect to a large number of facts and definitions. As stipulated, they are found and adopted by the court for purposes of this case. They are repeated in the opinion only to the extent deemed necessary for action on the motions before us.

At issue is the proper application of section 165 of the code and, in particular, subsection (b) thereof together with Treas.Reg. § 1.165-7 (1976),² which operate to limit the amount of the loss, that may be deducted, to the lesser of either (a) the amount equal to the difference in fair market values of the property immediately after and immediately before the casualty, or (b) the property's adjusted basis for determining loss, provided in section 1011 of the code.

Plaintiff is, and was during the periods in issue, a vertically integrated forest products concern, engaged principally in the production and sale of paper, pulp, converted paper products, timber, and chemicals. Corporate returns for the periods in issue, plaintiff's fiscal years ending October 31, 1959, through October 31, 1963, were timely and properly filed with the Internal Revenue Service,³ and the amounts shown to be due timely paid. Audit resulted in timely deficiency assessments. Following payment, claims for refund were timely filed and were rejected on May 12, 1971. This suit followed on May 11, 1973. This court has jurisdiction under 28 U.S.C. § 1491 (1976).

Over the years, plaintiff has acquired large areas of timberland for the purpose of supplying itself throughout the foreseeable future with an adequate source of raw material for its mills and other facilities. During the periods in issue, plaintiff's timberlands in both North and South Carolina suffered from the effects of five separate storms and fires: Hurricane Gracie, on September 29, 1959, principally affecting South Carolina; Hurricane Donna, on September 11, 1960, principally affecting North Carolina; wildfires on April 26 and 27, 1961, affecting North Carolina; an ice storm on March 3, 1962, principally affecting the coastal area of South Carolina; and six wildfires during March and April of 1963, principally affecting North Carolina.

The effects of the storms and fires on plaintiff's timberland have been divided into two categories. The first category, referred to as "mortal injuries," deals with those losses resulting from the fact that the storms and fires during the periods in issue destroyed or rendered economically unsalvable some of plaintiff's timber.⁴ The parties agree on the volume of timber destroyed, and on the fair market value of the merchantable units represented by destroyed timber, but disagree as to the appropriate legal limitation of the deductible loss.

The second category of losses claimed by plaintiff are those from "nonfatal injuries." Nonfatal injuries are those which are measurable but which did not render timber economically unsalvable, nor did they or would they normally be expected to cause extensive mortality. The nature of these injuries is agreed to by the parties. Plaintiff has agreed that these nonfatal injuries did not, for purposes of this case, result in the actual destruction or loss of any units of merchantable timber present on its timber tracts. Thus, the volume of merchantable timber present, measured in cords or board feet, was the same after the fires and storms as it had been prior to those events, except for the timber destroyed in mortally injured trees.

Plaintiff determined its losses from timber mortally injured by determining the number of cords or board feet which had been lost, multiplying that figure by the then-current fair market value of such timber, and subtracting its salvage value.⁵ On audit, the Internal Revenue Service limited plaintiff's loss deduction to the product obtained by multiplying the number of cords or board feet of timber lost by the depletion unit⁶ (depletion rate) used for determining the gain or loss from the sale or cutting of timber. Plaintiff's claim for loss deductions relating to nonfatally injured timber, first presented in its claims for refund, was rejected in full.⁷

Critical to resolution of the issues in this case are the questions: (1) Does the section 165 casualty loss deduction include only losses attributable to marketable timber totally destroyed or abandoned as economically unsalvable? (2) What is the identifiable unit constituting the "property" damaged or destroyed? and (3) What is the proper portion of plaintiff's adjusted basis allocable to that property?

In answering these questions it is necessary to consider the nature and extent of timber damage and destruction resulting from storms and fires. We also must determine the purposes and interrelationships of the various statutory and regulatory provisions covering losses, basis, depletion, and perhaps other tax incidents. In addition, a consideration of the business practices of the timber industry generally, and of plaintiff in particular, is required to determine the extent of their bearing on the central issues of the case.

I. Determination of the Loss

The limits of a casualty loss will largely be determined by the nature and extent of the causative disaster, but the deduction that will be allowed for "any loss" is, as with all deductions, a matter of legislative grace.

Thus, before examining the limitation imposed by the code on the deduction that will be allowed for any loss, it is necessary first to determine the loss itself. The sequence of this approach is compelled by the statutory provisions⁸ which apply to losses generally.⁹ Subsection 165(a) allows as a deduction "any loss sustained * * * and not compensated for" (emphasis supplied), and subsection 165(b) prescribes the basis, for purposes of subsection 165(a), for "determining the amount of the deduction for any loss." (Emphasis supplied.)

That the proper approach is first to delineate the loss is confirmed by the regulations with respect to losses generally,¹⁰ which include language to the effect that "disallowance" of certain losses is provided (subparagraph (a)); that "the amount of loss allowable as a deduction under section 165(a) shall not exceed" (subparagraph (c)(1)); and that proper adjustment shall be made for any salvage value and for any compensation received in "determining the amount of loss actually sustained for purposes of section 165(a)" (subparagraph (c)(4)). (Emphasis supplied.) Further confirmation is found in the regulations specifically applying to casualty losses, which state that "any loss arising from * * * casualty is allowable as a deduction under section 165(a)," and which also make reference to the manner of determining the amount of a casualty loss allowable as a deduction in computing taxable income.¹¹ (Emphasis supplied.)

Defendant does not dispute that plaintiff's merchantable trees have suffered casualties which produce losses from mortal and nonfatal injuries as well, or that measurable nonfatal injuries, of the type claimed by plaintiff, will tend to affect a particular tree's rate of growth, so that at harvest it may produce a lesser quantity of merchantable timber than it might be expected to have produced, absent the particular injury, or be usable only as a source of pulp. In essence, defendant's disallowance of a deduction in any amount for any loss due to nonfatal injuries is based on defendant's contentions that nonfatal injuries are "legally insufficient" to support a current loss deduction and, further, that plaintiff is incapable of estimating the claimed reduction in future growth or otherwise prove that a claimed reduction in overall fair market value of the woodlands would measure such loss, or that such an overall reduction in fair market value occurred at all.

Defendant also contends that, for Westvaco's losses to qualify under section 165(a), plaintiff's casualty must be evidenced by a closed transaction, and plaintiff's property must be totally worthless or abandoned prior to the taking of the casualty loss deduction. In Hubinger,¹² involving destruction by fire of the upper portion of a rental building, and smoke and water damage to the lower floors, the second circuit stated that a net loss of value, limited by cost basis, resulting from partial damage due to casualty was a closed transaction pro tanto, entitling the taxpayer to a casualty loss deduction. This characterization of a casualty loss has not been overruled. Nor is it required that plaintiff, in all instances, abandon its property before taking a casualty loss. In the S. S. White case¹³ taxpayer was...