Moore, Friendly and Kaufman, Circuit Judges. Moore, Circuit Judge (dissenting).
IRVING R. KAUFMAN, Circuit Judge:
This case comes before us on petition of the taxpayers for review of a decision of the Tax Court, 48 T.C. 515 upholding the Commissioner's determination of deficiencies in their income tax for the taxable year 1960.*fn1 The issue it presents for our determination is the proper method of computing a casualty loss deduction claimed under § 165 of the Internal Revenue Code for the partial destruction of a timber tract.
All of the petitioners herein either owned an interest in or filed a joint return for the taxable year 1960 with a person then owning an interest in the Namarib Company-Timber Venture, a joint venture organized under the laws of the State of New York [hereinafter venture]. Specifically, in 1960, Irene Rosenthal, with whom Fred Rosenthal filed a joint return, owned a 6 2/3% interest in the venture, and Feyna Ginzberg owned a 3 1/3% interest in it. The Namarib Company [Company], a New York partnership, owned another 67 1/2% interest in the venture. Joachim Ginzberg owned a 60% interest in the Company; Efim Golodetz, with whom Fanny Golodetz, now deceased, filed a joint return, owned a 20% interest in the Company; and Leo Eliash, with whom Zara Eliash filed a joint return, owned the remaining 20% interest in the Company.
As of January 1, 1960, the venture owned a timber tract of 24,605.6 acres in Tennessee. Of this total, 19,734.7 acres had been acquired in 1951 for $300,000, and the remaining 4,870.9 acres had been purchased in 1956 for $60,000. As required by the Regulations under § 611, dealing with depletion deductions,*fn2 the venture allocated these purchase prices between the land and the timber on it. Thus, of the initial $300,000 expenditure (to which certain capitalized expenditures were added), $93,825 was allocated to the land and $217,875 to the timber; and of the later $60,000 purchase price (again plus capital expenditures), $19,225.93 was allocated to the land and $44,800 to the timber. As of January 1, 1960, the venture's adjusted basis in all the land was $113,080.93, and its adjusted basis in the timber was $212.476.30.*fn3 At that time, the total amount of saw timber on the tract was estimated for purposes of determining the venture's depletion deduction to be 58,445,000 board feet.*fn4
On March 2, 1960, an ice storm struck the southern central section of the Tennessee River Basin, damaging the timber on the venture's tract. It is not disputed that, as the taxpayers have contended, the fair market value of the entire timber tract of 24,605 acres immediately preceding the storm exceeded the fair market value of the tract immediately thereafter by at least $130,000. The taxpayers computed this loss, for which they have received no compensation by insurance or otherwise, as follows:
destruction of 4,757.100 board feet of saw
timber from trees more than 8 inches in diameter at
breast height) having market value of $104,787.29
destruction of 5,058.3 cords of pulpwood (timber from
trees between 4 and 8 inches in diameter at breast
height) having a market value of 11,643.09
destruction of naturally produced young growth (trees
measuring less than 4 inches in diameter at breast
height) having a market value of 12,173.00
destruction of plantations on the tract having a market
On its 1960 partnership information return, the venture claimed the entire $130,500.38 as a § 165 casualty loss, and each of the taxpayers took the appropriate percentage of this amount as a deduction on his individual income tax for the same year.*fn5 The Commissioner allowed the $1,906 deduction for the loss of plantations*fn6 but disallowed all except $17,315 of the remaining amount claimed as a loss for damage to the rest of the timber. Accordingly, in his notice to each of the taxpayers, he determined a deficiency resulting from the portion of the venture's disallowed deduction each had claimed in his individual income tax return. The Tax Court upheld the Commissioner's determination, and the taxpayers petition this court for review of that decision. The American Paper Institute, Continental Can Company, Inc., International Paper Company, The Mead Corporation, and West Virginia Pulp and Paper Company have, with the permission of the court, filed a brief as amici curiae supporting the position of the taxpayers. For the reasons below, we affirm the decision of the Tax Court.
As noted, there is no dispute as to the market value of the taxpayers' loss resulting from the ice storm. The only point of contention is how much of this loss may be claimed as a deduction under § 165.
Section 165(a) sets forth the general rule: "There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise." As the Regulations make clear, a casualty loss coming within the provisions of § 165 is deductible to the extent of (1) the difference between the fair market value of the property immediately before and after the casualty, or (2) the taxpayer's basis in that property, whichever amount is less. Treas.Reg. § 1.165-7 (b)(1). The issue on which the taxpayers and the Commissioner differ is the proper basis figure to be used in computing the amount of their loss deduction.
