Waterman, Marshall and Anderson, Circuit Judges.
Western New York Water Company, the taxpayer,*fn1 was incorporated under the laws of the State of New York in 1902 for the purpose of selling water in Erie County. In July of that year it purchased all of the outstanding stock of the Depew & Lake Erie Water Company. In 1909 Depew was liquidated and all of its properties were transferred to Western.
In 1900 Depew entered into an agreement with the New York Central Railroad under the terms of which it was to supply water to the Railroad at a favorable rate in exchange for rights of way necessary for its pipeline system. Between 1902 and 1909 Western and Depew engaged in extensive construction of facilities, in excess of current demand, to increase their capacity to furnish water to customers. By March 1, 1913 the taxpayer had an established, operating water supply system, consisting of principal trunk lines laid in railroad rights of way, reservoirs, pumping stations, transmission mains to various communities, distribution mains and service pipes to customers.
The purpose in constructing the trunk lines and transmission mains for a larger water-carrying capacity than was actually required at the times they were laid, was to provide for future growth of the system without the added expense of laying new pipe from time to time as the increased demand might arise. Because of this added investment in what was then excess capacity and also, as Western claims, because of the low rates paid by the Railroad, the principal customer during that period, the two companies' combined statement of net earnings and losses for the period of 1900 to 1913 showed losses in the aggregate amount of $213,431.14.*fn2 The record does not disclose when, if ever, after March 1, 1913, the taxpayer's operations became profitable and does not reflect net earnings and losses for such years. Nor was there any evidence whatever on which a valuation expert could, as of March 1, 1913, have reasonably based a prognosis of any future increase in the demand for water.
In 1951 the Erie County Water Authority commenced condemnation proceedings against the taxpayer for the acquisition of all of the taxpayer's property. In 1953 a settlement in lieu of condemnation was reached. Under the terms of the involuntary sale which followed, the taxpayer's assets and properties were turned over to the Authority for a total consideration of $14,780,022.11. For Federal income tax purposes, Western reported a gain on the sale of $653,755.63. In computing the gain, Western deducted from the proceeds of the sale the sum of $14,126,266.48, as its cost basis, which included the following items and amounts, carried on its books as non-depreciable capital assets:
a) easements $5,221,150.00
d) engineering and super-