V SALES AND EXCHANGES: GENERAL RULES Income from sales and exchanges-general. Cost and value at March 1, 1913. Additions to basic value. Reductions of basic value. Exchanges. Sales of intangibles (patents, copyrights, franchise, good-will, and so forth). Rules for ascertaining March 1, 1913, values of intangibles. Hoskold's formula. Sales or purchases by a corporation of its own stocks or bonds. THE general rule applicable to sales, exchanges, and conversions of property is that taxable income is realized where the fair value of the property received exceeds the basic value. Basic value is defined as cost or the fair value at March 1, 1913, if the property was acquired prior to that date, increased by "any expenditure or item of loss properly chargeable to capital account" and decreased by "the amount of the deductions for exhaustion, wear and tear, obsolescence, amortization, and depletion, which have since the acquisition of the property been allowable in respect to such property" (Sec. 202 (b); Art. 1561, 1591). Certain exchanges and conversions do not give rise to taxable income or they may give rise to an immediate in- ✓ come less than the book profit, as, for example, exchanges in connection with reorganizations. A study of both costs and selling prices is necessary if the correct taxable income from these transactions is to be computed. In this chapter the general aspects of basic value are considered. In Chapters VI-VIII various applications of cost and selling price will be discussed. COST AND VALUE AT MARCH 1, 1913 Costs of assets sold would seem to offer few difficulties. Invoice costs, less discounts (unless already included as income), plus freight and costs of installation, plus capital additions as commented on below, and, in the case of unproductive property, plus taxes and other carrying charges not deducted in prior tax returns, are examples of what one would expect to find under this head (Art. 1561). Prior to 1924 cost to a corporation acquiring property for stock meant the fair market value of the property at the time of acquisition. From 1924 on, cost is restricted, generally, to cost to the transferor in cases where the corporation (a) is controlled by such transferor immediately after the acquisition, or (b) is the successor in a tax-free reorganization of another corporation, as described on pages 103 to 109. The aim of the 1924 rule is to prevent reorganizations "for tax purposes"-that is, changes in identity without change of ownership or beneficial interests. Since 1916, March 1, 1913, value has been a possible factor in the computation where the property was acquired before that date and has been held continuously since. Between 1916 and 1923, inclusive, cost, March 1, 1913, value and selling price bore a relationship indicated in the following rule (made retroactive to 1916 by virtue of Goodrich v. Edwards, 255 U. S., 527; U. S. v. Flannery, 272 U. S., 713; T. D. 3703; McCaughn v. Ludington, 272 U. S., 718; T. D. 3705): Ascertain cost, March 1, 1913, value, and selling price. Subtract from the selling price that one of the three values which falls in amount between the other two; the result is the taxable profit or deductible loss, if any. For 1924 and years following, the rule for determining the taxable gain or deductible loss from the sale of property acquired before March 1, 1913, is to set off against selling price the higher of cost or March 1, 1913, value (Art. 1591). The reason for these theories has been that, in the eyes of Congress, any diminution or increment of value prior to March 1, 1913, the effective date of the Constitutional Amendment permitting Congress to tax incomes, cannot be taxed nor yet permitted as an allowable deduction, although the courts have held that any realized income may be taxed by Congress1. In each instance hereafter, where "cost or March 1, 1913, value" is referred to, it will be understood that one of these rules, depending on the year of the sale, will apply. Applied to specific cases, the following possibilities arise: March 1, 1913, value was introduced by Congress for the first time in the 1916 act. Between 1913 and 1916, therefore, the profit or loss on sales and exchanges was always measured by the difference between cost and selling price. Under the 1909 law, January 1, 1909, was given a significance equal to March 1, 1913. March 1, 1913, value, in the case of depreciable assets, is its fair market value, if obtainable2; otherwise, cost less accrued depreciation at that date (2 B. T. A. 309; 3 B. T. A. 1006). The March 1, 1913, value of non-depreciable property may, in the case of land, be based on the values of contiguous property or on the evidence of experts (2 B. T. A. 309, 498, 661; 4 B. T. A. 619); shares of stock may be valued at market price, provided the sales which brought about the market price were representative, and the law provides in this connection that "due regard shall be given to the fair market value of the assets of the corporation 1e.g., page 122. 2 In Mim. 3209 the Department outlines the general requirements for "retrospective" appraisals, that is, appraisals made as of a previous year. But mere cost of reproduction less depreciation, without other evidence, is not fair market value (1 B.T.A. 552, 1107; 2 B.T.A. 817, 918; 4 B.T.A. 452, as of that date" (i. e. March 1, 1913) (Sec. 204 (b); Art. 1591). ADDITIONS TO BASIC VALUE Laws prior to the 1924 act did not state that capital expenditures and depreciation write-offs should affect the computation of profits from sales of business property, but the Treasury Department in its regulations and practice has always so held. From the text and cases in Chapter IV, one may readily conclude that the differentiation between so-called capital and revenue expenditures is not an easy matter, even for the trained accountant. The law, quoted above, states that only items "properly chargeable" should be added to the basic value. This should be interpreted to mean not only (1) items actually charged to the asset on the books of account but (2) items incorrectly carried to expense in earlier periods. The Department has tended in the past to permit the addition of expenditures falling in the first group, which, from the accounting viewpoint, actually belonged there, and none of the second group, especially in cases where the statute of limitations prevented the recomputation of the tax in the year in which the unwarranted deduction from income was made. An expenditure of any kind may have been entered on the books and in a tax return in accordance with recognized financial practice or, generally through ignorance or error, in opposition to it. An addition to a building, erroneously charged off as an expense, say in 1915, is a valid increase, less subsequent depreciation, to the basic value of the building in 1926; just as a repair charged to the building account in 1915 is a deduction therefrom in any later year. The Department's argument has been somewhat naive in this connection. It has asserted that to permit an addition to cost in 1926 of an item classified as expense in 1915 would be inequitable in that a taxpayer might thus deduct the same item twice. But what of the taxpayer whose bookkeeper, untrained in accounting theory, has cap |