PROBLEM 144

Illustrating Items Not Deductible-Amounts Spent for Permanent Improvements.

FACTS:

Mr. A. Jones, hardware merchant in order to be able to take care of his increased business and to extend his business still further, makes a permanent addition to his store building, and makes certain improvements in his old building.

QUESTION:

Are the amounts spent in effecting these permanent additions and improvements deductible in Mr. Jones' tax return?

ANSWER:
No.

REFERENCE:

Sec. 215 (a): "In computing net income no deduction shall in any case be allowed in respect of ... (2) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate."

NOTE:

Although the above problem as prepared relates to an individual, the same solution would apply in the case of a corporation. Reference: Sec. 235: "In computing net income" of corporations "no deduction shall in any case be allowed in respect of any of the items specified in section 215."

PROBLEM 145

Illustrating Items not Deductible-Amounts Expended in Defending Title to Property

FACTS:

J. Lawrence McMaster in 1921, spends $2,500 in defending title to business property which he owns.

QUESTION:

Is this amount deductible in Mr. McMaster's income tax

return?

ANSWER:
No.

REFERENCE:

Art. 293, Regulations 62: "The cost of defending or perfecting title to property constitutes a part of the cost of the property and is not a deductible expense."

NOTE:

While the above problem as prepared relates to an individual, the same answer would apply in the case of a corporation.

PROBLEM 146

Illustrating Items not Deductible-Fees Paid for Services in Securing Reduction of Assessment for Street

FACTS:

Improvement

F. Flanders, paper manufacturer, in 1921 was assessed $1,000 for street improvement along his factory. Through the services of an attorney Mr. Flanders obtained a reduction of the assessment to $600. The attorney charged Mr. Flanders $100 for the service rendered.

QUESTION:

Is the $100 expended in obtaining the reduction in the amount of the assessment a deductible item in Mr. Flander's income tax return?

ANSWER:
No.

REFERENCES:

Bul. 48-20-1324; O. D. 739: "The fees paid by a property owner

to an attorney for his services in securing a reduction of an assessment imposed for a local benefit are not a proper deduction as a business expense. As such fees were paid to reduce a necessary capital expenditure in connection with the property against which the assessment was levied, they constitute a part of such capital expenditure, and hence are to be considered a part of the cost price of the property for the purpose of determining gain or loss in event of its sale.'

Sec. 215 (a) (2): (Quoted under Problem 144.)

NOTE:

The rule is the same whether the taxpayer is an individual or a corporation. Reference: Sec. 235: "In computing net income" of corporations "no deduction shall in any case be allowed in respect of any of the items specified in section 215.”

PROBLEM 147

Illustrating Items not Deductible Brokerage-Legally Declared Dividends Voluntarily Returned-Assessment Against Stockholders.

FACTS:

J. J. Wiles in January, 1921, pays commissions amounting to $50 in acquiring certain shares of stock. In June dividends were legally declared and paid; but in October by agreement with the other stockholders in the company, the dividend was voluntarily returned in order to avoid impairment of the capital. In December, 1921, each stockholder is assessed $20 per share for the purpose of reorganizing the company.

QUESTION:

Which, if any, of the above items are deductible in Mr. Wiles' income tax return?

ANSWER:
None.

REFERENCES:

Art. 293, Reg. 45 Revised: "Commissions paid in purchasing securities are a part of the cost price of such securities. . . . Amounts

to be assessed and paid under an agreement between bondholders or stockholders of a corporation, to be used in a reorganization of the corporation, are investments of capital and not deductible for any purpose in returns of income."

Bul. 25-21-1691; Sol. Op. 110: "It is accordingly held that where a corporation legally declares and pays a dividend which is later voluntarily returned by the stockholders in order to avoid impairment of its capital the amount of such dividend (1) is subject to surtax in the year in which received by an individual stockholder and (2) being a contribution to capital may not be deducted from gross income of the stockholder in the year in which repaid to the corporation."

NOTE:

The rule would be the same, whether the taxpayer be an individual or a corporation.

PROBLEM 148

Illustrating Deductions Allowed-Betterments by Lessees

FACTS:

David Brewer, an attorney, leased an office on Oct. 1, 1920, for a period of five years, agreeing to make any desired improvements or alterations at his own expense. It was also agreed that upon termination of the lease, the premises revert to the lessor with all improvements or alterations or at his option the lessor may require the lessee to remove them at his own expense and restore the premises to their original condition. Accordingly, Mr. Brewer made several alterations and improvements all of which had a life of over five years, which were completed and paid for January 2, 1921.

QUESTION I:

Is the cost of these changes deductible in Mr. Brewer's return for the calendar year 1921?

ANSWER:

No; they must be capitalized and even though they had a life of over five years the cost is to be returned through depreciation ratably over the life of the lease; the annual deductions being

1257 of the cost for 1921, 1257 for 1922, 1257 for 1923, 157 for 1924, and 7 for 1925.

QUESTION II:

Would Mr. Brewer be permitted to set up as a reserve an estimate of the cost of removing the changes made (anticipating the possibility that the lessor may exercise the latter part of his option) deducting from gross income the annual credits to such reserve?

ANSWER:

No. Should Mr. Brewer be required to remove the improvements, etc., on Sept. 30, 1925, and restore the premises to their original condition, any expenses incurred thereby would be deductible in his return for 1925.

REFERENCES:

Art. 109, Regulations 62: "... The cost borne by a lessee in . . . making permanent improvements . . . is held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment of capital, an annual deduction may be made from gross income of an amount equal to the total cost of such improvements divided by the number of years remaining of the term of lease, and such deduction shall be in lieu of a deduction for depreciation."

In Bul. 21-20-952; O. D. 516, the Bureau "Held, that the lessee may pro rate the cost of the alterations and improvements over the life of the lease and claim a suitable deduction each year, but that it may not set up a reserve to cover the cost of restoring the premises to their original condition. The expense of restoring the property at the expiration of the lease, if the lessee is required to restore it, will be an allowable deduction for the year in which it is actually incurred."

CORPORATIONS:

Corporations having the same conditions outlined in the case of the foregoing individual, would be permitted the same deductions for depreciation, and would not be permitted to deduct from gross income any credits to a reserve set up to cover the possibility of removing the betterments at the expiration of the lease.