The taxpayers contend that the appropriate basis for this purpose is their basis in the entire tract. Under this theory, since the amount by which the market value of their property was reduced by the casualty ($130,500.38) is less than their basis in the property ($212,476.30), they are entitled to deduct all of the former amount. The Commissioner argues in response that the taxpayers cannot apply the whole of their basis in the tract to this partial loss, but that they must apportion that basis between the timber destroyed and that left unharmed in the manner in which they apportion basis for determining the allowable depletion allowance when timber is sold.
Briefly, the Regulations provide that deductions for depletion of timber shall be computed in the following manner. Each year the taxpayer is to estimate the total number of units of merchantable timber (e. g., board feet) on his timber tract. This number is then divided into his adjusted basis in all the timber on that tract, and the quotient obtained is called the "depletion unit." The depletion unit multiplied by the number of units of timber on the tract cut (or sold) during that year equals the amount of the depletion deduction to which the taxpayer is entitled for that taxable year.*fn7 Treas.Reg. § 1.611-3.
Following this formula, the Commissioner divided the taxpayers' adjusted basis in the tract as of January 1, 1960 ($212,476.30) by the total number of merchantable units of timber on the tract as of that date (58,445,000 board feet of saw timber) to arrive at a depletion unit for the timber of $3.64 per 1,000 board feet. Multiplying this figure by the number of units of merchantable timber destroyed by the casualty (4,757,100 board feet of saw timber), he arrived at $17,315.48,*fn8 which he claims to be the basis allocable to the timber lost.*fn9 This amount, substantially less than the loss of market value due to the casualty, then sets the limit on the amount of the § 165 deduction to which the taxpayers are entitled.
Both the taxpayers and the Commissioner seek to draw support for their respective positions from the language of the relevant Code provisions. The relevant words of the Code are to be found in typical "Cross-reference to" cross-reference and "exception upon exception" fashion. Dilliard, The Spirit of Liberty, 213 (quotation from Learned Hand). The starting point for both is § 165(b), which provides: "the basis for determining the amount of the deduction for any [§ 165] loss shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property." Section 1011 provides: "The adjusted basis for determining the gain or loss from the sale or other disposition of property * * * shall be the basis (determined under section 1012 * * * [or other sections not applicable here]), adjusted as provided in section 1016." Section 1012 in turn instructs: "The basis of property shall be the cost of such property * * *."
The taxpayers argue quite simply that the "property" referred to in each of these sections is, in their case, the entire tract of timber. This is the unit of property they purchased and its cost therefore provides the relevant basis. Further, they urge, nothing in §§ 1011 or 1012, to which § 165 refers for the definition of basis "requires or suggests that their cost had to be allocated to the trees or board feet of the tract purchased."
This overly simplistic argument, we believe, is of little help. It is true that §§ 1011 and 1012 in defining the basis of the property do not suggest any requirement that basis be allocated. But the "property" the taxpayers actually purchased was land with timber growing on it; and the Regulations make perfectly clear that for purposes of determining gain or loss on the sale of timber, the taxpayer must allocate his basis between the land and the timber. Treas.Reg. § 1.611-3(d) (3). Thus, the single property purchased -- timberland -- does become at least two separable properties for tax purposes. Indeed this proposition is so far beyond dispute that the taxpayers accept it unquestioningly while arguing that all the timber on the tract, separate from the land, is the relevant property for § 165 basis purposes in determining the allowable deduction for a partial loss.
The Commissioner's argument is somewhat more complex. He also begins with § 165(b): "the basis for determining the amount of the deduction for any loss shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property " [emphasis added]. This provision he quite reasonably interprets to mean that the same basis should be used in determining a loss deduction under § 165 as would be used in computing gain or loss had the same timber been sold. And in the case of a partial sale of timber, the taxpayer's basis in all the timber on the tract must be allocated between the timber sold and that remaining. This is accomplished in the form of a depletion deduction. Thus, § 611(a) provides as the general rule: "In the case of * * * timber, there shall be allowed as a deduction in computing taxable income a reasonable allowance for depletion * * *." And § 612 provides: "the basis on which depletion is to be allowed in respect of any property shall be the adjusted basis provided in section 1011 for the purpose of determining the gain upon the sale or other disposition of property." As we have stated, the amount of depletion allowable in any year is determined by allocating the taxpayer's adjusted basis in all the timber on the tract equally among all the units of merchantable timber on the tract and then multiplying the basis per unit by the number of units cut.Treas.Reg. §§ 1.611-3, 1.612-1(a).
