MIDLER COURT REALTY, INC., PETITIONER v. Commissioner of INTERNAL REVENUE, RESPONDENT

Docket Nos. 1989-68, 3023-68, 5751–71. Filed January 31, 1974.

The petitioners purchased certain buildings in an industrial park subject to existing leases. In some cases, these leases provided for substantially higher rentals for an initial term and the right to renew at substantially lower rentals thereafter. Petitioners computed depreciation on the buildings by using the "declining balance" method and a useful life of 15 years from the date of acquisition. The respondent determined that the buildings had a useful life of 40 years from such date. Petitioners countered by claiming that a part of the cost should be allocated to the excess rentals to be received over the initial term of some of the leases and amortized accordingly. With respect to such buildings, petitioners further claimed a useful life measured by the initial term and specified renewals. With respect to other buildings, petitioners claimed a useful life of 33% years from the date of construction. Held, (1) petitioners are not entitled to claim accelerated depreciation or amortization on account of the higher rentals provided for in the initial term of some of these leases except as provided for in sec. 167(b); (2) petitioners have failed to establish that consideration should be given to any extraordinary obsolescence in determining the useful lives of the buildings; (3) the useful life of the buildings was determined to be 33% years from the date of acquisition.

Benjamin Alpert, Myles J. Sachs, and Gerald W. Keil, for the petitioner.

John J. O'Toole and Gerald Backer, for the respondent.

QUEALY, Judge: The respondent determined deficiencies in the corporate income taxes due from petitioner and its subsidiaries, as follows:

The deficiency for the taxable year 1967 is an increased deficiency over the amount of $228,649 asserted in the statutory notice, claimed by the respondent in an amended answer with respect to which petitioner has stipulated to the facts pleaded therein.

As a result of concessions made by the parties, the questions remaining for decision relate to the following:

(1) Whether any part of the purchase price paid by petitioner for the properties under lease to General Electric may be amortized over

the initial terms of the leases on account of the so-called excess rentals provided for therein; and,

(2) The remaining useful lives of the buildings leased to the General Electric Co. and of the buildings leased to other tenants for purposes of determining a reasonable allowance for depreciation under section 167 for the taxable years 1962 to 1968, inclusive.1

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts and exhibits are incorporated herein by this reference.

The petitioner is a corporation duly organized and existing under the laws of the State of New York, with its principal office at the time of the filing of the petitions at Newark, N.J. It is the common parent of three wholly owned subsidiary corporations, Midler Land Development, Inc., New York State Investors, Inc., and Frel Properties, Inc., with which it filed consolidated returns for the short period ended December 31, 1961, and the calendar years 1962 through 1968, inclusive, with the district director of internal revenue, Newark, N.J. Each of these corporations were engaged in the ownership and leasing of commercial real estate and are hereinafter collectively referred to as "petitioners."

On November 30, 1961, petitioners acquired by purchase 19 buildings located in the Syracuse Industrial Park in the Town of De Witt, near Syracuse, N.Y., for a total cost of $11,983,661, of which the sum of $658, 661 was allocated as the cost of the land, and the balance represented the cost of the buildings and other depreciable improvements. The amount allocated to the cost of the General Electric buildings was $10,191,525, of which $496,525 was for the land, and the balance of $9,695,000 was for the buildings and improvements. The amount allocated to the cost of the 9 buildings leased to other tenants was $1,777,342, of which $147,342 was for the land, and $1,630,000 was for buildings and improvements.

The buildings acquired by petitioners had been constructed during the years 1954 to 1960, inclusive, to be used as warehouses, manufacturing and office facilities, or combinations thereof. For the most part, the buildings were single-story masonry and steel construction with tilt-up precast concrete sidewalls with bar joist construction and metal decks with tar and gravel built-up roofs. Two of the buildings had concrete block sidewalls with the same roof construction. With the possible exception of the office building leased to General Electric Co., the buildings were general purpose buildings suitable in some cases either

1 All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.

for warehouse or light manufacturing use and in other cases for warehouse and heavy manufacturing.

The Syracuse Industrial Park was located approximate to an exit of the New York State Thruway and adjacent to the main line of the New York Central Railroad near the airport serving the City of Syracuse.

