Lumbard, Chief Judge, and Waterman and Moore, Circuit Judges.
Two taxpayers, Turner Construction Company (Turner) and Edmund A. Prentis, Lazarus White, Charles B. Spencer, Inc.,*fn1 appeal from two judgments of the United States District Court for the Southern District of New York. The cases were tried together because they contained a common issue of fact and law. Since that issue is contested here by both taxpayers, the appeals have also been consolidated. Each taxpayer also presses an issue applicable only to it.
The appeals present three questions. First, whether the useful life for depreciation purposes of certain Turner warehouse buildings was 25 years or 33 1/3 years. Second, whether each taxpayer may claim a loss in its 1951 tax year on the "sale" of stock in a joint venture corporation. Third, whether Spencer properly assigned a stepped-up basis to machinery and equipment received from a predecessor corporation in 1952. A fourth issue involves whether Spencer should have been permitted to amend its complaint after the trial court's opinions were announced so as to press a new theory with respect to issue III. We find against the taxpayers on issues I and II and we affirm those portions of the lower court's orders. On issue III we reverse and remand for further proceedings. For this reason, we do not decide the amendment question.
The three issues are essentially unrelated and will be treated independently. The parties stipulated many of the relevant facts. A three-day trial without a jury developed additional facts. The cases are governed by the provisions of the Internal Revenue Code of 1939 (hereinafter referred to by section numbers only).
I. Useful Life of the Hackensack Buildings
Turner contends that the district court erred in upholding the Commissioner's determination that the useful life for depreciation purposes of three warehouse buildings in Hackensack, New Jersey, was 33 1/3 years instead of 25 years, as Turner had claimed in its tax returns. Turner constructed these buildings in 1952 when it shifted its repair and storage facilities from Maspeth, Long Island, to New Jersey. The State of New Jersey's Highway Department condemned the buildings after the tax years in question.
Since the stipulation contained only a technical description of the buildings, resolution of this issue turned on the oral testimony. Francis B. Warren, Turner's executive vice president and treasurer, testified that the buildings were open air storage and repair facilities made from light, prefabricated materials, that they received rough treatment from the company's heavy construction equipment, and that 25 years was a reasonable estimate of their useful lives. The government countered with testimony by the revenue agent who had examined these buildings -- a graduate engineer who had made similar estimates for the Commissioner since 1946. He described the buildings and explained his reasons for concluding that these structures had a useful life of 40 years.
After reviewing this conflicting evidence, Judge Levet concluded that the taxpayer had failed to meet its burden of proving that the Commissioner's estimate -- the compromise figure of 33 1/3 years -- was incorrect. Turner refers us to many cases which have set the useful lives of warehouse buildings at 25 years or less, and urges us to reverse the decision of the trial judge. But the question here is the useful life of these particular structures. The record reveals that the Hackensack buildings replaced Maspeth buildings having an admitted useful life of 50-60 years. Under these circumstances, we find no error in the lower court's conclusion that neither side had affirmatively proved its position. In such a case, the taxpayer, who has the burden of proof, cannot prevail.
II. River Construction Corporation Transaction
Both Turner and Spencer assail the district court's holding that the Commissioner properly disallowed losses claimed by the taxpayers on the "sale" of their stock in the River Construction Corporation (River) in June of 1951. Here a complex factual situation raises a fundamental tax question in a novel form.
Early in 1947, six construction companies, including Turner and Spencer, agreed to undertake a joint venture to secure a government contract for the construction of Lock No. 27, Chain of Rocks Canal, on the Mississippi River near Granite City, Illinois. The companies incorporated River as a Delaware corporation on April 29, 1947. On May 1, the six signed an agreement which fixed their respective interests in River,*fn2 and defined their rights and obligations as shareholders. Significantly, the agreement provided that none of the six would sell its River shares without unanimous approval of all; that such a sale would not relieve the seller of any obligations under the contract; and that each of the six would hold harmless, up to a designated amount, any surety which executed a bid bond on the lock project.
The six participants eventually agreed on a bid for the project which was submitted by River. On the basis of this bid, and the surety bond of the United States Fidelity and Guaranty Company, River was awarded the construction contract and, shortly after work began, was awarded a companion contract to install a 54" pipe under the Chain of Rocks Canal.