The taxpayers argue that § 611 is not relevant for our purposes because it provides for a depletion deduction not a tax basis of property. But again, their almost liturgical repetition of words in an area as complex as this, without supplying any convincing rationale, is to glorify semantics over substance. When the actual functioning of the depletion deduction is examined, it becomes apparent that it is in effect the basis used in determining the gain or loss from the sale or other disposition of timber. The depletion deduction is determined at the time the timber is cut and is dependent upon the number of units of merchantable timber cut (and the depletion unit, or adjusted basis per unit of merchantable timber on the tract). However, to ensure that the depletion deduction for the timber cut will be matched against the income derived from the sale of that timber, the Regulations further provide: "To the extent that depletion is allowable in a particular taxable year with respect to timber the products of which are not sold during such year, the depletion so allowable shall be included as an item of cost in the closing inventory of such products for such year." In short, the taxpayer obtains the benefit of the depletion deduction assignable to specific units of timber, which represents his cost in those units, only in the year when he actually disposes of the timber. Thus, the depletion deduction allocable to specific timber has precisely the same significance as basis in the case of an ordinary sale or disposition of property: it represents the cost of the property to the taxpayer, the standard for determining whether he enjoys a taxable gain or recognizable loss upon its sale or other disposition.
A consideration of § 631 buttresses the Commissioner's analysis. Section 631(a) provides: "If the taxpayer so elects on his return for a taxable year, the cutting of timber * * * during such year by the taxpayer who owns * * * such timber * * * shall be considered as a sale or exchange of such timber cut during such year. If such election has been made, gain or loss to the taxpayer shall be recognized in an amount equal to the difference between the fair market value of such timber, and the adjusted basis for depletion of such timber in the hands of the taxpayer * * *" [emphasis added].*fn10 And, as the Regulations make clear, "the adjusted basis for depletion of such timber" to be used in determining the gain or loss to be recognized upon a sale under § 631 equals the depletion unit applicable to the timber on the tract multiplied by the number of units of timber cut (and treated as sold). Treas.Reg. § 1.631-1(d). Manifestly then, when the taxpayer makes an election to treat the cutting of timber as a constructive sale of such timber, he is required to allocate a portion of his adjusted basis in the entire tract to the specific timber cut -- and that basis is the depletion deduction applicable to such timber provided for in § 611.
This analysis, we believe, conclusively rebuts taxpayers' contention that the only basis available for use in determining the amount of their allowable deduction under § 165 is their basis in the entire timber tract. Rather, it is quite obvious that the basis used in determining gain or loss on a partial sale or exchange of timber is that portion of the basis in the tract ratably allocable to such specific timber. And since this allocable basis is "the adjusted basis provided in section 1011 for determining the loss from the sale or other exchange" of this property (i.e., the timber destroyed), the interrelated statutory provisions do provide strong support for the Commissioner's result. We do not rest our conclusion as to the correctness of the Tax Court's decision on the statutory language alone, however, for we believe that a reasoned consideration of the basic principles governing the deduction of casualty losses generally offers even more weighty support for this result.
The taxpayers strenuously contend that the Commissioner's result would defeat the purpose of § 165, which they say is to provide tax relief "for economic loss suffered, not for some proportionate part of that loss." This description of the statute's purpose is wholly misleading. Undeniably, § 165 was designed to afford some measure of tax relief to persons suffering uncompensated casualty losses. But, as we have stated, the amount of the loss deduction allowable under this section is in every case limited to the lesser amount of either the decrease in market value of the property as a result of the casualty or the taxpayer's basis in the property. Manifestly, the purpose of § 165 is not to allow the taxpayer a full deduction for every loss in market value his property suffers by reason of a casualty. The permissible deduction for such loss is always limited to the taxpayer's basis, or cost, in the property damaged. And the reason for this limitation is clear. Where the taxpayer suffers a loss from a destruction of market value greater than the cost of the property to him, that excess of value destroyed represents unrealized appreciation. And he may not claim a deduction for such loss because he has never recognized or paid a tax on the gain. In the extreme case, where the taxpayer's basis in the property damaged is zero, and its ...