Millinery Center Building Corporation v. Commissioner of Internal Revenue

PETITIONER:Millinery Center Building Corporation
RESPONDENT:Commissioner of Internal Revenue

DECIDED BY: Warren Court (1955-1956)
LOWER COURT: United States Court of Appeals for the Second Circuit

ARGUED: Mar 01, 1956
DECIDED: Mar 26, 1956

Hilbert P. Zarky – for the respondent

Facts of the case


  • Oral Argument – March 01, 1956 (Part 1)
  • Audio Transcription for Oral Argument – March 01, 1956 (Part 1) in Millinery Center Building Corporation v. Commissioner of Internal Revenue

    Audio Transcription for Oral Argument – March 01, 1956 (Part 2) in Millinery Center Building Corporation v. Commissioner of Internal Revenue

    Earl Warren:

    Mr. Weiss, you may proceed.

    Bernard Weiss:

    The Tax Court in its decision determined that the petitioner in acquiring the fee to the land and paying $2,100,000 therefore did so in order to obtain a release in the obligations of a lease.

    That language to me can only mean one thing and with due deference to the court below, this taxpayer cannot be treated in the same manner as a third party and the basis of the decision of the court below is to treat this taxpayer as if he were a person who would have no connection whatsoever with the property.

    And in the case of such a person who has no rights in the property at all, the basis of cause would have been if you are acquiring land with a lease on it that you would have to take your cost and allocate the value of your cost between the land and the value of the lease.

    Obviously, the landlord couldn’t sell that which he did not own.

    He did not own the building.

    The building was owned by the lessee and he did not have to purchase this building again.

    He had all the rights of ownership.

    He had, throughout the time of the lease, he had the right to receive all of the rents.

    He had the — he had the use of the property.

    What did he acquire over here except to be relieved of the payment of $118,840 for the next 21 years.

    He did acquire a capital asset, yes, land.

    It was only worth $660,000.

    And in view of that, that is the reason why we claimed in — in the ordinary business parlance, you’ll always make an investment to save money.

    We are increasing the income of this taxpayer by this expenditure.

    How were you doing it?

    Not by increasing the gross income which they already have and which will not be disturbed by this purchase, but by eliminating a deduction, an expense that is a recurring expense for the next 21 years.

    And this amount of money is being paid now and it’s just the opposite of what took place in the Hort case when the tenant paid Hort to as the landlord an amount of money to get out of burdensome lease — lease.

    Hort tried to claim that this amount was not taxable or should be treated first out of — he treated — he sought to treat all together as a reduction of his cost of his property, but the — but this Court properly held that all that was happening there was that this taxpayer was receiving currently the rent that would have been received over a period of years.

    And by taxing him in this year, what happens is that in the subsequent years, he wouldn’t have to pay.

    He’ll have that much less income.

    In other words, the rental payments would have been — would not have been received by Hort and that is what we’re doing.

    We’re just doing just as the opposite.

    We are a tenant.

    We are caught in a dilemma.

    And as a result of this dilemma, we are required to make this unconscionable expenditure.

    Now, we claim if it is — it is possible that in determining the value of the land, there was something said by the court below, that you must take into consideration the fact that this land has got an improvement on it which cost $3 million.

    This value of $660,000 means $6600 of front foot is only a little piece of land, 100 by 200.

    It takes into consideration the fact that an adequate improvement is going to be put on that land.

    And in fact that is on that land, then that’s what that $660,000 represents.

    Bernard Weiss:

    And therefore, the only logical thing in this case would be to do one of two things, either to allow the whole thing in the one-year, in the year of payment as was done in the Cassatt case and the Denholm & McKay case and as was — as was done in the Cleveland Allerton case or in the alternative.

    It might be better taxwise and that maybe accounting-wise and for the public revenue to say that pro rata over the period for which — which will be benefited by this expenditure that an aliquot amount should be taken and deducted on each of the subsequent years.

    That is the second proposition contended for by this petitioner in the alternative that the amount and there’s nothing new about this type of a contention.

    I have quoted a number of cases in this — in my brief, the Miller case and the Hamlin’s Trust case which had the — had a situation where the landlord was buying out the interest of the tenant.

    We had a major of title.

    A — a minor interest in real estate was being absorbed by the major interest.

    Nevertheless, the law has been and still is that that amount of money paid to buy out the interest of this tenant even though you’re cancelling the lease is to be written off over the time of the cancelled lease or there are some cases now which take the same sum and write it off over a new lease that may have been given to somebody else when they cancelled out the other lease.

    But there, these two — this is nothing new and it’s not unreasonable.

    It’s not unfair to the revenue, but to come in and attempt to say that this taxpayer is going — is being treated fairly by attempting to come in with some ridiculous basis that this man would be paying $2,100,000 today for a depreciated building, 21 years hence, and then take the — the discounted value of that amount of money and say that that is the figure that’s to be written off over the next 30 years.

