The opinion of the court was delivered by: HERLANDS
This is an action for refund of taxes paid for the calendar year 1948. The material facts are stipulated.
On the question of law which remains, both sides move for summary judgment.
That question of law may be stated as follows:
On a sale in 1948 of depreciable property (a hotel) by trustees of a liquidating trust for the account of remaindermen (including these plaintiffs), must adjustment of the cost basis -- for the purpose of determining gain or loss -- be made for depreciation of the property during the period from February 1, 1915 (the approximate date of the creation of the trust) up to January 1, 1928 (the effective date of section 23(k) of the Revenue Act of 1928, 26 U.S.C.A. (I.R.C.1939) § 23(l))?
The trust instrument did not require or empower the trustees to accumulate a reserve for depreciation. Similarly, under New York law governing such trust, the Trustees could not properly accumulate a reserve for depreciation.
One of the major circumstances giving rise to the litigation is that the liquidating trustees did not make deductions for depreciation for income tax purposes during the period from February 1, 1915 up to January 1, 1928, the effective date of 23(k) of the Revenue Act of 1928. In explanation of their not deducting depreciation for income tax purposes during the 1915-1928 period mentioned, the trustees claim that such depreciation was not allowable for income tax purposes under the tax laws and regulations in force during that particular period. With that interpretation of the tax laws and regulations as their premise, the trustees them make the following argument: since depreciation was not allowable for income tax purposes during the particular period mentioned, the trustees were not required to take into account depreciation for that period in adjusting and determining the original cost basis of the hotel and in computing the profit on the sale of the hotel in 1948.
The Government's position is that the original cost basis of the hotel should be reduced to reflect depreciation for the thirteen-year period from February 1, 1915 to December 31, 1927, inclusive. In order to find that the Government's position is correct, it is only necessary for the Court to determine that a deduction for depreciation was allowable under the statutes applicable to those years. It is not necessary for such determination that depreciation shall have been actually claimed as a deduction for such depreciation to be considered as an adjustment of the original cost basis of the hotel.
The statute applicable to a sale of property in 1948 -- the year in which the hotel was sold -- was Internal Revenue Code of 1939. Section 113(b)(1)(B)
of that Code, 26 U.S.C.A. § 113(b)(1)(B), required the adjusted cost basis -- for determining the gain or loss from the sale of property -- to reflect depreciation since February 28, 1913, the extent being not less than the amount 'allowable' under the 1939 Code 'or prior income tax laws.'
It has been held that the adjusted cost basis should reflect 'allowable' depreciation, notwithstanding the circumstance that a deduction for allowable depreciation would not have benefited the taxpayer taxwise, as where the taxpayer owned a depreciable property which produced no income and where he had no other sources of income.
Thus, the question to be decided is whether depreciation was 'allowable' during the thirteen-year period in question.
The taxpayers' fundamental argument is that, during the thirteen-year period here involved, deductions for depreciation in computing taxable income could not have been taken by either the trustees or the income beneficiaries or the remaindermen because the trust was subject to the following two conditions: (1) under the express terms of the trust instrument, all of the income was required to be and was, in fact, distributed currently; and (2) under the laws of New York State, which determined the trust administration, a depreciation reserve was not authorized, in view of the fact that the trust instrument did not contain an express provision for such a reserve. Plaintiffs concede that, if they had been owners in fee simple of the property for the entire thirteen-year period, they would have been allowed to deduct depreciation and that, consequently, the adjustment of original cost basis now challenged would have been proper. United States v. Ludey, 1927, 274 U.S. 295, 47 S. Ct. 608, 71 L. Ed. 1054.
But the structure of plaintiffs' argument attacking the Commissioner's adjustment to reflect depreciation during the thirteen-year period, is built upon the proposition that, for the particular period, plaintiffs were beneficiaries of an express testamentary trust that was qualified and circumscribed by the two conditions specified above. In this connection, certain facts must be noted.
Plaintiffs are the remaindermen of the express testamentary trust created by Gustavus Sidenberg (who died in 1915) in favor of (inter alia) Henry Sidenberg (who died in 1925). Although the trustees continued to administer the trust in solido (because the hotel could not be divided readily), from and after Henry Sidenberg's death in 1925, these plaintiffs-remaindermen were never beneficiaries under the trust instrument,
but were presumably owners in fee simple of an undivided one-third interest in the hotel when they took as remaindermen in 1925. Thus, as to them, the trustees were, in legal effect, acting not as trustees but as agents. Consequently, as to the period from Henry Sidenberg's death in 1925 to December 31, 1927, there is no arguable basis for plaintiffs' challenge of the Commissioner's adjustment to reflect allowable depreciation. This narrows the scope of plaintiffs' challenge to the period from February 1, 1915 to the death of Henry Sidenberg in 1925.
Citing the applicable statutes
and six judicial decisions
allegedly supporting plaintiffs' statutory construction, plaintiffs strenuously contend that the adjusted original cost basis as reported by plaintiffs should not have been altered by the Commissioner to reflect non-allowable depreciation. Additional reliance for their argument is placed by plaintiffs upon contemporary interpretative regulations issued by the Commissioner.
The Government's position is that the applicable statutes allowed depreciation on the trust property during the thirteen-year period and that, therefore, the Commissioner properly deducted the agregate depreciation for the period in computing the gain on the sale of the hotel. The following cases are relied upon by the Government: Fidelity-Philadelphia Trust Co. v. Commissioner, 3Cir., 1931, 47 F.2d 36; United States Trust Co. of New York v. Commissioner, 1934, 31 B.T.A. 54; Hall v. United States, 1942, 43 F.Supp. 130, 95 Ct.Cl. 539, certiorari denied 1942, 316 U.S. 664, 62 S. Ct. 944, 86 L. Ed. 1740, rehearing denied 1942, 316 U.S. 709, 62 S. Ct. 1105, 86 L. Ed. 1776; Jones v. Commissioner, 8 Cir., 1934, 72 F.2d 114, certiorari denied 1934, 294 U.S. 716, 55 S. Ct. 515, 79 L. Ed. 1249; Old Colony Trust Co. v. White, D.C.Mass.1929, 34 F.2d 448.
An analysis of the above-cited cases shows them to be clearly in point. In the Fidelity-Philadelphia Trust Co. case, which bears striking similarities to the litigation now before this Court, the taxpayer petitioned the Third Circuit to review a Board of Tax Appeals order sustaining an assessment of income tax by the Commissioner. The issue was whether the Commissioner could adjust the cost basis of property at the time of its sale in 1923 to reflect depreciation for the years 1913 to 1923, which depreciation had in fact never been claimed because the trustee (as in the case at bar) contended that, under the applicable acts and regulations, it was not entitled to take deductions for depreciation. The precise question before the Third Circuit was whether depreciation was 'allowable' to the trustee during the applicable years.
The following three arguments advanced by the trustee as to why depreciation was not 'allowable' closely parallel those submitted by the plaintiffs at bar: (1) that the trustee was not permitted to take a depreciation deduction under the applicable Revenue codes; (2) that the regulations specifically forbade a deduction for depreciation by the trustee except where the trust instrument made specific provision for keeping the corpus intact; (3) that deductions for depreciation were not available to the trustee and, therefore, not binding upon it in view of a specific Pennsylvania statute which forbade ...