By 1950, due principally to unforeseen weather and labor conditions, it was apparent that River would incur substantial losses on the contracts. In the fall of 1950, the Winston Brothers and Al Johnson companies announced their desire to sell out so as to realize in that tax year a capital loss on the River venture. The other participants refused to permit a sale to third parties, but it was agreed that each of these two could return its shares to River in exchange for $9,000 in cash and a non-assignable, non-interestbearing note in the amount of $171,000.*fn3
By the middle of 1951, River's construction work on the two contracts was over 95% completed. However, the amount of the ultimate loss was still unpredictable because River had contingent claims against the government which might take years of litigation and negotiation. At this point, the four remaining shareholders decided that River should have only a single owner during this "liquidation" period.
To reduce River from four shareholders to one posed significant problems. None of the participants wanted River stock sold to outside interests. In addition, each was contractually bound to the surety company to meet its share of River's losses. Finally, though they wanted only one shareholder, they agreed to share the ultimate burden of River's losses equally.
These considerations were met in the following manner. Morrison-Knudsen Company agreed to pay $125,000 into the corporate surplus of River. Turner, Spencer and Raymond Concrete Pile Company each agreed to transfer its shares to River in exchange for $11,000 in cash and a non-assignable, non-interest-bearing note in the amount of $209,000. Each of the three notes was subordinated to claims of the surety, and each contained the following provision:
3. When and if the aforementioned contract is completed and upon closing of accounts of said contract it shall appear that such stock, exclusive of good will, tax credits and other similar intangibles, is worth less than $220,000 [the total purchase price to Turner and Spencer], based on its original capitalization less losses on said lock contracts and pipe line contract, plus $125,000 [the amount of Morrison-Knudsen's contribution], then and in that event this note shall be reduced by a sum represented by the difference between its then so determined true worth and $220,000. (Emphasis added.)
The $220,000 purchase price amounted to $44 per share. This figure allegedly was determined by rough calculations based on River's current balance sheet and its anticipated total loss. When final payment on the notes was finally made to Turner and Spencer in 1957, it was found that all payments had totaled only $118,134.27, or $23.63 per share, to each company. The taxpayers vigorously contend that $44 per share was nevertheless a fair and reasonable estimate of River's value in 1951, and that only a disappointing realization on the contingent claims against the government prevented a larger recovery. But Judge Levet pointed out in his opinion evident miscalculations which produced a liberal estimate of River's worth. Given taxpayers' disproportionately low recovery on the notes, we infer that $44 was agreed upon because it was a "safe" price. In other words, it presented a maximum amount per share which the parties anticipated in 1951 could finally be realized by River on the project.
These transactions provided a number of possible benefits to the participants. Morrison-Knudsen, by becoming sole parent of River, no doubt hoped to utilize more fully River's large net operating loss carryover. Turner and Spencer, by exchanging their River stock for cash and a note, not only profited from the $125,000 paid by Morrison-Knudsen into River but also hoped to realize some of their loss on the River venture so as to offset 1951 income.*fn4 On the other hand, the ultimate risk of loss remained evenly distributed among all six of the original shareholders, and the surety company retained satisfactory protection.
This appeal raises only the question whether Turner and Spencer properly declared as a loss in 1951 the difference between the $220,000 "paid" for their stock and their original investments of $500,000. The government argues that the loss was properly disallowed for four reasons: (1) the sales were fictitious and therefore no losses were realized in 1951; (2) the transactions were not adequately closed and completed in 1951; (3) the amounts of the losses were not sufficiently ascertainable in 1951; and (4) taxpayers' "sales" to River were in fact parts of a tax-free recapitalization. Judge Levet agreed with the first three contentions and disallowed the losses in the 1951 tax years of Turner and Spencer. We agree that in 1951 the losses were neither sufficiently ascertainable nor properly evidenced by a closed transaction.
Under Section 23(f), now Section 165 of the Internal Revenue Code of 1954, a deduction was allowed "in the case of a corporation, [for] losses sustained during the taxable year and not compensated for by insurance or otherwise." For help in resolving a specific problem, we look to Treasury Regulation 111, § 29.23(e)-1 (1939), which provides that to qualify as a deduction a loss "must be evidenced by closed and completed transactions, fixed by identifiable events, bona fide and actually sustained during the taxable period for which allowed." In accordance with these principles, Turner and Spencer must each establish that its loss was "realized * * * by a sale," Weiss v. Wiener, 279 U.S. 333, 335, 49 S. Ct. 337, 73 L. Ed. 720 (1929); that the sale was a completed transaction in 1951, see Burnet v. Logan, 283 U.S. 404, 413, 51 S. Ct. 550, 75 L. Ed. 1143 (1931); and that the exact amount of the loss was in 1951 "so reasonably certain in fact and ascertainable in amount as to justify [its] deduction" at that time, Lucas v. American Code Co., 280 U.S. 445, 449, 50 S. Ct. 202, 203, 74 L. Ed. 538 (1930).
