Amicus Curiae Brief — Fribourg Navigation Co. v. Commissioner

Supreme Court brief1966

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MII POIIIIG | 5. 62s csscicteie ciency csevinnsicesssssisescceeversnes Tera he BOR eT 1

Statement of Interest of Amicus Curiae......... BO ae eR OR A Anes 2

Summary of Argument... ete 3

Argument:

Petitioner Is Entitled to the Deduction of $135,367.24 Claimed

by Petitioner on Its Federal Income Tax Return for the Year

1957 for Depreciation for the Period January 1, 1957, to Decem-

ber 23, 1957, with Respect to the Depreciable Asset Which Peti-

tioner Sold to a Competitor on December 23, 1957, Prior to the

Expiration of the Estimated “Useful Life’ of Such Asset... . 8

A. Nature of the controversy............. 8

B. The decision of a majority of the Court of aii | is

based upon a complete misunderstanding of fundamental

accounting principles of depreciation which are embodied

in the basic statutory provision and which have been rec-

ognized, enunciated, refined, and followed by this Court. 13

C. The lower courts in this case misinterpreted two decisions

of this Court and a decision of the Court of Appeals for

the Sixth Circuit... Ee en ; 27

D. The Treasury anetetiods are asinine consistent with

well-established principles of depreciation accounting and

were misinterpreted by the lower courts in this case........ 35

BE. The majority of the Court of Appeals ignored the rela-

tionship between depreciation, on the one hand, and gain

or loss on sale, on the other hand, and the clearly-defined

dichotomy between these concepts which is expressed in

the tax statute and in the Treasury Regulations and

which has been recognized in long-standing judicial prece-

dents and administrative practice. ................................0000. 40

F. The lower courts in this case ignored clear indicia of Con-

gressional intent as reflected for more than 20 years....... 48

G. The theory adopted by the lower courts in this case has

been thoroughly discredited by the overwhelming weight

of contemporary cour: decisions................................eeeees 55

RN ao ode crane ave vmnddad satan niatiacedvakesiicavistoningy vonewaneeubaanis 62

NM oy sep cupccsenue ses inuded cess sbooceds case ovaupanay Weaegdeov eds </esvcurivcsn cube wakes 65

—

AUTHORITIES CITED

CASES: Page

Paimaneda Adams, 23 CCH Tax Ct. Mem. 1743 (1964), on appeal

OR ea EER CREE RIM eas © STATED esa eae RANE A Sot See 61

American Auto. Ass’n v. United States, 367 U.S. 687 (1961)...... . 68

Grosvenor Atterbury, 1 B.T.A. 169 (1924) 44

Beckridge Corp. v. United States, 129 F.2d 318 (2d Cir. 1942). 44

Bell Lines, Inc., 43 T.C. 358 (1964) ; 61

Cammarano v. United States, 358 U.S. 498 (1959)... 55

Capital City Inv. Co., 4 B.T.A. 933 (1926) 44

W. W. Carter, 1 B.T.A. 849 (1925) Sm

Clark Thread Co. v. Commissioner, 100 F.2d 257 (3d Cir. 1938). 44

Cohn v. United States, 259 F.2d 371 (6th Cir. 1968).........0.000000..

Guieiebiakaadidiah ti abGeirs chaeesemaeveaind cbelaiiies idcuiad haat aes nea 12, 27, 29, 30, 33, 34, 57

Commissioner v. Brown, __ U.S. , CCH 1965 Stand. Fed. Tax

Rep. (65-1 U.S. Tax Cas.) 79375. (Apr. 27, 1965)....................65, 68

Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955) 55

Commissioner v. P. G. Lake, Inc., 356 U.S. 260 (1958).................. 55

Contra Costa Trucking Co., 22 CCH Tax Ct. Mem. 1018 (1963)... 61

Cotton Concentration Co., 4 B.T.A. 121 (1926) 44

The Covered Wagon, Inc., CCH Tax Ct. Mem. 1965-79, 24 CCH Tax

Ct. Mem, 427 (Apr. 5, 1965) : “es 61

Detroit Edison Co. v. Commissioner, 319 US. 98 (1943) ee,

Duncan-Homer Realty Co., 6 B.T.A. 730 (1927) ...... ae

Andrew J. Easter, 23 CCH Tax Ct. Mem. 413 (1964)... a 25

Max Eichenberg, 16 B.T.A. 1368 (1929) 44

Eldorado Coal & Mining Co. v. Mager, 255 U.S. 522 (1921) 43

Engineers Ltd. Pipeline Co., 44 T.C. _ No. 25, CCH Tax Ct. Rep.,

ec: 3t.tt 3; 1968)... 36, 61

Evans v. Commissioner, 264 F.2d 502 (9th Cir. 1959), rev’d sub

nom., Massey Motors, Inc. v. United States, 364 U.S. 92 (1960) 29

Even Realty Co., 1 B.T.A. 355 (1925) ....0.0....00..cccccccccccccceeccecereeeeneeee 44

Forrester Box Co. v. Commissioner, 123 F.2d 225 (8th Cir. 1941) 45

Walter Frank, 2 B.T.A. 905 (1925) .....0000.000ccccooceccccccceeeeeceen 44

Franklin Lumber & Power Co., 18 B.T.A. 1207 (1930), rev’d on

other grounds, 50 F.2d 1059 (4th Cir. 1931)...000000000n.. 44

Fribourg Navigation Co., Inc., 21 CCH Tax Ct. Mem. 1533 (1962),

aff'd, 335 F.2d 15 (2d Cir. 1964), cert. granted, __—s:vU“.S. __-

(No. 679, 1964 Term; renumbered No. 23, 1965 Term)......... 61, 62

Harry Friend, CCH Tax Ct. Mem. 1965-35, 24 CCH Tax Ct. Mem.

