World Publishing Company v. CIR

• Decision Date: 21 February 1962
• Docket Number: No. 16734.,16734.
• Citation: 299 F.2d 614
• Parties: WORLD PUBLISHING COMPANY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Eighth Circuit

299 F.2d 614 (1962)

WORLD PUBLISHING COMPANY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 16734.

United States Court of Appeals Eighth Circuit.

February 21, 1962.

Barton H. Kuhns, Omaha, Neb., made argument for the petitioner and Alexander McKie, Jr., Omaha Neb., was with him on the brief.

Fred E. Youngman, Atty., Dept. of Justice, Washington, D. C., made argument for respondent and Louis Oberdorfer, Asst. Atty. Gen., and Lee A. Jackson and A. F. Prescott, Attys., Dept. of Justice, Washington, D. C., were with him on the brief.

Before VOGEL, VAN OOSTERHOUT and BLACKMUN, Circuit Judges.

BLACKMUN, Circuit Judge.

This is a petition for review of a decision of the Tax Court approving the Commissioner's determination of deficiencies¹ in the taxpayer's income taxes for the respective calendar years 1952, 1953 and 1954.² 35 T.C. 7. The taxpayer, World Publishing Company, is a Nebraska corporation on the accrual basis. Its taxable year is the calendar year. It is engaged primarily in the newspaper business and it publishes the Omaha World Herald.

The issue before us concerns the taxpayer's right to a deduction for depreciation of a portion of the price it paid when it purchased improved real estate subject to an outstanding lease to the tenant who had built the building on the property.

The facts are not in dispute: On June 29, 1928, George Warren Smith, Inc., was the owner of two mid-block lots in downtown Omaha. On that date Smith leased those lots to Farnam Realty Corporation. The lease was for a term of fifty years from July 1, 1928, and called for annual rentals averaging $28,500 but varying between $25,000 and $32,500 for specified decades. It required Farnam immediately to construct a "six (6) story, or more, and basement building" on the property at a cost of not less than $250,000. Farnam complied with this requirement.

On January 4, 1950, the taxpayer purchased as an investment Smith's entire interest in the property, including the lease, for $700,000. The deed recited that it was subject to the lease to Farnam. The parties have stipulated that "the remaining useful life of the building in January, 1950, was not greater than the unexpired term of the lease".

In its income tax return for each of the years in question the taxpayer asserted a deduction of $10,547.92 for "Depreciation and Amortization". This amount was determined by spreading $300,000 (constituting that part of its purchase price which the taxpayer claimed was allocable to the building) over the remaining years of the still outstanding lease. The Commissioner disallowed this deduction.³

Certain other provisions of the lease of June 29, 1928, from Smith, as lessor, to Farnam, as lessee, may be pertinent.

1. The parties agreed that "Any and all buildings erected on the said premises under covenants by, or permission granted, to the Lessee shall, at and upon the construction thereof, be and become a part of the realty and upon the termination of this lease, by the expiration of its term or by default or otherwise, any and all such buildings and improvements shall pass to and remain the property of the Lessor".

2. The lessee agreed to pay all taxes and assessments upon the land or the improvements or "which the Lessor shall be required to pay by reason of or on account of its interest in said land or improvements, or its interest in or under this lease, except estate, inheritance, and income taxes".

3. The lessee agreed, before beginning construction of the building, to submit all plans and specifications to the lessor for approval. The lessor could reject or amend these.

4. The lessee agreed to post security with a named Omaha bank for the construction of the building, and the lessor possessed rights, in the event of default in the construction, to call upon that security.

5. The lessee agreed at its expense to procure fire and tornado insurance for the full insurable value of the improvements, with the lessor having the right to attach any mortgage clause its mortgagee might require; to buy plate glass and explosion insurance "in such form as to furnish protection to the Lessor and Lessee"; to buy workmen's compensation insurance "for the protection of the Lessor"; and to buy upon demand "such other reasonable insurance protection as the Lessor may require". The lessee agreed to carry rental interruption insurance in its own favor.

6. The lessee agreed, in case of damage or destruction of the building or any part thereof during the lease, to repair and restore it; it was then entitled to the insurance collected. If, however, the damage or destruction occurred on or after noon of July 1, 1958, the lessee's obligation to restore, in the absence of default in its insurance covenants, was limited to the insurance received.

