Hubinger v. Commissioner

               CIRCUIT COURT OF APPEALS, SECOND CIRCUIT

AUGUSTUS N. HAND, Circuit Judge. The appellant, in 1920, was the owner of a six-story building in New Haven, Conn., which was rented for business purposes. On February 14, 1920, a fire burned off the tower, the roof, the sixth, and a part of the fifth floors. The lower floors were damaged by smoke and water. After the fire, the appellant spent $ 70,872.14 in reconditioning the building. The tower was not rebuilt; the same kind of materials were used for reconditioning as were originally in the building. No improvements or betterments were made; some of the damaged floors were covered with linoleum at a somewhat smaller expense than if they had been repaired; and the life of the building was not extended. In fact, it was not in as good condition after the fire as it had been before.

The value of the building in 1913 was $ 125,000, and prior to the fire as $ 225,000. It was insured for $ 29,730, and insurance collected was expended in reconditioning it.

The appellant contends that he was entitled to a deduction from his gross income of the difference between his expenditures of $ 70,872.14 and the insurance of $ 29,730, or $ 41,142.14, in calaculating his income tax.

The Board of Tax Appeals did not allow the deducition claimed, either as a necessary expense or as a loss sustained. There was no definite proof of the salvage value of the building after the fire.

The statutory provisions particularly to be considered are the following:

     "Sec. 214. (a) That in computing net income there shall be

The following provisions in Treasury Department Regulations 45, articles 49 and 141, are also pertinent:

     "Art. 49. Compensation for Loss -- In the case of

In other words, where a loss sufficient to be regarded as within the purview of (a)(4) or (a)(6) occurs, it is the occasion rather than the precise kind of reconditioning done that determines whether the particular outlay involves "ordinary and necessary expenses" or "losses." Any other view requires a determination in case of each serious fire which comes short of total destruction of just the extent of damage from that casualty which involves a capital expenditure to restore it and which involves a mere ordinary repair. We think the statute contemplates no such difficult classification, but places damage due to casualty in the sense we have used that term in the category of "losses." Moreover, a replacement of property due to damage from a devastating fire while perhaps a "necessary" expense cannot be regarded as an "ordinary" one. "Ordinary * * * expenses" in the most natural meaning of the words are those due to wear and tear and trifling accidental causes.

Assuming, then, that appellant's outlay, "not compensated for by insurance," amounted to $ 41,142.14, was this a deductible loss within the meaning of the income tax? As the property was merely restored and not improved, appellant certainly in one sense suffered a loss represented by the difference between the value of the buildings before and after the fire. Article 141 of Treasury Regulations 45, which was in force in 1920, provided that: "* * * When the loss is claimed through the destruction of property by fire * * * the amount deductible will be the difference between the cost of the property or its fair market value as of March 1, 1913, if acquired before that date, and the salvage value thereof, after deducting from such cost or such value as of March 1, 1913, the amount, if any, which has been or should have been set aside and deducted in the current year and previous years from gross income on account of depreciation and which has not been paid out in making good the depreciation sustained.But the loss should be reduced by the amount of any insurance or other compensation received. * * * " This regulation is in accordance with the whole trend of the income tax law in respect to sales of property. Section 202(a) of the Act of 1918 (40 Stat. 1060) provides:

     "That for the purpose of ascertaining the gain derived or loss

It is true, as article 141 of the Regulations intimates, losses must usually be evidenced by closed transactions, but a fire damage, even though partial, if it results in a net loss of value at the time of the fire based on original cost is a closed transaction pro tanto which the statute allows the taxpayer to claim as a deduction.

In the present case there was no proof of a loss. The salvage value of the property after the fire was not shown, and if we should assume that it was the value before the fire, less the cost of reconditioning (or $ 225,000 -- $ 70,000), there remained damaged property worth $ 155,000, a sum far more than the value of $ 125,000 on March 1, 1913.

There was no attempt by the taxpayer to establish a loss by showing an original cost less annual depreciation greater than the value of the property at the time of the fire in order to bring the case within such decisions as Goodrich v. Edwards, 255 U. S. 527, 41 S. Ct. 390, 65 L. Ed. 758; Walsh v. Brewster, 225 U. S. 536, 41 S. Ct. 392, 65 L. Ed. 762, and United States v. Flannery, 268 U. S. 98, 45 S. Ct. 420, 69 L. Ed. 865. We, therefore, have nothing but the value on March 1, 1913, as a basis for comparison with the value after fire loss, and, as already statued, utterly lack proof of the salvage value of the property.

In view of the proof, the taxpayer can claim no loss under the provisions of section 214, supra, due to his expenditure of $ 41,142.14. But, in the event of a sale of the property, this expendture would doubtless reduce any taxable profit pro tanto, because it has increased the cost of the building.

In Zimmern v. Commissioner, 28 F. (2d) 769, repairs to recondition a sunken barge were held deductible under section 214(a) (1) by the Circuit Court of Appeals of the Fifth Circuit. The court there followed Grant v. Hartford & New Haven R. R. Co., 93 U. S. 225, 23 L. Ed. 878. But that replacement was due to no casualty, and was treated as a current repair to keep railroad property up to condition. The questions as to whether section 214(a)(4), rather than section 214(a) (1), did not apply, and whether, if it did, there was no proof of loss, do not appear to have been discussed in Zimmern v. Commissioner, supra, in the opinion of the court.

It is contended on behalf of the Commissioner that there can be no deduction because of section 215(c), prohibiting deductions in respect of "any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made."

But this provision was designed to prevent double deductions. The amount spent on reconditioning could not add to annual charges for depreciation because it did not add to the value of the property. It does not, therefore, come within the terms of section 215 (c).

We are of the opinion that the expenses of reconditioning the property were all losses to be deducted, if at all, under section 214 (a) (4) or (a)(6) and that there has been no proof of loss within the meaning of that section of the income tax act.

The order of redetermination of the Board of Tax Appeals is affirmed.