192 (Feb. 23, 1965), on appeal to Fourth Circuit................ 61

Thos. Goggan & Bro., 45 B.T.A. 218 (1941)... nn. 36, 44

Hall v. United States, 43 F. Supp. 130 (Ct. Cl.), cert. denied, 316

Py SE I a Hh drs spas ndinahotidsiey Premtn vier: ces deedcavaserecars beth vcieednaeiiacs 44

Hecht v. Malley, 265 U.S. 144 (1924)... eaters 55

R. A. Heintz Constr. Co. v. United States, F. Supp. __., CCH

1965 Stand. Fed. Tax Rep. (65-2 U.S. Tax Cas.) dln (D. Ore.

Mar. 25, 1965).. ants 61

" —

Page

Herschel M. Hays, CCH Tax Ct. Mem. 1965-213, 24 CCH Tax Ct.

Mem, 1103 (Aug. 9, 1965).............. beddvbneabacs 61

Hertz Corp. v. United States, 364 U.S. 122 (1960).

Sea dadawade ilai A avi 21, 23, 24, 26, 27, 28, 29, 35, 57

Holder Driv-Ur-Self, Inc., 43 T.C, 202 (1964), nonacq., 1965 Int.

Rev. Bull. No. 30, at 6.. - 61

Island Line Shipping Co., 4 B.T.A. 1055 (1926) 44

Louis Kalb, 15 B.T.A. 865 (1929) 44

Killebrew v. United States, 234 F. Supp. 481 (D. Tenn. 1964), on

appeal to Sixth Circuit............. . 61

Kimball Gas Prods. Co. v. United States, F. Supp. __, CCH

1963 Stand, Fed. Tax Rep. (63-2 U.S. Tax ax Cas.) 4 9507 (W.D.

Tex. Nov. 3, 1962), on appeal to Fifth Circuit 61

Kittredge v. Commissioner, 88 F.2d 632 (2d Cir. 1937) 44

L. M. Lockhart, 43 T.C. 776 (1965), on appeal to Ninth Circuit 61

Macabe Co., Inc., 42 T.C. 1105 (1964), on appeal to Ninth Circuit

chau desnsivas esteem td airstadaiadlaa bed dade Hak Tieton ; 61, 62

Marchetti Roma Cafe Co., 2 B.T.A. 529 (1925) 44

Massey Motors, Inc. v. United States, 364 U.S. 92 (1960)

a . 12, 21, 23, 24, 26, 27, 28, 29, 35, 57

Melvon C. Miller, 23 CCH ‘Tax Ct. Mem. 1866 (1964) 61

Moses Lake Homes, Inc., 23 CCH Tax Ct. Mem. 1756 (1964), on

appeal to Ninth Circuit................ 61

The Motorlease Corp. v. United States, 215 F. Supp. 356 (D. Conn.

1963), rev’d, 334 F.2d 617 (2d Cir. 1964), petition for cert.

filed (No..685, 1964 Term; renumbered No. 24,1965 Term) 25, 61

Mountain States Mixed Feed Co. v. United States, ___ ~F. Supp. __,

CCH 1965 Stand. Fed. Tax Rep. (65-2 U.S. Tax Cas.) § 9551

(D. Colo. May 26, 1965). 4200s apt MAE ENS LES RE 61

Occidental Loan Co. v. United States, 235 F. Supp. 519 (S.D. Calif.

1964), on appeal to Ninth Circuit 200.000 ccccccceee 61

W. Lawrence Oliver, CCH Tax Ct. Mem. 1965-83, 24 CCH Tax Ct.

a I a ci Pd 0d cas dss paid endear os eve caw dams nd aeen 61

Parkersburg & Marietta Sand Co., 11 B.T.A. 87 (1928) Pe

Real Estate Title Co. v. United States, 309 U.S. 13 (1940).......... 22

Rieck v. Heiner, 25 F.2d 453 (3d Cir.), cert. denied, 277 U.S. 608

CE Sat. leslie ve séhc cotcexeavens ae ee

John W. Roddy, 20 CCH Tax Ct. Mem. 1129 (1961). PASSIONS 25, 28

Ranuolph D. Rouse, 39 T.C. 70 (1962). ; 61

S & A Co. v. United States, 218 F. Supp. 677 (D. Minn, 1963),

aff’'d, 338 F.2d 629 (Sth Cir. 1964), petition for cert. filed (No.