On November 30, 1961, when the properties were acquired by the petitioners, the 19 buildings were under lease to various tenants. The following schedule sets forth the floor area and stipulated cost of each property (including the land), together with the basic terms of the lease applicable thereto :

The initial development of the Syracuse Industrial Park was undertaken by a Mr. Stover, who was with Eagan Real Estate, Inc., an established firm in Syracuse, N.Y. In 1952, Mr. Stover learned that

General Electric Co. was interested in expanding its operations in the Syracuse area but did not have land available for such expansion. Mr. Stover thereupon enlisted as participants a Mr. Barrett of the Eagan firm and Messrs. Easter and Smith, contractors. A corporation was formed with Mr. Stover holding 40 percent of the stock and each of the others holding 20 percent of the stock. They thereupon acquired 115 acres of unimproved farmland for the purpose of developing the industrial park.

At the outset, General Electric's requirements comprised only two buildings to be used primarily for warehousing. Before these buildings could be completed, General Electric's requirements were expanded to include both offices and manufacturing space, requiring an additional cost of about $2 million. The needs of General Electric continued to expand resulting in the ultimate construction of approximately 775,200 square feet consisting of offices, manufacturing, warehousing, and laboratory space.

In addition, the developers proceeded with the construction of nine other buildings which were leased to various tenants. These additional buildings comprised a total area of approximately 223,580 square feet, ranging from 4,000 to 45,000 square feet per building.

In order to enable the developers to finance the erection of its buildings, General Electric from time to time entered into leases pursuant to which rentals would be established over a relatively short term at an amount sufficient to finance the cost of the buildings, following which General Electric reserved the right to renew at reduced rentals. In such leases, upon the expiration of the original term and a socalled 2-year "tail" or renewal, General Electric had the option thereafter to renew the leases at rentals which were "below market" for comparable facilities. The developers set these renewal rentals at an amount which, in their minds, would make it most attractive for General Electric to renew.

Due to the utilization of accelerated methods of depreciation, the developers realized that by the year 1963 the depreciable costs of the development would have largely been recovered through depreciation, and the net cash flow from rentals would be inadequate to amortize the indebtedness on the property. The developers thereupon unsuccessfully sought additional financing. In the meanwhile, the other participants had also contracted to purchase the interest held by Mr. Stover. In order to meet such obligations, they thereupon offered the property for sale.

Mr. Leo T. Eagan of Eagan Real Estate, Inc., acted as broker for the sellers. After unsuccessful efforts to sell the buildings at higher prices, the sellers offered the buildings for a price computed by them. by adding some $4 million to the unpaid balance of the mortgage

indebtedness. Certain of Mr. Eagan's family, acting through the petitioners, thereupon agreed to purchase the properties at that price. In order to complete the purchase, petitioners obtained additional financing of some $5,500,000 for a term of 23 years.

There were no negotiations or discussions concerning a separate price attributable to, and paid for the General Electric leases, as part of the total purchase price.

The petitioners filed a consolidated U.S. corporation income tax return for the taxable period ended December 31, 1961. In said return, and in the returns filed for subsequent taxable years, the petitioners determined that the average useful life of the 19 buildings and improvements was 15 years from the date of acquisition of the property by the petitioners. Petitioners elected to claim depreciation on said properties on the basis of a 15-year life and the "declining balance” method.

In the statutory notices of deficiency, respondent determined petitioners' allowable depreciation deductions in the years in issue (using the "declining balance" method) by employing an average useful life of 40 years at date of acquisition of the 19 buildings rather than the 15 years utilized by petitioners in its returns.

In amended petitions filed after the trial with the permission of the Court given at trial, petitioners contend that a portion of the total purchase price paid for the 10 buildings leased to General Electric should be allocated to the right to receive "excess"rentals from General Electric during the original term and 2-year "tails" in those leases, which amount should be amortized over a period consisting of the remaining term at November 30, 1961, of the initial General Electric leases and, where applicable, the 2-year "tail." Petitioners further allege that with respect to the remaining portion of the purchase price of the said 10 buildings that such sum be depreciated as the cost of these buildings over useful lives equal to the unexpended portion of the initial term, plus the first 2-year renewal, if applicable, and two succeeding 5-year optional renewal terms.

In the amended petitions with respect to the remaining nine buildings not leased to tenants other than General Electric, the petitioners claimed useful lives for said buildings of not more than 33 years from the date of construction.

OPINION

The petitioners acquired a complex of buildings located in the Syracuse Industrial Park, all of which were under lease, for a total consideration of $11,983,661. Of this amount, it is agreed that the sum of $10,191,525 represented the cost of the properties leased to