Comm'r of Internal Revenue

United States Tax CourtMay 27, 1970
54 T.C. 1175 (U.S.T.C. 1970)

Docket Nos. 6562-67 2017-69.



Max Myers, for the petitioner. Larry K. Hercules, for the respondent.

Max Myers, for the petitioner. Larry K. Hercules, for the respondent.

Petitioner and her husband (Elo) held land as community property which they leased to a third party for 10 years. At the same time they granted an option to purchase such land, exercisable on the termination of the lease. Elo thereafter died and his community half of said lease and option (but not the land itself) were included in his Federal estate tax return and there valued and taxed. Petitioner thus acquired a basis for Elo's half of the lease which she now seeks to amortize over the remainder of its term. Held: Basis and depreciable interest are not synonymous terms, and absent any showing that this was a premium lease, calling for rent in excess of fair market value, petitioner has nothing to depreciate. Exercise of the option at the end of the term of the lease would prevent the merger of petitioner's interests in the land back into fee simple title, but such exercise is here speculative and consequently our conclusion is unchanged.


Respondent has determined deficiencies in petitioner's income tax as follows:

+--------------------------------------------+ ¦Docket No. ¦TYE Dec. 31— ¦Deficiencies ¦ +------------+----------------+--------------¦ ¦6562-67 ¦1964 ¦$289.72 ¦ +------------+----------------+--------------¦ ¦ ¦( 1965 ¦6,137.92 ¦ +------------+----------------+--------------¦ ¦2017-69 ¦( 1966 ¦5,408.40 ¦ +------------+----------------+--------------¦ ¦ ¦( 1967 ¦5,523.69 ¦ +--------------------------------------------+

Concessions having been made, the only issue for decision is whether petitioner, as successor lessor of a one-half interest in a lease which she received from her husband upon his death, may, under section 167, amortize her basis in the lease received under section 1014 against the rental income from the lease.

All statutory references are to the Internal Revenue Code of 1954 unless otherwise indicated.


All facts have been stipulated. The stipulations and exhibits attached thereto are incorporated herein by this reference.

Petitioner is LeBelle Michaelis (hereinafter sometimes referred to as LeBelle). At the time petitions were filed in these consolidated cases, LeBelle resided in Winters, Tex. Here income tax returns for 1964, 1965, 1966, and 1967, respectively, were filed with the district director of internal revenue, Dallas, Tex.

On December 27, 1962, LeBelle and her husband, Elo Michaelis (Elo) leased 400 acres of Arkansas land which they held as community property to Steel Canning Co. (hereinafter sometimes referred to as Steele) for 10 years. The terms of the agreement required an initial rental payment of $15,000 on February 1, 1963, and rental payments of $20,000 each on February 1 of the 9 succeeding years.

Stipulation No. 3 stated that the initial rental was $20,000 and $15,000 in each succeeding year. This apparently was a typographical error. The contract itself and the income tax return of LeBelle indicate that the rental amounts are as in our findings and respondent did not object to this proposed finding by petitioner.

On the same date, December 27, 1962, petitioner and her husband also sold (for $5,000) to Steele Investment Co. (hereinafter sometimes referred to as Investment) an option to purchase the above land for $50,000 at any time between February 1, 1973, and March 31, 1973.

LeBelle's husband, Elo, died on December 14, 1963. From his estate she received as an heir, legatee, or distributee his one-half interest in the above-mentioned lease.

The lease contract and the option agreement were included in Elo's Federal estate tax return, but the land, as such, was not. Values of $156,792.30 and $38,171.30, respectively, were assigned to the lease and the option, and were each reduced by petitioner's one-half community property interest. These figures were arrived at in Elo's estate tax return as follows:

+----------------------------------------------------------------------+ ¦Lease contract: ¦¦¦ +----------------------------------------------------------------------¦ ¦Present value of 10-year lease—$20,000.00 due February 1, 1964 through¦ +----------------------------------------------------------------------¦ ¦February 1, 1972, or $180,000.00 for 8 1/8 years. Discounted at 3.5% ¦ +----------------------------------------------------------------------¦ ¦compounded annually. ¦¦¦ +--------------------------------------------------------------------++¦ ¦ ¦¦¦ +----------------------------------------------------------------------+

Principal Due Value $20,000 2/1/64 $19,912.78 $20,000 2/1/65 19,239.40 $20,000 2/1/66 18,588.79 $20,000 2/1/67 17,960.18 $20,000 2/1/68 17,352.83 $20,000 2/1/69 16,766.02 $20,000 2/1/70 16,199.05 $20,000 2/1/71 15,651.26 $20,000 2/1/72 15,121.90

$180,000 156,792.30 [1/2=$90,000] [1/2=$78,396.15] Land option: Present value of option to sell 400 acres of land for $50,000.00—Option may not be exercised before February 1, 1973 or after March 31, 1973. $50,000 discounted at 3 1/2% for 9 1/8 years Present value $38,171.30 [1/2=$19,085.65]

For the years 1964, 1965, 1966, and 1967, petitioner reported the entire rental income under the lease agreement in her Federal tax returns. She deducted therefrom in each year a prorata amount of the entire basis which she claimed with respect to this said lease as follows:

+-------------------+ ¦Year ¦Deduction ¦ +------+------------¦ ¦1964 ¦$19,912.78 ¦ +------+------------¦ ¦1965 ¦19,239.40 ¦ +------+------------¦ ¦1966 ¦18,588.79 ¦ +------+------------¦ ¦1967 ¦17,960.18 ¦ +-------------------+

Petitioner now concedes that in any event she is entitled to only half of these claimed deductions. Respondent's determination disallowed them entirely.