862, 1964 Term; renumbered No. 50, 1965 Term)

Pah a6 tee 39, 46-47, 54, 55, 61

Seton Falls Realty Co., 6 B.T.A. 883 (1927)... Soha 44

Herbert Simons, 19 B.T.A. 711 (1930)............... dessus eiedes naire ae

Katherine Slider, 20 CCH Tax (t. Mem. 1327 (1961). 25

Smith Leasing Co., Inc., 43 T.C. 37 (1964), on appeal to Fifth

Cireuit ati tsos cate caneateaes eaackuaeliia . 61

) Page

Specialty Paper & Board Co., CCH Tax Ct. Mem, 1965-208, 24

CCH Tax Ct. Mem, 1085 (July 28, 1965) ...00...cccccccceeeeeee 61

} Stockstrom v. Commissioner, 190 F.2d 283 (D.C. Cir. 1961)........ 46

Stratton’s Independence, Ltd. v. Howbert, 231 U.S. 399 (1918).... 21

| Harry Trotz, 43 T.C. 127 (1964), on appeal to Tenth Circuit........ 61

United States v. Calamaro, 354 U.S. 361 (1957)... BB

United States v. Leslie Salt Co., 350 U.S. 383 (1956)... 63

United States v. Ludey, 274 U.S. 295 (1927)................22, 28, 26, 36, 44

Virginian Hotel Corp. v. Helvering, 219 U.S. 623 (1943)............. 20-21

Von Baumbach v. Sargent Land Co., 242 U.S. 5603 (1927)........... 21, 22

j Wier Long Leaf Lumber Co., 9 T.C. 990 (1947), acq., 1° 48-1

Cum, Bull. 3 (withdrawn), nonacq., 1962-1 Cum. Bull. 6, aff’d

and rev'd on other issues, 173 F.2d 549 (5th Cir, 1949)....45, 46, 54

Wyoming Builders, Inc. v. United States, 227 F.Supp. 534 (D.

Wyo. 1964), on appeal to Tenth Circuit : 61

STATUTES:

Corp. Excise Tax Act of 1909, Section 38 (Second)...................21, 22

. Rev. Act of 1913:

a cra emananae sihdniaidibaniasshadesontaseaanioucead 20

i gs oop h Sassy cas syodedyuees suciweds cuakdiriaeoaenuhd salad vetoes 20

Rev. Act of 1916:

Section 5(a) (Seventh) es aahnthce vepuensad grnaeenisins tails Weiner ee

BI BU CD isinciiscisnidcedsv noes doushvesdevoeddviusovadovedkrenssnacddceces 22

Rev. Act of 1918, Section 214(a)(8).......... 5 adele earn WE eiretea deen.

} Rev. Act of 1921:

Section 206(a) (6), (Dy 2occcccccccccccccceeeccceeee cece sees RODE Nee 5A 47

NN sir sc bs sav dapdonivaveavedenivarsvvandervc@euses Sipadicun ds bea are

Rev. Act of 1924:

Ns ysdiics icrdotivaidveienbeaeiad sevicdendesicispens uteio eat. 47

I 5 sn 05hd iu ais ane sv anbtoawededounksodecessteesaiacvesosh dieses 47

I Lao cing dessa cacoans od nse agtivianalaties stu ricesy Vie door atiatesieee 47

ST RUUD, ove ciccnehssccccevesiecscarevesesinvcsséeeeein AO rte 19

Rev. Act of 1926:

EM isons, cs dosiveleusevinancttscsdsssvsiewassdecuiniscccste as stihaanes 47

' Sak 25, sora mages oad de aki itewtd lakes tite niece hiv Gah 47

I UY 8b oseisb co se eilcatove dvs ogo bbsavuets vedadebivenen with eckowTeree 47

ns oxdulpsing Subicdeddian wires veekaaed ceyveoleriaie te ee 19

Rev. Act of 1928:

I iss ode deccewvisess Gnsdeusvadsisiteadarincs Se age Advie:! =a

I NS opis 4s sc pncteccunncnipantesieesanpansescuiiais xérecesent eevusa teens 47

I MII hs eta cts xd ecrcxanap iad haudbeaseed tidhn cake inces coon 47

} SI PARED. cisicssdvevecsegvenvarverenevsecdsxsasecsua pihedysexetdecrkodteves 47

Rev. Act of 1932:

EE DV csks stad inven ndiadunstednaVhaasvnedden iets deasudec edie Peeneiautin ts oe 19

SE IEEE «5/4: cous aecbsacases pen unweissaddaudisedrecsaiesitre Teena ae ee 47

NN EE. | cenicnsvuxivsvscisertiveresetupnckauier Rar dvinoaracwl tine elemida ove 47

Rev. Act of 1964, Section 231(a)

ou ————

Page

Rev. Act of 1934:

SN MII Sie sie gusso ce xe'abdsovnoueebtode check asad saboeenenakdlebewvied kts, 19

he gg EEE SEIS TE SEW apap Nie Bitte eee ee 47

sins cvso. adidenrurtdercisaimdconiiencase nee KD we 47

Rev. Act of 1936:

a bg cas ics drs ody An isp vb rasta vooons ee aa 19

I a ol a ON Nis ne” Suro 47

UII, s charis casvosvasena deve eeekutntia scovunewedaue cman) cco nankoite.iaehoicta 47

Rev. Act of 1938:

ee ee 19

Section 117(a)(1)........ 47

at. Rev. Code of 1939:

IN MN la rn ac tees ats dsy rds hob winc Weeeae ek Pealdes skis eeiea 19

4g aS RRRESIREESES See e SN ot Nat Ree cha 46, 50

PE I cic isenivcct visits evsseretvesindeteieeias 48, 49

IE Lax odeuls tucadsdaduchvsvounbiniTvsuinleceticenecmel tisk ek ise tae 61

EE MHIP. sus toni esnsosersectixseavescsicrsare 49

Rev. Act of 1942:

Section 121(c) .... 19

Section 151(b) 48

Rev. Act of 1950:

Section 216(a) 49

Section 216(c) _........... Sicilodedicsk 50

Rev. Act of 1951, Section B28(a). §1

Int. Rev. Code of 1954:

SN ME ntavacevisobersveresedaistescrteccdiven 19, 20, 41, 43

Section 167(b) (2) 42,51

Section 167(b) (3) 42,51

Section 167(b) (4) 42,61

NS IEE Soe Bersewcsivasryrcunechctarvvens vobaehoncers 49

Section 179 .. 42

SE TIE) = dn, pi0 Sicrvnuedevnviertn enc Ae duviaeoeccs indy 41

Section 1001(c) ,

Section 1002 41, 43

IN fe ashetces ri seis cnvesdianssiccs Goes toes odsere¥ ate ne 41

Section 1016(a)(2) 41

Section 337(a) 41

Section 1201... BAN Fano Soom tsa ; 47

Section 1231... PPR es aA EA RETR 41, 42, 43, 48, 51

IRIN dd aloes Cart cine recasacnecesvesewes ca lon hac ink 27

Section 1238 50

PIII 65s ax os feet 100 sha Sarcactyputarinissiee eigen 51

MIL Weis kasits poawihoet:xsienenaess sesceaawedeicatabdeasysanteel hails 41,52

I odo foes <0 dcach cous sce Sedvawadeatedere eedobecs 41, 53

ee MN eno sods bn cdievvie ibe enc eisiaacin th Ae 63

Deetiod TEGCCH\ ER) — -.......0:.-cscescccccccese 53

Section 1250(b) (1) . CaS Ue 53

Rev. Act of 1962, Section 13(a) Sauber 52

MISCELLANEOUS: Page

Accounting Terminology Bulletin No. 1 (Committee on Terminol-

ogy, American Institute of Certified Public Accountants, 1953),

republished in Accounting Terminology Bulletin No. 1, Review

and Resume, Accounting Research & Terminology Bulletins

(American Institute of Certified Public Accountants, Final Ed.

MS sc itiucs mene Gewiiegscaecdunnrud o4saia seascaneno eae) 18

Accounting Research Bulletin No. 43, Ch. 9(A) (Committee on

Accounting Procedure, American Institute of Certified Public

INN: PIER vein hi ccck i Pevtouatacate cnt yale dlddaemeke vititdoca et beckawicwerbave 16

A.R.R. 6930, III-1 Cum. Bull. 45 (1924).......... 46

Braunstein & Johnson, Public Utility Depreciation and the Income

Tax, 52 Harv. L. Rev. 1077 (1939) 15

Brief for the Appellee in Cohn v. United States, 259 F.2d 371 (6th

le N eccchcc ibe cincnsteewsins lk Acrnianei ote ccocnesveuscerier carte kvinveaionl cs caWisineciaeae 31

The Budget of the United States Government for the Fiscal Year

Ending June 30, 1961. =H 52

Bulletin “F’’ (as revised in January, 1942) anA , 35

96 Cong. Rec, 14057 (1950).............. = as sicchceiereae ee

100 Cong. Rec. 3678 (1954) 51

Cranstoun, Tangible Fixed Assets, Contemporary Accounting

DR Revciede oa etna i oictcrniesces ea cooeseeah orcas jefeatacetvaviceenanee! (Ca

Current Practice in Accounting for Depreciation: National Asso-

ciation of Accountants Research Report (1958) 18

1 Dewing, The Financial Policy of Corporations (5th Ed. 1953)..15,17

19 Fed. Reg. 6229 (1954). 37

20 Fed, Reg. 8454 (1955)... nf fees : 37

21 Fed. Reg. 3985 (1956).......... “hee Lote eM BV Sten oD Heke ae

Se ee I I cc | cioes ovscshunivancanercnevnt deel ipeiiecnesskiwetanan 46,50

Finney & Miller, Principles of Accounting—lIntermediate (4th Ed.

WR Pac sstcotasetnter ices teeincccnstoxees 18

G.C.M. 1597, VI-1 Cum. Bull. 71 (1927). BLUE hn ent 46

H.R. 8920, 81st Cong., 2d Sess. (1950)... , 49

H.R. Rep. No. 2319, 81st Cong., 2d Sess. (1950) Ni ping 49

H.R. Rep. No. 3124, 81st Cong., 2d Sess. (1950) 50

H.R. Rep. No. 586, 82d Cong., 1st Sess. (1951)... =O

H.R. Rep. No. 1337, 83d Cong., 2d Sess. (1954) . hi 51

H.R. Doc. No. 140, 87th Cong., 1st Sess. (1961).................... 52

H.R. Rep. No. 1447, 87th Cong., 2d Sess. (1962) : 52

H.R. Rep. No. 749, 88th Cong., 1st Sess. (1964) 53

Hearings Before the Committee on Finance, United States Senate,

83d Cong., 2d Sess. on H.R. 8300, Part 3 51

-Hearings Before the Committee on Ways and Means, House of

Representatives, 80th Cong., Ist Sess. on Revenue Revisions

iis, I iso cen seer ees ahh csr ines 49

Hearings Before the Committee on Ways and Means, House of

Representatives, on the President’s 1961 Tax Recommendations 52

I.T. 1158, I-1 Cum. Bull. 173 (1922)....... 45

1.T. 1494, I-2 Cum. Bull. 19 (1922)........ ; ramcanbe pen 46

vu |

Page

Karenbrock & Simons, Intermediate Accounting (3d Ed. 1958). 18

Kennedy & McCullen, Financial Statements—-Form, Analysis & In-

terpretation (4th Ed. 1962) 18

Montgomery, Auditing (7th Ed. 1949) 18

Montgomery, Auditing (8th Ed. 1957)... . 14, 15, 16 ;