    I think that’s just plain ordinary months.

    And while the court below did not go into this face, it is not aware of this.

    The fact of the matter is that in talking to — to the general counsel’s office and official to the Treasury Department that’s how they construe this language.

    And that is one of the reasons that we were forced to take this case in here against the better judgment of the taxpayer himself.

    If he was one to be dealt within that manner, he thought that the right place to do is to decide what is the law in this situation and that’s why we’re here.

    And I think that I would like to take a — a recess and give the other side a chance to say something on this subject and then I’ll come back on when —

    Stanley Reed:

    Well, the — the $660,000 was the value of the fair land, was it not?

    Bernard Weiss:

    That’s right.

    It was the value of the fair — it was the value of the land as if vacant and unimproved, but that was the terms of your lease.

    It must be remembered.

    That’s how they were supposed to figure it out.

    And an identical puzzle of land which happen to be vacant owned by the same owner were sold on the other side of the street and that man testified in this case and he also set the fair rental value at $40,000 for our property.

    And he said he would have been happy to receive between 35 and $40,000 as a net rental on his property at a very moment that this thing was happening.

    Earl Warren:

    Mr. Zarky.

    Hilbert P. Zarky:

    If the Court please.

    The holding of the Court of Appeals was this, this taxpayer in purchasing the property for $2,100,000 had necessarily paid some value for the improvements on the property.

    Because the record contained no evidence and because there were no findings by the Tax Court as to how much of that purchase price was properly and fairly allocable to the building, it remanded the case to the Tax Court for proper determinations of value.

    And the Court of Appeals’ holding is that that value, whatever it maybe, maybe deducted by the taxpayer in a way of depreciation deductions or the remaining useful life of the building, 30 years.

    That decision, we submit, is absolutely correct as a sensible decision.

    The Court was quite correct in rejecting the taxpayer’s primary argument that it was entitled to deduct in one year as a business expense, their difference between the value of the bare ground unimproved and the $2,100,000 which had paid for the property.

    In its ultimate aspects, this case is really one of where taxpayer has acquired the capital asset.

    Hilbert P. Zarky:

    By that, I mean an asset which will give benefits flowing over a long period of time.

    The benefits will not be exhausted in one year.

    It’s a cardinal principle of tax law that when you acquire an asset of that nature, if the asset is an exhausting asset, an asset which will ultimately come to an end in its useful life.

    You will deduct over the period of that life a proportion amount of what you paid for it.

    Now, that’s sensible and it results in a fair reflection of income because it certainly would distort a taxpayer’s income, sometimes take as advantage, sometimes take as disadvantage to be able to deduct in full in the first year, the full cost of an item which will result an income being earned in future years.

    And it’s fair to the taxpayer and a revenue alike to insist that.

    As the income is being earned from the use of this asset, you deduct or match against the income of each future year that aliquot part of the cost of that item.

    And we submit that that’s this case, pure and simple.

    This taxpayer now owns to be simple without any strings attached to it a building having a useful life of 30 years.

    During the next 30 years, this taxpayer is going to earn income from that building.

    And against that income, it will deduct whatever values are found by the Tax Court to be that part of the purchase price that went into the building, a proportion amount each year.

    The taxpayer’s insistence that it’s entitled to deduct in the first year, the difference between what it paid for the property and the bare ground’s value unimproved which was the position of Sixth Circuit took in Cleveland Allerton, we think is mistaken and then demonstrably sold.

    In Cleveland Allerton, the Sixth Circuit and the taxpayer here attempts to analogize its position to that of a lessee who pays to get out from under a lease and then all connection with the property.

    Now, the principle is also clear that such a lessee is entitled to deduct in the year when he terminates his lease whatever he has to pay to get out from under it having severed all connection with the property that payment is the end of the road and he deducts at that year.

    Now, there are two things wrong with the Cleveland Allerton analysis and the taxpayer’s analysis here.

    It first assumes that everything paid to the landlord, the fee owner, over and above the bare value of the land is necessarily a payment to get rid of a lease.

    I hope to demonstrate that that can’t be sold.

    And the second mistake is in thinking that even if it were or even if at some part of the payment were paid to get rid of the lease, it could be deducted in one year.

    Let me first turn to the proposition as to whether such a payment is one to get rid of a lease.

    The taxpayer’s argument emphasized and we think it gets it into an error, the fact, that it had a record of the building, it had paid the cost of construction and it had title to the building.

    Therefore, the argument runs, everything we pay over and above the value with the land can’t be paid for the building, it must be paid for something else.

    And that something else is to get rid of the lease.

    Well, this, we submit, confuses title to the building with ownership of the building.

