In 1934 petitioner retired from service certain of its ways and structures. Consistent with its accounting practice in all prior years, it claimed in its return, either by way of charges to operating expenses or to surplus, deductions on account of such retirement representing the cost of the property retired, reduced only by the value of the salvage recovered therefrom. Depreciation occurred prior to March 1, 1913, with respect to the assets which petitioner retired in 1934, and the parties stipulate that if material the amount thereof may be taken to be $88,694.34.

The retirement method of accounting for ways and structures is recognized and generally employed in the railroad industry in keeping books of account and in computing net income. Respondent has never objected and still does not object to the use of the retirement method of accounting with respect to ways and structures.

The units of ways and structures of a going railroad do not constitute separate properties held primarily for sale, but their component parts in their aggregate and with the right of way constitute the railroad as a single composite property. The replacement of individual units of ways and structures in whole or in part is a continuing necessity for the maintenance and operation of the railroad in an efficient condition. Petitioner's road was completed in 1905 and prior to March 1, 1913, petitioner was a well maintained and growing railroad. The ways and structures of petitioner through all years 1913 to 1934 were growing in dollar amount.

The accounting regulations prescribed by the Interstate Commerce Commission for petitioner and other steam railroads effective since July 1, 1914, called for an election in the method of accounting for depreciation, and permitted continuance of the use of the existing retirement method of accounting, with no deductions from income for current depreciation. The accounting regulations of the Interstate Commerce Commission in effect prior to July 1, 1914, did not require depreciation to be charged with respect of ways and structures and petitioner did not in its accounts charge any depreciation upon ways and structures. Pursuant to the election given, petitioner continued to use the retirement method for ways and structures and consistently used that method at all times prior to and throughout 1934.

Las Vegas Land & Water Co., hereinafter sometimes called the land company, during the period here pertinent was a corporation organized and existing under the laws of Nevada. It was incorporated in 1905 and was a wholly owned subsidiary of petitioner.

In order to secure water for the operation of its railroad it was necessary for petitioner to acquire on July 2, 1903, a tract of land containing about 1,861 acres lying on both the east side and west side of its right of way. Three springs were located on the westernmost part

of this tract. The tract embraced a very large area of land not needed for strictly railroad operating purposes, nor was the traffic at that time of sufficient volume to absorb all of the available water. That portion of the tract lying west of the railroad tracks was retained by petitioner mainly for the purpose of protecting the water supply, but part of it was also used for right of way or freight and passenger depots for a terminal yard, shop plant, storehouse, repair tracks, and the usual terminal facilities.

On May 8, 1905, petitioner conveyed that part of the tract lying east of its right of way, containing about 1,277 acres, to the land company, which was incorporated originally to establish the town site of Las Vegas, at which place petitioner had created a main division point or terminal on its railroad. The land company established the town site during 1905 and later made an addition thereto, using for these purposes much less than one-half of the land conveyed to it. The remainder was held in its original condition and, so far as it was used at all, was devoted to agricultural purposes. The spring water that was acquired by petitioner had been previously used beneficially on the tract for irrigation purposes many years prior to the railroad's advent into that country, and the water rights were acquired before there was any comprehensive water law in Nevada and were vested rights. At first the water was used there for irrigation purposes. In order to preserve its water rights in its springs it was necessary under state law that the water be used beneficially. Accordingly, until about 1921 petitioner sold the excess over its needs for railroad purposes to the land company, which as a public utility distributed and sold it to the inhabitants of Las Vegas under a certificate of public convenience and necessity issued by the Public Service Commission of Nevada.

Until about 1921 there was sufficient water flowing from the springs for all railroad and municipal purposes, irrigation purposes having dwindled. As the town of Las Vegas began to grow and as its area increased and the population moved outside the original town site into the adjacent subdivisions there began to be a shortage of water for municipal purposes. About 1934 petitioner drilled an artesian well adjacent to the springs and secured a flow of over 8 cubic feet per second. Petitioner appropriated 2.5 cubic feet per second for railroad and domestic uses and a certificate of appropriation was issued to it by the State of Nevada. This quantity of water was sufficient for the present and contemplated needs of petitioner and the appropriation needed no protection other than use of the water for railroad purposes. The balance of the flow was appropriated by the land company for either municipal or irrigation purposes other than railroad purposes. At no time did petitioner have a franchise from the city of Las Vegas, Nevada, to operate or to install the facilities necessary to oper

ate a water distribution system within the limits of that city, and at no time did petitioner have a certificate of convenience and necessity to operate such utilities within the city. There was no legal bar under state law or under petitioner's articles of incorporation to petitioner's obtaining such certificate and distributing water as a public utility. A part of the land within the town site and addition was dedicated to the public by the land company for use as streets and ways, public schools, a court house, public parks, etc. The remainder was laid out in 2,053 lots. Prior to January 1, 1934, the land company built 64 dwellings on 64 of these lots. It sold 45 of the houses and lots to railroad employees and 2 to persons not connected with the railroad. It built a boarding house on 4 lots for the accommodation of 75 unmarried railroad employees. It sold 2,008 lots to buyers not identified by the evidence. On January 1, 1934, the land company owned 17 lots improved with dwellings which it rented to railroad employees and others, the boarding house, and 74 unimproved lots held for sale. In selling and renting its properties the land company made no concessions to railroad employees as such. Where credit was extended to an employee, payment was secured by provision for deductions from the employee's pay check.