Though River's construction work on the project was nearly completed in 1951, the exact loss which its shareholders would realize on their investments could not then be determined. Therefore, had the six shareholders held their stock from 1951 until the final winding up of the project in 1957, they could not have deducted any portion of the eventual loss before 1957, even if the corporation had made distributions in partial liquidation during that period. As the Court of Claims stated in Dresser v. United States, 74 Ct. Cl. 55, 55 F.2d 499, 511-512, cert. denied, 287 U.S. 635, 53 S. Ct. 85, 77 L. Ed. 550 (1932):
It often happens, as here, that the liquidation of a corporation extends over a period of years and a decision that a loss may be taken upon the basis of a valuation of the unliquidated assets and an estimate of the remaining liabilities and expenses would enable the taxing authorities to place the loss in a taxable year in which the taxpayer might have a very small income and would enable the taxpayer to select a taxable year in which to take the loss in which he might have a large income and thereby obtain a greater benefit from the loss. * * * A stock loss is no different from a loss on any other property, and if a taxpayer acquires property at a certain cost which has not been disposed of he may not take a deduction from gross income as a loss of any amount merely because it may appear that when the property is finally disposed of he will receive less than what he paid for it.*fn5
The situation here is somewhat different from that in Dresser because five of the six River shareholders returned their stock to the corporation in exchange for cash and notes of indefinite value and duration. Taxpayers contend that these transactions, unlike distributions in partial liquidation, were a realization of their losses in 1951. Of course, when stock is actually sold by a shareholder for a loss, either to a third party or to the corporation itself, that loss is immediately allowed so long as the consideration received is reasonably ascertainable in amount. Cf. Commissioner v. Winthrop, 98 F.2d 74 (2 Cir. 1938). Thus, in 1951, Turner and Spencer could have realized part of their eventual losses by selling outright a part of their stock, or all of their losses by selling all of their stock, for cash.
But neither of these alternatives was adopted, and with good reason. Since Turner and Spencer wished to relinquish stock ownership but not the ultimate risk of loss, they transferred all of their stock in exchange for cash and carefully tailored notes. Because of paragraph 3 of the notes, p. 528 supra, the holders were entitled to no greater portion of future distributions of River assets than Morrison-Knudsen, the sole remaining shareholder. While the taxpayers did surrender in 1951 their rights as shareholders to participate in managing the business, from a financial standpoint the notes represented the same stake in River as their stock had represented. Given the safety of the $44 price and the nature of the notes received, these transactions had no more financial significance than an accounting entry debiting $280,000 to a "Loss on River Investment" account and crediting an equal amount to whatever investment account taxpayers used to signify their River venture. While such an interim entry might well reflect sound accounting practice, the tax laws allow losses to shareholders only for closed and completed stock sales for reasons made clear in the Dresser opinion, supra.
The taxpayer's main argument is that, because of the terms of the notes, their minimum ultimate losses -- i. e., the difference between $44 per share and their original investments -- were unalterably fixed in 1951 and that the transactions were therefore closed to that extent. This argument, like the transactions in question, is ingenious. The difficulty with it is that the precise amount of consideration received in the 1951 transactions was not reasonably ascertainable in 1951 because the notes were of indefinite value. This indefiniteness was an intentional feature of the taxpayers' transactions, and we cannot ignore it merely because the maximum value of the notes, $209,000 each, was fixed. It was this indefiniteness that distinguished the transactions from completed sales of the stock. If they are nonetheless treated as sales, as appellants urge, shareholders could easily split anticipated stock losses in substantially the same way as that condemned in Dresser. Under these circumstances, we do not think that the losses were "actually sustained" in the 1951 tax year. Treas. Reg. 111, § 29.23(e)-1 (1939). We hold that they may not be allowed even in part in that year.
In view of the above, we need not reach the government's alternative contention that the notes received by Turner and Spencer from River were "securities" and hence that the transactions were part of a tax free recapitalization in which no loss is recognized under Section 112(b)(3), 112(e), and 112(g)(1)(E).
III. Basis for Depreciation of Machinery
Spencer appeals from the district court's decision accepting the basis for depreciation set by the Commissioner for machinery transferred from Spencer's predecessor in 1952. The Commissioner disallowed $30,442.46 in depreciation for the tax year ending June 30, 1953, on the ground that Spencer was limited to the adjusted basis of the machinery in its predecessor's hands ($215,304.80) because the machinery had been transferred as part of a tax free transaction under Section 112(b)(4) and (b)(5).*fn6 Spencer contends that the proper basis is its cost ($381,112.83) ...