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March 31, 1958

Robert G. GOELET, Francis Goelet and Henry B. Guthrie, as Trustees U/W of Robert W. Goelet (John Goelet), Plaintiffs,
UNITED STATES of America, Defendant, and related cases

The opinion of the court was delivered by: BICKS

Plaintiffs, heirs and trustees for heirs of Robert Walton Goelet, deceased, have brought this consolidated suit for refund of federal income taxes claiming that they are entitled to depreciation deductions on certain improved real property inherited from the testator.

The critical facts, to which the parties have agreed by stipulation, are briefly as follows: In 1929, Robert W. Goelet, the fee owner, demised a 28,000 square foot plot of land known as 1400 Broadway to the Tanager Construction Corporation for a forty-four year term commencing July 1, 1929 and ending April 30, 1973, at a rental and upon terms and conditions more fully set forth in the lease. Consistent with the terms of the lease, the lessee removed the improvements then on the land and erected thereon a 38 story commercial building all at its own cost and expense. The cost to the lessee of demolition, and construction of the new improvements was $ 3,943,997.33.

Since the completion of the building in 1931, the lessee has been permitted to deduct from its annual income for tax purposes an allowance for depreciation of the building at a constant rate based on the capitalized value of the improvements over a 42 year period, the unexpired term of the lease at the time the improvements were completed.

 In 1941 the lessor died testate and by the terms of his will plaintiffs here inherited his interest in the property.

 Plaintiffs received rental income from the property thus leased and paid taxes thereon. They now claim refunds for the years 1944, 1946, 1947, 1948 on the ground that the taxes were computed and paid without a deduction having been taken for depreciation of their interest in the property. They urge that either (1) the building itself is depreciable property in their hands or (2) that the lease has a 'premium value' which is amortizable over the term thereof.

 The applicable section of the 1939 Internal Revenue Code is § 23(l). *fn1" The purpose of Congress in enacting § 23(l) was to allow the taxpayer a means of recouping his investment. The amount which may be deducted is that which should be set aside each year, in order that, at the end of the useful life of the property, the total of the sums thus set aside plus any salvage value will equal the original cost. United States v. Ludey, 1926, 274 U.S. 295, 47 S. Ct. 608, 71 L. Ed. 1054. The major thrust of the statute is toward an allowance for recovery of investment in a wasting asset. See Detroit Edison Co. v. Commissioner of Internal Revenue, 1943, 319 U.S. 98, 63 S. Ct. 902, 87 L. Ed. 1286 and Commissioner of Internal Revenue v. Revere Land Co., 3 Cir., 1948, 169 F.2d 469. Admittedly, there was no investment in the building by the original lessor, and he was not, plaintiffs agree, entitled to a deduction under § 23(l) of the 1939 Code. By what alchemy his heirs have acquired an investment status when Goelet himself had none is not demonstrated by plaintiffs. They point to the fact that they now have a basis for depreciation by virtue of § 113(a)(5) *fn2" and § 114(a) *fn3" whereas the basis to Goelet was cost, here zero. The section allowing the heirs to take a new basis, however, was not intended to create a depreciable interest where none existed before. Its purpose was to establish a new basis for the heirs which would accurately reflect the value of the property at the time of acquisition. The depreciability of the interest is a question quite apart from the value assigned to the property in taxpayers' hands. It is only after the existence of a depreciable interest has been demonstrated that we turn to the basis to discover the extent of the allowable deduction.

 The suggestion, (never clearly spelled out), was made that the payment of an estate tax not only establishes a new basis but somehow constitutes an investment, the value of which is lost through the effects of wear and tear and time giving rise to a depreciable interest in the hands of the legatees. *fn4" Such an interpretation of the effect of the estate tax provisions is clearly erroneous. It has been established beyond cavil that this tax is one upon the transfer of property and not a tax upon the property itself so that an investment cannot be considered to have been made by virtue of the payment of an estate tax if, in fact, such a tax was paid. *fn5" See United States Trust Co. of New York v. Helvering, 1938, 307 U.S. 57, 59 S. Ct. 692, 83 L. Ed. 1104; May v. Heiner, 1929, 281 U.S. 238, 50 S. Ct. 286, 74 L. Ed. 826. Since the original lessor admittedly had no basis for depreciation his heirs stand, so far as investment status is concerned, in the same position as the decedent; they did not acquire such status by virtue of the payment of an estate tax. The court, therefore, is constrained to find that plaintiffs fall without the intendment of § 23(l) of the 1939 Code.