Petitioner seeks to amortize, under section 167, her interest in a lease received from her husband upon his death. She argues that by virtue of section 1014 she obtained a basis in the lease which may be amortized. Respondent, on the other hand, argues that section 1014 does not give petitioner a depreciable basis for purposes of section 167 but rather a valuation for the purpose of ascertaining gain or loss in the event of a future sale of the lease. He further contends that the lease in the instant case is not the type of depreciable asset to which section 167 applies, i.e., that the lease is not a wasting asset, even assuming a basis for depreciation was obtained.

SEC. 167. DEPRECIATION.(a) GENERAL RULE.— There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence)—(1) of property used in the trade or business, or(2) of property held for the production of income.

SEC. 1014. BASIS OF PROPERTY ACQUIRED FROM A DECEDENT.(a) IN GENERAL.— Except as otherwise provided in this section, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent's death by such person, be the fair market value of the property at the date of the decedent's death, or, * * *

In Commissioner v. Moore, 207 F.2d 265 (C.A. 9, 1953), certiorari denied 347 U.S. 942 (1954), reversing 15 T.C. 906 (1950), and cited with approval by us in Albert L. Rowan, 22 T.C. 865 (1954), the Ninth Circuit stated (p.269):

a ‘basis' is only one of the factors which must exist before depreciation may be claimed. More important is the necessity of a ‘depreciable interest’ in exhausting and deteriorating property. If the taxpayer's interest is of such character that it is not affected by the deterioration, then it is not of a depreciable nature. That the provision defining basis is by itself insufficient to authorize the deduction was well stated by the Court of Appeals for the Eighth Circuit in First National Bank of Kansas City v. Nee, 190 F.2d 61, 64, as follows: ‘It must at once be obvious that unless an item of property in respect of which depreciation has been claimed is properly within the reach of the quoted portion of the statute, those further provisions of the law are quite irrelevant which serve merely to define the basis upon which depreciation , validly asserted, is to be computed. The prescription of a depreciation basis presupposes, but does not amplify, depreciability.’

Therefore, whether or not petitioner obtained a ‘basis for depreciation’ in that portion of the lease which she acquired by reason of her husband's death, she has the burden of proving that it was a wasting or depreciable asset. Cf. also Rosalie H. Schubert, 33 T.C. 1048 (1960), affd. 286 F.2d 573 (C.A. 4, 1961), certiorari denied 366 U.S. 960 (1961).

The purpose behind the allowance for depreciation or amortization under section 167 and the so-called wasting-asset theory behind such a deduction was enunciated clearly by the Supreme Court in Detroit Edison Co. v. Commissioner, 319 U.S. 98, 101 (1943), as follows:

The end and purpose of it all is to approximate and reflect the financial consequences to the taxpayer of the subtle effects of time and use on the value of his capital assets. For this purpose it is sound accounting practice annually to accrue * * * an amount which at the time it is retired will with its salvage value replace the original investment therein.

Amortization of the lease in this case does not fall within that purpose.

Elo's Federal estate tax return did not include the 400 Arkansas acres except by showing the lease and the option, and assigning values to each. There is no indication in this fully stipulated case that the rental payments called for, both before and after Elo's death, are other than at fair rental value, i.e., this was not a so-called premium lease. Absent such a showing it appears obvious that what petitioner received from her husband on his death was an interest in the land subject to the lease; that what petitioner was receiving under the lease was ground rental; and that the values allocated to the lease and option were simply factors entering into the value of the land. Albert L. Rowan, supra. The land is not a depreciable asset. Upon termination of the lease, the lessor will again hold all estates in the land, undiminished and ‘unwasted.’

Presuming no economic changes have occurred, the land may again be rented at the same fair market rental. Such case illustrates that the lease is not a wasting asset within the purview of section 167, and amortization, accordingly, must be disallowed. It also illustrates that what was really being included in Elo's Federal estate tax return was the value of the underlying land, as encumbered by the lease and the option.

The above theory for disallowing amortization was implicitly recognized and stated in an early opinion of this Court, William Robert Farmer, 1 B.T.A. 711 (1925). We held therein that when an individual purchases a fee simple in property and thereafter leases it, he may not allocate part of his cost for the land to the right to use the land for the term represented by the lease and depreciate that portion of ‘cost basis' over the life of the lease. In so doing, we stated (1 B.T.A.at 713-714):

A fee simple title is the highest estate in land contemplated by the law. In such a title all lesser estates, rights, titles, and interests merge. When all such interests so merge there is a complete solidification of title and the various interests going to constitute that title lose their identity and are no longer distinguishable. In thus dealing with interests and estates in property, we are faced with an entirely different situation from that where a property has physically divisible values. * * * in the instant case, the freehold estate comprehended every right and privilege appertaining to the land. A right or privilege growing out of such ownership is not susceptible of a separate valuation.

This principle of inseparability of the bundle of rights constituting the fee simple has been reaffirmed several times by this Court. Rosalie M. Schubert, supra at 1053-1054; Martha R. Peters, 4 T.C. 1236, 1240-1241 (1945).

This principle is squarely applicable to the instant case. Petitioner's interest in the lease and in the land are inseparable for purposes of amortization under section 167. The lease is not a wasting asset and the deductions accordingly are disallowed.

The petitioner argued on brief that the lease was a wasting asset, inter alia, because Investment would assuredly exercise its option to buy the land upon the lease's termination; but there is no foundation in the record for such a finding. Many contingencies can arise by 1973 to prevent an exercise of the option and, accordingly, we need not decide whether, if this proposed fact were true, our decision would be changed.

Decisions will be entered for the respondent.