    The lessee had title, it’s true, but in order to enjoy the use of the building, the tenant had to observe the terms of the lease and not the lease of this was to pay rent each year.

    This taxpayer could only use this building by paying $118,000 a year rent and it had to pay so for — to use this building for the next 30 years.

    It would have cost it his rent some $3,500,000 over the next 30 years.

    But by buying the property, it no longer has that obligation.

    I think I can illustrate what’s wrong with the assumption by an easy example.

    Take the lessee who comes to the landlord and says, I want to get out from under this lease.

    You — you keep the property as you’re entitled to do under the terms of the lease when the lease comes to an end whether at the end of the term or prematurely and I’ll pay you whatever I have to, to get out from under the lease.

    Hilbert P. Zarky:

    That’s the first tenant.

    The second tenant says to the landlord, “I want the building.

    I want to own the building.

    I want to pay you for it.

    What do you take?”

    Now, I submit that, just common sense, that if the landlords when they get the building and end the lease, he’s going to exact much less to let the tenant out, then the landlord who’s going to transfer full ownership and possession to the — to the lessee who now becomes the owner.

    So that, obviously, the difference paid between the bare value with the ground and what’s paid to acquire ownership in possession in its full sense is different than what’s paid to get out from under a lease.

    Let me pause at this moment to say that there’s nothing in the record in this case to indicate that this lease is owner as to the taxpayer.

    The only evidence and the only finding that relate to value is what the experts testify as to what the land was worth unimproved and without the lease.

    Now, that’s either just the beginning or completely irrelevant but it doesn’t touch on the values that the taxpayer had to pay for it to acquire ownership.

    We don’t know what this building is worth in its improved state.

    We don’t know what it could be rented for in an arms-length transaction without the lease.

    As a matter of fact, the only admitted evidence that would touch on the value of this property is a statement given on cross-examination which is not in the printed record in this Court.

    It was before the Tax Court which indicates that the taxpayer put a mortgage of $1,900,000 on the property for which it paid $2,100,000.

    So that even if the mortgage were 90% of the value with the property which showed that the $2,100,000 was fair market value but that, of course, is not a question for this Court.

    That’s the problem that the Tax Court will be faced with on a remand.

    But the one sure thing is that the taxpayer ought not to be able to deduct in one year this amount on the assumption that it was paid to get rid of an onerous lease when it’s based on the false assumption that anything over the bare value, bare the value of that bare ground was something the taxpayer didn’t have to pay for.

    It had to pay for the property if it wanted to go into possession without paying any future rent.

    It’s going to save that $3,500,000 over the next 30 years.

    Its income to that extent will be increased and it will have one of the Court of Appeals’ opinion a matching deduction each year for that part of the value which it paid for the building.

    We assume — we — we submit that the case can’t be any clearer or any fairer in its tax results.

    The taxpayer’s alternative proposition is that if it’s not entitled to deduct the full difference between the bare ground value and the value of the building, at least, it should amortize it over the rest of the period of the lease instead of over 30 years, the useful life of the building.

    Now, again, we submit that that would not be the proper tax treatment.

    The Court of Appeals was right in saying that you must allocate this over the 30 years, the useful life of the building.

    Of course, to the extent, you paid value for the building that’s what period of the time you’re going to get the tax benefits and that’s the period of time through which you should take the deductions.

    Obviously, the remaining unexpired period of the lease here has no significance for two reasons.

    It bears no necessary relationship to what the taxpayer acquired.

    Assume what the — if you will, the change of facts in this case where the taxpayer renewed the lease only one month before it purchased the property.

    And I may — may interject to say that that certainly may have some bearing on the question of whether it paid full value, whether it was getting out of an onerous lease when he had one month before had renewed the lease a full 21-year period.

    But let’s change the facts and say that one month before the renewal, the taxpayer had bought the property.

    Hilbert P. Zarky:

    That is when there’s only one month of the original term left.

    If the taxpayer were right in saying that the rule should be, it’s entitled to deduct this amount whatever it may be or the remaining period of a lease, it would have a deduction in that one year because only one month was left to the lease, when in fact, it now owns, in its fullest sense, a building which it didn’t own before it acquired full ownership by paying the purchase price which was demanded.

    So that we think that, as its stands, the Court of Appeals’ decision is unsalable.

    I should make only one more observation of the taxpayer’s observations about some conversations that we’ve had with Internal Revenue Service about value.

    As I take it, whatever those conversations were, they do not represent the Government’s position, ultimate position.

    They were made in the course of negotiations for a settlement of the case.

    Whether they’re correct or incorrect, I do not know.

    I do know this that I would hate to make a determination of value on the record in this case when most if not all of the ultimate relevant facts had not been introduced into the record.

