Hotel Sulgrave, Inc.
v.
Comm'r of Internal Revenue

Tax Court of the United States.Jan 29, 1954
21 T.C. 619 (U.S.T.C. 1954)
21 T.C. 619T.C.

Docket No. 41449.

1954-01-29

HOTEL SULGRAVE, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Paul V. Wolfe, Esq., for the petitioner. George E. Grimball, Jr., Eq., for the respondent.


Paul V. Wolfe, Esq., for the petitioner. George E. Grimball, Jr., Eq., for the respondent.

Cost of installing sprinkler system in petitioner's hotel held to constitute a capital outlay and not an ordinary and necessary business expense. Held, further, amount by which it exceeded cost of installing similar system in comparable new building is merely part of capital outlay and not a currently deductible expense.

The respondent determined a deficiency in the income tax of the petitioner in the amount of $2,419.32 for the fiscal year ended June 30, 1948.

The sole issue is whether the petitioner is entitled to deduct as an ordinary and necessary business expense all or any part of the cost of the installing a sprinkler system in a building owned by it.

FINDINGS OF FACT.

The petitioner, a corporation organized in 1945 under the laws of the State of New York, has its principal place of business in New York City. It filed its return for the fiscal year ended June 30, 1948, with the collector of internal revenue for the third district of New York. It is on the accrual basis.

During the year ended June 30, 1950, and for some time prior thereto the petitioner owned an 8-story building, known as 646-8 Park Avenue. There were two apartments on each floor, one in the front and one in the rear, and each apartment had its own fire escape. The building was 60 years old, and was constructed of steel, brick, and stone, with wooden floors.

In 1947 or 1948 the Department of Housing and Building of the City of New York issued an order that a sprinkler system be installed in the building. Pursuant to that order, the installation of a sprinkler system, having 80 sprinkler heads and connecting pipes, was made during the fiscal year ended June 30, 1950, at a cost of $6,400, of which $5,390 was for the installation of the 80 sprinkler heads and $1,010 for architectural and engineering services.

The cost of installing a sprinkler system in an old building such as 646-8 Park Avenue, exceeded the cost of installing a similar system in a new building under construction because of the necessity of cutting pipe to fit existing conditions, of making alterations to permit the installation of various risers to each floor, of cutting concrete arches to permit the hangers to be installed to support the sprinklers, of cutting into existing partitions to permit pipe to go through, and of doing some patching of ceilings, partitions, and floors after all the cutting had been completed. When a sprinkler system is installed in a new building under construction, the pipe comes cut to measurement and all that is necessary is to assemble it and put it together. The cost of installing a sprinkler system, similar to that installed at 646-8 Park Avenue, in a new building under construction would have been approximately $2,000. A sprinkler system will ‘last‘ from 10 to 20 years.

No additional income was realized by petitioner as the result of the installation of the sprinkler system, and it added nothing to the desirability of the apartments from a rental standpoint. No reduction in the cost of fire insurance resulted from its installation. The installation was made because the Department of Housing and Building of the City of New York ordered it and had effective means of enforcing its orders.

In determining the deficiency the respondent reduced the net operating loss carry-back deduction from the year ended June 30, 1950, by the amount of $6,366.67. This amount was determined by capitalizing the cost of installing the sprinkler system in the amount of $6,400, and by the corresponding allowance of depreciation in the amount of $33.33.

OPINION.

RAUM, Judge:

The petitioner contends that the installation of the sprinkler system was a repair which was made for the purpose of keeping the hotel property in ordinarily efficient operating condition and which did not add to the value of the property or prolong its life; and that the expenditure made therefor is an ordinary and necessary business expense deductible in the year ended June 30, 1950.

We do not agree that the installation of the sprinkler system constituted a repair made ‘for the purpose of keeping the property in an ordinarily efficient operating condition.‘ Cf. Illinois Merchants Trust Co., 4 B.T.A. 103, 106, cited by petitioner. It was a permanent addition to the property ordered by the city of New York to give the property additional protection from the hazard of fire. It was an improvement or betterment having a life extending beyond the year in which it was made and which depreciates over a period of years. While it may not have increased the value of the hotel property or prolonged its useful life, the property became more valuable for use in the petitioner's business by reason of compliance with the city's order. The respondent did not err in determining that the cost of this improvement or betterment should be added to petitioner's capital investment in the building, and recovered through depreciation deductions in the years of its useful life. International Building Co., 21 B.T.A. 617, 621, and cases cited therein; Difco Laboratories, Inc., 10 T.C. 660, 669.

The petitioner contends, in the alternative, that $3,938.46 of the $6,400 which it paid for the installation of the sprinkler system constituted an extraordinary expense in any event. Its position in the main is based upon the fact that the cost of the sprinkler system was considerably in excess of what it would have been had it been installed during the construction of a new building. However, that fact cannot convert a capital item or any portion of it into a current expense. In the course of events there may be many circumstances that require an increased capital outlay. In the construction of a building, for example, a variety of factors may increase the normal expected cost, such as changes in plans, workmen's mistakes, errors in design or plan, overtime pay in order to meet a deadline, and the like. Cf. Driscoll v. Commissioner, 147 F.2d 493 (C.A. 5). Yet all such increases, whatever be the reason, are in general merely increases in the cost of the capital asset, and enter into the total cost which is to be depreciated over the life of the asset; they are not in the nature of current expenses.

This case is unlike Rankin v. Commissioner, 60 F.2d 76 (C.A. 6), and Frank & Seder Co. v. Commissioner, 44 F.2d 147 (C.A. 3), relied upon by petitioner. The Rankin case involved a unique situation in which the taxpayer paid a disproportionate amount of wages to a mechanic as ‘idle‘ time while waiting for parts to install a printing press. It is unlike the ordinary case of overtime pay incurred in acquiring a capital asset, and, regardless of the soundness of the Rankin decision, it is in any event inapplicable here. Although there was some general testimony by petitioner's president as to overtime, there was no proof of any particular amount of overtime, and there is no indication of any charges for overtime in the contractor's bills, which are in evidence. In the Frank & Seder Co. case amounts were paid for expediting completion of a building, and since the completion of the building was necessary in order to carry on business during that very year it was held that such amounts were a direct charge against income earned during that year. But cf. W. P. Brown & Sons Lumber Co., 26 B.T.A. 1192, appeal dismissed, 68 F.2d 1022 (C.A. 6). No such circumstances are presented here. Whatever additional costs may have been incurred here were not a charge against current earnings. Such costs are allocable to the life of the capital asset, and are recoverable through depreciation. The evidence introduced at the trial, that the cost of installing the sprinkler system in petitioner's old building substantially exceeded the cost of a similar installation in a new building under construction, does not prove that any part of the cost of installation in the old building was an expense rather than a capital outlay. It represented the amount which petitioner might reasonably have expected to pay for such an installation under normal conditions for a building such as it owned. Petitioner has not established that any part of the $6,400 payment is deductible as an ordinary and necessary business expense in the year ended June 30, 1950.

Decision will be entered for the respondent.