O.D, 758, 3 Cum, Bull, 171 (1920)......... 45

Paton, Accountants’ Handbook (3d Ed. 1944) 44, 15,16

Rev, Proc. 62-21 (Part II), 1962-2 Cum, Bull. 418 356

Rev. Rul, 62-92, 1962-1 Cum. Bull. 29 36, 54

S. Rep. No. 2375, 8lst Cong., 2d Sess. (1950) . 49

S. Rep. No. 1881, 87th Cong., 2d Sess, (1962) 52

S. Rep. No. 830, 88th Cong., 2d Sess, (1964)... 63

Saliers, Depreciation: Principles and Application (3d Ed, 1939)

. 14,156, 16

Statement of Secretary of the Treasury Before the Committee on

Ways and Means, House of Representatives, on the President's

Special Message on Tax Reduction and Reform, on February 6,

1963 MTN ama UE Cedi tcol ea Ec Teaueaea cottivcstaxinincateveiadbiiseese teen onde vavarace 63

1 Sutherland, Statutory Construction (8d Ed. 1943) 65

T.D. 6861, 1961-2 Cum, Bull, 63 46

T.D. 6182, 1966-1 Cum, Bull, 98 87 }

T.D. 62563, 1967-2 Cum, Bull, 647 46

Treasury Department Release A-761, dated February 15, 1960 62

Treasury Information Release 374, dated June 7, 1962 54

Treasury Regulations on Income Tax (1954 Code):

Section 1.167(a)-1(a) 36, 36

Section 1.167(a)-1(b) $5, 36, 37, 38

Section 1.167(a)-1(c) $2, 36,37, 38

Section 1.167(a)-8(a) 43

Section 1.167(a)-10(b) 43

Section 1.167(b)-0(a) 39

Section 1.167(a)-1(c) ' $7-38

Section 1.1238-1 0.0... ; 46, 50

Webster's Seventh New Collegiate Dictionary (1968) Eviestuvetant 13

In the

Supreme Court of the Gnited States

October Term, 1965

No. 23

FRIBOURG NAVIGATION COMPANY, INC.,

Petitioner,

vB.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

ON WRIT OF CERTIORARI TO THE UNITED STATES

COURT OF APPEALS FOR THE SBOOND CIROUIT

BRIEF OF AMICUS CURIAE

ero

QUESTION PRESENTED

Whether, as a matter of law, the unanticipated sale of

depreciable property in the middle of its estimated “useful

life” for an amount in excess of its depreciated basis at the

beginning of the year of sale necessarily bars the deduction

of depreciation on the property for the period of its use dur-

ing the year of sale.

STATEMENT OF INTEREST OF AMICUS CURIAE

This brief is filed by the undersigned attorneys as friends

of the Court, with the consent of the petitioner and the re-

spondent. ‘The undersigned attorneys represent the taxpayer

in the almost identical case of S € A Co. v. United States,

218 F. Supp. 677 (D. Minn. 1963), aff’d, 338 F.2d 629 (8th

Cir. 1964), petition for cert. filed (No. 862, 1964 Term; re-

numbered No. 50, 1965 Term). The undersigned attorneys

also are concerned, in their capacity as members of the Bar,

with the serious implications of the theories proposed by the

respondent and accepted both by the Tax Court’ and by a

majority of the Court of Appeals? in this case, as these

theories would (if accepted by this Court) overturn over 40

years of relevant precedents and adversely affect numerous

other taxpayers.

1The opinion of the Tax Court is not officially reported, but it is unofficially )

reported at 21 CCH Tax Ct. Mem. 1533 (1962), and is reprinted at pages 3

2 to 18, inclusive, of the Transcript of Record before the Court in this case.

2The opinion of the Court of Appeals is reported at 335 F.2d 15 (1964). The

majority opinion is reprinted at pages 76 to 82, inclusive, of the Transcript

of Record, and Judge Moore’s opinion in dissent is reprinted at pages 82 to

90, inclusive.

——————

SUMMARY OF ARGUMENT

The Tax Court and a majority of the Court of Appeals in

this case accepted respondent’s novel theory that, as a matter

of law, the sale of a depreciable asset conclusively terminates

its previously estimated “useful life”, and the sale price re-

ceived for the asset automatically supplants any previously

estimated “salvage value” of the asset for purposes of com-

puting depreciation on the asset in the year of sale, and,

therefore, the unanticipated sale of a depreciable asset in

the middle of its estimated “useful life’ for an amount in

excess of its depreciated basis at the beginning of the year

of sale necessarily bars any deduction for depreciation of

the asset for the period of its use in that year. The lower

courts denied the deduction for depreciation despite the fact

that the “useful life’ and “salvage value” of the asset in-

volved which were used by taxpayer in computing the claimed

depreciation had originally been approved by the Internal

Revenue Service, and the reasonableness and accuracy of the

“useful life’ and “salvage value” so approved have not been

questioned in this proceeding. In accepting this theory, and

concluding that peti‘ioner was not entitled to any deduction

for year-of-sale depreciation of an asset sold in 1957, the

lower courts completely misunderstood fundamental prin-

ciples of depreciation accounting which are embodied in the

basic statutory provision and which have been recognized,

enunciated, refined, and followed by this Court, misinter-

preted two decisions of this Court and a decision of the Court

of Appeals for the Sixth Circuit, misapplied the pertinent

provisions of the Treasury Regulations, ignored the basic

dichotomy in the tax law between denreriation of property

during the period of its use and recognition of gain or loss on

its disposition, which is reflected in over 40 vears of indicial

precedents and administrative rulings and practice, ignored

clear indicia of Congressional intent as evidenced for more

than 20 veava, and, in general, gave their stamp of approval

. —

to a novel theory which has been thoroughly discredited in

the overwhelming majority of contemporary court decisions.