    And without knowing what the value of the building was, what its rental value, sale value or any other factor which would determine how much of this $2,100,000 went to acquire the use of the building without the added information, I say, I don’t think anyone could has it or guessed as to what deductions attached, they will be entitled through over the next 30 years.

    Earl Warren:

    Mr. Weiss, would you mind addressing yourself just for moment to — to the suggestion that Mr. Zarky made, but suppose this deal had been made one month before your lease expired instead of one month afterward, would you — would you still be in Court here — making these contentions?

    Bernard Weiss:

    Yes, sir.

    I don’t think it makes the slightest bit difference.

    The fact of the matter is that this taxpayer own — owned the building.

    He owned it under by agreement here for its useful life and its useful life was — was 50 years originally, 20 — 20 had expired, at least, 30 remained under the agreed facts.

    So there was no necessity for this taxpayer to go out there and buy that which he owned and had the right to use.

    He was now coming in there when we talk about a value of $660,000 and that it must be remembered that under the terms of the lease, the rent was fixed at 6% of the value of the land vacant and unimproved.

    It would have been $40,000 if it had not been for the fact that this minimum cost was in there requiring this taxpayer to pay $118,840.

    And it was to be relieved of this amount, this excessive rent that the taxpayer was forced to acquire the property.

    And in acquiring the property, there’s no doubt about it that when you acquire a capital asset, it must be set up as a capital asset but to say that you — you are requiring a — that I would go out and actually buy something which I already own is ridiculous.

    On its face, it doesn’t — it doesn’t make the slightest bit of sense.

    The taxpayer in this case was — there’s an argument in here and I’d like to get to that because before we lose the trend here, there is a statement then here to the effect that the income would be distorted if we allow this full deduction in the one end.

    Now, every time you make — under the ordinary case which they even — which the respondent concedes when you cancel a lease and you make a payment, there is no doubt about it that you are distorting the income for that year because it will be deducted in that year, it won’t be deducted thereafter.

    That — that’s the natural or nothing and I say that it will give no harm to the respondent at all if this taxpayer were allowed even the full amount in the one year which would only mean that the taxpayer would have no deductions in this subsequent years and the Government would — and the Commissioner would then be collecting the tax or in the alternative to take the period that is benefited.

    This excess value above the 660 is entirely due to the lease and to nothing else.

    If it weren’t for this lease and the taxpayer had no building on it, he could then have gotten a renewal like that.

    And the — the man just wouldn’t go in for the thing.

    It wouldn’t make any sense.

    And I cannot conceive of any — of the Court actually saying that this taxpayer who is out with this money, this excess value, should not be entitled to get this whole figure of $1,440,000 either as an expansive for or to be written off over the period that’s going to be benefited because this lease had 21 more years.

    Here, the unexpired portion of the lease had 21 more years to run.

    That is the amount of the deduction that will be absent from the tax return which he would have had — had the — had the lease continued and therefore, the Commission who is collecting the tax throughout this period of $118,000.

    Bernard Weiss:

    Now, if you want to be accounting-wise, it might make sense to say that this $1,440,000 should be written off and be place in there in lieu of this $118,840 and which would give the taxpayer roughly $68,000 a year to be written off over the 21-year remaining life of an unexpired life of a cancelled lease.

    And I think that — I think that it does makes broad sense that this taxpayer should be permitted to deduct this amount of money and this business about a reflationary interest or valuing even land.

    When a person purchases land for $660,000 and places a building thereon for $3 million, there is no authority anywhere which says that because you’ll now have a building on it that you have a right to take any part of the cost of that building and transfer it over to the land and increase the value of the land and that’s what is being contended for by the Commissioner on this case.

    And that is the mistake that the court below is making when it makes that statement.

    What it really is trying to say is that you take into consideration the use to which this property can be put the maximum use and the rental value that — that surrounds this property.

    That’s what he’s trying to say and when we place a value $660,000 on this thing by one of the greatest men in the — one of the greatest real estate experts that was on the stand in this particular case, he knew this property backwards and forwards.

    You have the man on the stand in here who have dealt in over $190 million worth of property.

    This man knew all the property in the neighborhood and knew exactly what the values were and how these values are determined.

    And to say that this taxpayer should be penalized on some technical language of — by the use of the words bundle of rights.

    What — what is the bundle of rights that this taxpayer received outside of the fact that he got out of this lease?

    He already had the use of the property, the gross income he was getting, an outsider who acquires an interest in this property.

    What does he do?

    He — first is he has no — in the first place, he has no investment.

    He has no right to receive the income.

    An outsider would have received income if he acquired this lease.

    Do we receive any income by reason of that?

    No, we don’t receive income.

    We merely eliminate an expense and that is the difference between this case and the case of the — the hypothetical case that was cited by the respondent’s counsel.

    I think I’ve said enough.