In 1934 Las Vegas had a population of about 8,000, of whom 300 to 400 were railroad employees.

In 1934 the land company did not produce or sell electricity. Its water operations that year resulted in a profit of $24,711.85.

By three deeds dated September 24, 1924, July 22, 1925, and May 11, 1928, respectively, petitioner conveyed to land company 917,564 square feet of land adjacent to the terminal facilities of petitioner at Yermo, California. This property was acquired, on recommendations of W. H. Comstock, the general manager of petitioner, and of Walter R. Bracken, vice president and agent of the land company, and of E. E. Calvin, president of the land company, assented to by the executives of petitioner at Omaha and New York, for the purpose of laying out a town site. The lots were to be sold preferentially to employees of petitioner for the purpose of encouraging and enabling all worthy and desirable employees to obtain permanent residence. Sales to others than employees who would build houses for rental to employees, as well as sales for public purposes in connection with supplying the wants of employees, were contemplated. None of the lots were to be sold for speculative purposes. It was hoped that this scheme would so improve conditions that petitioner would be able to obtain the best type of employees, with the result that there would be a material saving in cost due to labor turnover. By January 1, 1934, 106 lots had been sold to employees and others, and 86 remained unsold.

In 1922 petitioner determined to obtain a larger share of citrus fruit and nut shipments from packing companies in southern California. This required the construction of packing houses on the lines of petitioner and development of industrial properties on its lines. The land company commenced the acquisition or construction of "packing houses," which it leased to packers. These packing houses were, with one exception, located outside of Los Angeles.

The leases in the first instance were negotiated by representatives of the operating department of petitioner and a representative of petitioner's traffic department. The financial responsibility of a prospective lessee and the potential traffic he might produce for petitioner were considered carefully, as was also the yield to the land company on its investment. If potential traffic was not considered satisfactory, negotiations were terminated. When these two representatives of petitioner recommended a lease jointly to their superiors the recommendation was forwarded to Omaha, and if assented to by petitioner's representatives it was transmitted to New York for the assent of the executive committee of petitioner there. This assent was expressed in the form of a resolution reading as follows:

Resolved, that this Company, as stockholder of Las Vegas Land and Water Company, hereby assents to the execution by that Company of the aforesaid new lease on terms recommended by President Gray.

After such assent was expressed by the executive committee the necessary documents were executed by officers of the land company and the execution of these documents was ratified by the board of directors of the land company.

In 1922 the land company also acquired in East Los Angeles extensive tracts of farm lands. Such lands had inadequate street access, no public utilities, and no development in the way of trackage. Through the efforts of one Strong, who in 1923 had been assigned to take charge of industrial properties of petitioner and also those of the land company, the city and county authorities were persuaded to construct highways to and through the properties and to install sanitary and storm sewers and to provide for electricity and gas. The land company paid for these improvements. Lead tracks from petitioner's railroad were also installed. The properties were held for sale rather than lease. In 1934 there were no leases of industrial properties. Sales of these industrial properties were negotiated in the same manner as the leases on packing houses, and the same considerations of financial responsibility of the purchaser, the potential traffic to petitioner, and the profit to be derived by the land company governed. There was a general policy with respect to the property of the land company of holding back the more attractive properties. Such a

policy had been effective, and as of 1934 the best properties were still to be sold. By January 1, 1934, the land company had sold 21 of these tracts to industries.

Both the packing houses and industrial properties were in proximity to the lines of petitioner and susceptible to railroad service by petitioner. These properties could not be served by any other railroad. Petitioner derived a substantial revenue from shipments to and from the packing houses and from industries built on the industrial tracts. For the years 1925 to 1934, inclusive, 17,884 carloads of citrus fruit originated in the citrus packing houses alone, on which the estimated Union Pacific revenue was $5,740,764. Shipments to and from industrial tracts were likewise substantial. No exact figures of industrial shipments for the period 1925 through 1934 are available. It is estimated that carload shipments to or from these industrial tracts to and from an eastern destination were in the neighborhood of 1,000 carloads a year, and there were approximately 1,100 carloads of such traffic locally. There were also substantial shipments from packing houses other than citrus fruit packing houses amounting to over 1,000 carloads a year for eastern destinations. Out of approximately 81 parcels of land company property, 36 had been sold and 21 leased during 1934. Of those disposed of 54 produced no, or substantially no, traffic. An aggregate of approximately 5,184 carloads of traffic in 1934 were from industries which had bought or leased land company property.

Between December 22 and December 31, 1934, petitioner, Short Line, Union Pacific, and the land company entered into a contract effective January 1, 1934. The agreement recited that the land company owned real estate chiefly in Los Angeles, California, adjacent to or in close proximity to the lines of petitioner, which it had acquired for the purpose of sale or lease to industry which would produce traffic over the lines of one or more of the Union Pacific System companies; that the land company was engaged in making sales and leases of such real estate but only when and as requested by officers of the Union Pacific System companies and upon explicit assent of petitioner; that sales or leases except in relatively unimportant instances were made only to such traffic-producing industries; that such real estate operations can be carried on by a separate company more advantageously than by any of the system companies; that sales or leases of real estate in a small market were retarded by the policy of selling only to such traffic-producing industries; that the land company's income for this reason was insufficient to meet its expenses; that the real estate operations constitute the major part of the land company's business, but other activities are profitable; that petitioner, Short Line, and Union Pacific desired the land company to continue its op