The Court of Appeals, viewing the purpose of depreciation

for income tax purposes to be to account for “the diminution

of the asset’s value each year”, applied a literal meaning to

the term “depreciation” for tax purposes. However, any use

or meaning of the term “depreciation” as the converse of

“appreciation” is irrelevant in determining the income tax

allowance for depreciation. This irrelevance is made abun-

dantly clear in basic, well-established accounting principles

of depreciation, which this Court has held to be the matrix

of the income tax allowance for depreciation, and in the

pertinent statutory provision, Section 167(a) of the Internal

Revenue Code, which allows as a depreciation deduction “a

reasonable allowance for the exhaustion, wear .. . tear

. . . [and] obsolescence” “of property used in the trade or

business’, and in the depreciation formula first enunciated

by this Court in United States v. Ludey, 274 U.S. 295 (1927).

These authorities all recognize that the term “depreciation”

for income tax purposes means the physical and functional

deterioration of property with use and lapse of time, and

that depreciation accounting is a process of cost allocation,

not of asset valuation.

The depreciation formula of the Ludey case recognizes

that, in computing depreciation for income tax purposes, the

allocable sum is original cost of an asset less its estimated

“salvage value” and that the rate of allocation is determined

by the asset’s estimated “useful life’. This Court, in Massey

Motors, Inc. v. United States (decided with Commissioner v.

Evans), 364 U.S. 92 (1960), and in Hertz Corp. v. United

States, 364 U.S. 122 (1960), refined that formula, entirely

consistent with well-established accounting authorities, by

holding that “useful life” is the period, determined at the

time of acquisition, for which the taxpayer reasonably exr-

pects the property to he useful in the business, and that

( 5

“salvage value’, also determined at the time of acquisition,

is the amount which the taxpayer anticipates the asset will

be worth at the end of that “useful life’. The Tax Court in

this case erroneously assumed that this Court in Massey and

Hertz had discarded the “old, well-established rules relating

to depreciation allowances.” In fact, those cases merely re-

stated the principles outlined above and held that the origi-

nal estimates of “useful life” and “salvage value” must take

into account the taxpayer’s established practices in disposing

of assets of the type involved prior to the expiration of their

normal physical life.

The decision of tue Sixth Circuit in Cohn v. United States,

259 F.2d 371 (6th Cir. 1958), simply applied these well-

settled principles to the peculiar facts involved in that case,

viz., a sale at or near the end of redetermined “useful life”,

and in no way supports the decisions of the lower courts in

this case. The Tax Court in this case erroneously believed

that Cohn also had discarded the “old, well-established

rules”, and a majority of the Court of Appeals concluded in

error that respondent’s new theory was “suggested by” the

decision in Cohn.

The Treasury Regulations simply mirror the depreciation

formula developed in accordance with well-established ac-

counting principles and enunciated by this Court in Ladey

and later refined and followed by this Court in Massey and

Hertz, and also make it clear that, once properly estimated

at the time of acquisition, “useful life’ may not later be re-

determined unless there is a “clear and convincing basis for”

the change, and “salvage value” may not later be redeter-

; mined “merely because of changes in price levels,” but may

be redetermined only in connection with a redetermination

of “useful life” and at no other time.

The dichotomy in the tax law between depreciation deduc-

tions while property is used in the trade or business and

computing and recognizing gain on the subsequent disposi-

tion of the asset is expressly recognized in respondent's

Treasury Regulations. For over 40 years, from 1920 until

the trial of this case in the Tax Court, respondent’s long-

standing practice of allowing depreciation in the year of

sale of depreciable assets at a profit was fully reflected in his

published rulings, practice, and acquiescence and in long-

standing judicial precedents approving respondent’s practice,

including this Court’s decisions in Eldorado Coal & Mining

Co. v. Mager, 255 U.S. 522 (1921), and in United States v.

Indey, supra, and numerous other decisions of many lower

courts including the Second Circuit’s decisions in Beckridge

Corp. v. United States, 129 F.2d 318 (2d Cir. 1942), and in

Kittredge v. Commissioner, 88 F.2d 632 (2d Cir. 1937). All

of these judicial and administrative precedents are complete-

ly consistent with well-established accounting principles in

flatly contradicting respondent’s present theory that a sale

at a gain of a depreciable asset bars a deduction for deprecia-

tion in the year of sale and plainly indicate that such depre-

ciation in fact is allowable.