 Furthermore, plaintiffs have not shown that they have an interest which will in fact be lost with the passage of time. They urge the existence of a depreciable interest but an examination of the property rights they inherited does not support that conclusion. Plaintiffs inherited the fee subject to the lease, the right to receive the ground rentals reserved by the lease, and a reversionary interest in the building itself. Their interest in the building is restricted to a right to occupy it some 32 years after the crucial date in 1941. It is plain that such right suffers no diminution in value as a result of the passage of time; on the contrary, the value of the right must increase as the time for its actual enjoyment advances. This reversion is the only interest which plaintiffs have in the building as such; and as pointed out above, it is not depreciable.

 The fact that by the terms of the lease technical legal title in the building rests in the lessor or his successors is not determinative for tax purposes of the actual economic interests which were retained by the land owner. It is well established that 'Federal income taxes are based on reality not form, on fact not fancy, on substance not seeming. See, Bowers v. Kerbaugh-Empire Co., 271 U.S. 170, 46 S. Ct. 449, 70 L. Ed. 886; Irwin v. Gavit, 268 U.S. 161, 166, 45 S. Ct. 475, 69 L. Ed. 897; Roberts v. Commissioner of Internal Revenue, 9 Cir., 176 F.2d 221, 225, (10 A.L.R.2d 186).' United States v. Maryland Jockey Club, 4 Cir., 1954, 210 F.2d 367, 371. See also, Weiss v. Stern, 1923, 265 U.S. 242, 44 S. Ct. 490, 68 L. Ed. 1001; United States v. Phellis, 1921, 257 U.S. 156, 42 S. Ct. 63, 66 L. Ed. 180. Beneficial ownership of the building was in the lessee. It is the lessee who would receive the proceeds representing the value of the structure of any award allocable to the building if the property were taken by the right of eminent domain (Article 4, para. 14 of the lease); and if the building were destroyed by fire it is the lessee who would receive the 'balance of * * * insurance moneys remaining after the reconstruction is completed * * *' (Article 4, para. 3 of the lease). These provisions serve as reinforcement for the view that actual beneficial ownership is entirely in the lessee. The provision for title in the lessor does not create a right to depreciate the cost of the building which would otherwise not exist. Realistically, the principal difference between title remaining in the lessee who built the structure or in the owner of the land upon which it was erected is the right to remove it at the expiration of the term of the lease. Being relieved of the duty to do so in the instant case probably redounds to the benefit of the lessee since the cost of demolition might well exceed the value of the salvage. In 1941 the only interest the lessor or his successors had in the building was the then value of the anticipated reversion, a right which at that time was worth very little. Even, therefore, if taxpayers' argument that they are to be treated as purchasers, even though neither they nor their predecessor in interest made an investment, were to be accepted, they would still not be entitled to the deductions they ask in their claims for refund since their interest in the building is limited to the value of the reversion, whose market value, had it been proven, would undoubtedly be very small, and which taxpayers have not shown would be lost through the effects of time.

 The cases cited by plaintiffs through which they seek to demonstrate a depreciable interest do not support the proposition for which they were advanced. Plaintiffs attempt to draw an analogy between those cases which involve purchasers for value of the fee and the building subject to the lease and themselves. *fn6" An extension of these decisions to the instant case is not warranted. The crucial distinguishing factor is the payment of a purchase price or the existence of an investment, not present here, to which type of transaction the statute was meant to apply

 More directly in point are the cases cited by plaintiffs which treat with the depreciation problems of legatees who inherited land and building subject to a lease, much as taxpayers here. These cases, however, are no longer authority for plaintiffs' argument. On the contrary, every case to which our attention has been directed which dealt with this issue has either ruled that the heirs of a lessor who had not cost basis are not entitled to a depreciation deduction *fn7" or, having held to the contrary the case has either been reversed *fn8" or overruled by the court rendering the decision. *fn9"

 Plaintiffs have laid much stress on the fact of newly acquired basis but have failed to point out how they meet the requirement of § 23(l) that the property for which the deduction is sought be held for the production of income. Their income is derived solely from the ground rentals. Income which is a product of the use of the structure and the rental of various parts thereof inures to the benefit of the Tanager Construction Co., the lessee. Plaintiffs do not hold the wasting property for the production of income and are, therefore, not entitled to the statutory exclusion. First National Bank of Kansas City v. Nee, 8 Cir., 1951, 190 F.2d 61, 40 A.L.R.2d 423; Rowan v. Com'r, supra.

 Sustaining plaintiffs' position would result in an unwarranted depletion of the Treasury. The lessee is properly taking depreciation deductions on his investment in the building and will be entitled to continue to do so until his entire basis has been recovered. To allow plaintiffs to also take deductions on what would essentially be the same investment deprives the Treasury of revenue to an extent not envisioned by Congress.

 With respect to the taxpayers' second theory, the Government contends that the plaintiffs are precluded from basing their claim to relief thereon. The Government argues that under the claim as filed they are restricted to proceeding on a theory of depreciation on the value of the building and may not advance a ...

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