7. The lessee agreed that upon the completion of the building it "shall not be altered in any manner whatsoever" without the written consent of the lessor, except by governmental authority and except that the lessee could make at its own expense alterations and improvements "in a first-class manner" without such consent if the cost did not exceed $10,000. It was stated that it was "the intention that the building shall at all times be kept in such physical condition that excessive depreciation shall not occur".

8. The lessee agreed at its own cost to maintain the building, the premises and the fixtures in good condition and repair; to permit inspection by the lessor; and to permit the lessor to enter the premises and effect repairs when the lessee failed to keep its repair covenant.

9. The lessee agreed that the lessor could, up to a stated percentage of the ground value, borrow money on the security of the property and secure it by mortgages or deeds of trust "which shall constitute a lien on the grounds and buildings prior to the claim of the Lessee" or its assigns.

10. The lessee had the right to assign, if it was not in default, but was not thereby released from its obligations under the lease unless the lessor so consented in writing.

11. The lessee agreed that at the termination of the lease it would "surrender the possession of the demised premises to the Lessor with the buildings and improvements thereon without delay".

The taxpayer in fact has received and retained the insurance policies required by the lease. These are issued in the name of the taxpayer as the insured.

There is substantial, and uncontradicted, evidence in the record to support the $300,000 figure. A qualified appraiser testified that at the time of purchase the fair and reasonable value of the ground alone was $400,000 and the fair and reasonable value of the building alone was around $300,000. These valuation allocations correspond, too, with the full valuations thereof used for real estate assessment purposes at the time of the purchase. The witness also testified that in his opinion the probable value of the land alone at the expiration of the lease in 1978 would be approximately $400,000.

On these facts, uninfluenced by any decided lease cases, it would seem clearly to follow that the taxpayer is entitled to a deduction, under § 167(a)⁴ and under the parallel § 23(l) of the 1939 Code, respectively applicable to the tax years in question, for depreciation of the $300,000 portion of its 1950 purchase price allocable to the improvements on the real estate in question. See Detroit Edison Co. v. Commissioner, 1943, 319 U.S. 98, 101, 63 S.Ct. 902, 87 L.Ed. 1286. The building, as well as the land, was acquired and held by the taxpayer "for the production of income". The taxpayer's interest was one acquired by purchase and was not in any sense a derivative right acquired without investment on its part. By the stipulation, the building is a wasting asset and its complete exhaustion will have been effected before the end of the lease term. The taxpayer's spreading of the wasting portion of its purchase price over the entire remaining lease term by the straight-line method⁵ approximated the minimal deduction for the taxpayer.

Furthermore, for what it may be worth, the lessor, and consequently the taxpayer, in spite of a contrary suggestion at the trial by the Commissioner's counsel, clearly owned the building in more than a bare-legal-title sense. The lease recites that all buildings erected on the premises "shall, at and upon the construction thereof, be and become a part of the realty and upon the termination of this lease * * * shall pass to and remain the property of the Lessor". (Emphasis supplied.) Consistent with this are other provisions of the lease: the reference in the tax clause to the lessor's interest in the "land or improvements"; the lessor's right to amend and even reject plans and specifications for the building; the insurance protection afforded the lessor and its being named as insured; the lessor's right to subject the improvements as well as the ground to a mortgage lien; and the lessee's inability to alter the completed building beyond a $10,000 cost without the lessor's approval. Compare Bueltermann v. United States, 8 Cir., 1946, 155 F.2d 597, 598; First Nat. Bank of Kansas City v. Nee, 8 Cir., 1951, 190 F.2d 61, 68, 40 A.L.R.2d 423. This is consistent, too, with the general law, evidently recognized in Nebraska, to the effect that, unless provided otherwise by contract, a building permanently affixed to the land becomes a part of it. See Freeman v. Lynch, 8 Neb. 192; Frost v. Schinkel, 1931, 121 Neb. 784, 238 N.W. 659, 664-666, 77 A.L.R. 1381; Friedlander v. Rider, 1890, 30 Neb. 783, 47 N.W. 83, 84-85, 9 L.R.A. 700.

But the Commissioner — and the Tax Court has agreed with him — has taken the position that the taxpayer here acquired no depreciable interest in the property; that what it acquired was the land, not a wasting asset, for which it received ground rental income; that the taxpayer has not shown that it held any interest in the building for the production of income; that it...