Since 1918, Congress has repeatedly reenacted the basic

statutory provision relating fo the allowance for depreciation

without relevant change. Moreover, from 1942 to 1962, Con-

gress first granted, then expanded capital gains treatment

to gains realized on the sale of depreciable assets, in spite

of persistent warnings from the Treasury Department that

this favorable treatment resulted in so-called “abuses.” Dur-

ing that period, Congress considered and uniformly rejected

proposed legislation designed to eliminate or to reduce these

“abuses”. Not until 1962, however, did Congress act upon

any of these recommendations, and in 1962 and again in

1964 Congress approached the problem, prospectively, solely

in terms of the nature of the gain recognized and not through

a change in the long-standing statutory scheme pertaining to

esti

depreciation deductions. By its reenactment of the deprecia-

tion provision in the light of an established administrative

and judicial interpretation, Congress is presumed to have

approved and adopted that interpretation.

These well-established principles of depreciation account-

ing, which were ignored by the lower courts in this case,

have been applied in the overwhelming weight of contempo-

rary court decisions in which respondent’s new theory has

been flatly rejected. The most carefully considered and

thorough of these decisions is found in the opinion of Judge

Blackmun in the case of United States v. S & A Co., 338 F.2d

629 (8th Cir. 1964), affirming 218 F.Supp. 677 (D. Minn.

1963), petition for cert. filed (No. 862, 1964 Term; renum-

bered No. 50, 1965 Term). In the S € A Co. case, the Court

of Appeals for the Eighth Circuit analyzed the applicable

principles and reached conclusions identical in almost every

respect with those urged in this brief. While the court con-

sidered all of the relevant arguments, its key comment is

found in this statement:

. There is no absolute identity of salvage value

with sales price. The one is not necessarily equivalent

to the other. Neither the statute nor the regulations

equate them or make an exception out of the sale year.

The emphasis, as has been noted, is, instead, on the esti-

mate of salvage value, on such estimate at acquisition,

on redetermination as the exception, on the distinct pos-

sibility of gain or loss on disposition, and on divorce-

ment of salvage value from price level fluctuations.*

The decision of a majority of the Court of Appeals in this

case, in parting company with all recognized principles of

depreciation accounting as developed and followed in a long

line of judicial and administrative precedents and accounting

authorities and as evidenced in over 20 vears of clear indicia

of Congressional intent, is erroneons and should be reversed.

3338 F.2d at 640.

ARGUMENT

PETITIONER IS ENTITLED TO THE DEDUCTION OF $135,367.24

CLAIMED BY PETITIONER ON ITS FEDERAL INCOME TAX RE-

TURN FOR THE YEAR 1957 FOR DEPRECIATION FOR THE

PERIOD JANUARY 1, 1957, TO DECEMBER 23, 1957, WITH

RESPECT TO THE DEPRECIABLE ASSET WHICH PETITIONER

SOLD TO A COMPETITOR ON DECEMBER 23, 1957, PRIOR

TO THE EXPIRATION OF TE ESTIMATED “USEFUL LIFE" OF

SUCH ASSET.

A. Nature of the controversy.

The sole issue in this case involves a determination wheth-

er petitioner is entitled to the deduction of $135,367.24, which

petitioner claimed on its federal income tax return for its

taxable year 1957, for depreciation for the period January 1,

1957, to December 23, 1957, with respect to the S.S. Joseph

Feuer (the “Feuer”), a Liberty-type dry cargo ship, which

petitioner sold to a competitor for $695,500 on December 23,

1957. This-determination in turn depends upon whether, as

a matter of law, the sale price received for the Feuer, which

exceeded the undepreciated cost of the vessel on January 1,

1957, determined the “salvage value” of the ship for purposes

of computing depreciation in the year of sale, as the respond-

ent contends and as the Tax Court and a majority of Court

of Appeals concluded, or whether the sale price merely re-

fiected the market value, and not the “salvage value,” of the

ship at a particular point in time prior to the expiration of

the estimated “useful life” of the ship, as the petitioner and

the undersigned attorneys contend.

IP SO CALC MRENIAAEST REEILENEE LIE S SLE IEELGS IE MO TIE: ——

The pertinent facts may be summarized briefly as follows :*

Petitioner was organized in 1946 and owned and operated

ships for charter to exporters for the shipment of dry bulk

cargoes in foreign commerce. (R. 3, 7-8.) On December 21,

1955, petitioner purchased the Feuer for $469,000 (R. 4)

and thereafter operated it under the American flag as a

tramp ship for the carriage of various dry commodities from

the United States to Asian and African ports. (R. 7-8.)

Prior to purchasing the Feuer, the petitioner applied for

and received from the Engineering and Valuation Branch of

the Internal Revenue Service a letter ruling dated December

8, 1955, with respect to its depreciation. (R. 4.) The ruling

stated that the Internal Revenue Service would accept a

“useful economic life” of three vears from the date of acquisi-

tion and a “salvage value” of $5 per dead weight ton

($54,000) for the Feuer and that the Feuer’s cost of $469,000,

less its $54,000 “salvage value”, should be spread ratably

over its three-vear “useful economic life”. (R. 4.)

Petitioner claimed deductions for depreciation of the

Feuer on its federal income tax returns for the years 1955

and 1956 in the respective amounts of $8,786.50 and $138,-

585.77, leaving an undepreciated cost of $326,627.73 as of

January 1, 1957. (R. 4.) The Internal Revenue Service has

audited petitioner’s income tax returns for 1955 and 1956

and has accepted the depreciation deductions without ad-

justment. (R. 5.)

The Feuer had been built in 1943 for the United States

Maritime Commission for emergency use during World War

4The facts before the Court in this case are thoroughly set forth at pages 19

to 75, inclusive, of the Transcript of Record. Inasmuch as the facts are not

disputed in this case, and since the Tax Court accurately and completely

summarized the pertinent facts in its Findings of Fact. references herein to

the pertinent facts will be to the Tax Court's findings as set forth at pages

8 to 11, inclusive, of the Transcript of Record (hereinafter referred to as

- msi

II (R. 4), as part of an accelerated Liberty-type shipbuild-

ing program. In post-war commerce, Liberty ships carried

low-paying bulk commodities, principally grain and coal,

were slow and had a low cargo capacity and, faced with

mounting competition from modern post-war ships, were rap-

idly becoming obsolete. (R. 8, 10.) However, the economic

and market conditions resulting from the blockage of the

Suez Canal in 1956-1957 temporarily relieved the precarious

economic position of American flag Liberty-type ships. In

fact, during this brief crisis the operation of any type of

ocean-going vessel, including American flag Liberty-type

ships, became highly profitable, and the temporary scarcity

of ships caused sales prices of ships to rise sharply. (R. 5.)

In January and February of 1957, purchasers were willing

to pay as much as $1,000,000 for American flag Liberty-type

ships, and as a resulié the Feuer appreciated in value. (R. 5.)

In June of 1957, a competitor of petitioner, the Isbrandtsen

Company, Inc., which was engaged in the business of using

Liberty-type ships as tramp carriers of grain and other bulk

commodities, offered such an excellent price for the Feuer

that petitioner decided to sell it. (R. 6.) On June 14, 1957,

petitioner entered into a contract for the sale of the Feuer to

Isbrandtsen for $700,000, which amount was reduced to

$695,000 as a result of a change in financing. (R. 6.) The

contract called for delivery of the Feuer to Isbrandtsen in

December of 1957, and petitioner made delivery on December

23, 1957. (R. 6.)

Petitioner had not followed a practice of using ships for a

short time and then reselling them while still in good oper-

ating condition. (R. 6.) Petitioner had not put the Feuer

up for sale, but had decided to sell the ship solely because

Isbrandtsen had offered such an excellent price. (R. 6.)

The contract of sale was entered into halfway through the

three-vear “nsefiu! economic life” established for the Feuer

’

by the letter ruling, and when the Fewer was delivered to

Isbrandtsen one-third of that “useful life’ remained. (R.

6.)

By December of 1957, when petitioner delivered the Feuer

under the June contract of sale, charter rates had fallen

sharply (R. 8-9), competition for dry bulk cargoes was in-

creasing (R. 8, 10), Liberty ships were finding it harder to

secure cargoes (R. 10), and prices of such ships had fallen

to the level of $400,000 to $500,000 (R. 11), all of which con-

firmed the Feuer’s obsolescence and the correctness of the

estimates of “useful economic life” and “salvage value” made

in the letter ruling. Furthermore, scrap steel prices also were

falling, and the scrap value of a Liberty ship was between

$53,000 and $60,000 (R. 11), almost exactly as established

by the letter ruling.

In its federal income tax return for 1957, petitioner re-

ported gross profit of $289,340 from the operation of the

Feuer up to the date of sale, and also deducted $135,367.24

for depreciation of the Feuer from January 1, 1957, to De-

cember 23, 1957 (R. 7), under the formula authorized by the

letter ruling and approved for prior years. Respondent

never has questioned the originally established three-year

“useful economic life” for the Feuer, nor has he changed the

letter ruling as to such “useful economic life” or as to “sal-

vage value”. (R. 5.) Nevertheless, respondent disallowed in

its entirety the deduction of $135,367.24 for depreciation of

the Feuer from January 1, 1957, to December 23, 1957,

claimed by petitivuner on its income tax return for 1957, on

the ground that, as a matter of law, the profitable sale of the

Feuer barred any depreciation deduction for the year of

sale. (R. 7.)

In a single-judge memorandum derision, the Tax Court sus-

tained the respondent’s disallowance, admitting in the proe-

ess that it had discarded the “old, well-established rules re-

as - BU

lating to depreciation allowances”, and announced the novel !

proposition that whenever a depreciable asset is sold, even in

the middle of its estimated “useful life’, at an amount sub-

stantially in excess of its adjusted basis at the beginning of

the year of sale, no depreciation is allowable on the asset for |

that year. In arriving at this new doctrine, the Tax Court re-

lied on three higher court decisions which it erroneously

thoug!: had rejected the “old, well established rules”: viz. |

the companion decisions of this Court in Massey Motors, Inc. |

v. United States, 364 U.S. 92 (1960), and the decision of the

Court of Appeals for the Sixth Circuit in Cohn v. United

States, 259 F.2d 371 (6th Cir. 1958). (R. 17-18.)

In a two-to-one decision, the Court of Appeals affirmed

the judgment of the Tax Court. A majority of the Court

accepted the respondent’s position that, as a matter of law,

a taxpayer is not entitled to a deduction for depreciation in '

the year of sale with respect to depreciable property sold at ;

a profit, citing only the Cohn decision. (R. 78-79, 81.)

Simply stated, the propositions adopted by the Tax Court

and by a majority of the Court of Appeals are that, as a

matter of law, the sale of a depreciable asset conclusively

terminates the previously estimated “useful life” of the asset,

and the sale price received for the asset supplants any previ-

ously estimated “salvage value” of the asset for purposes of

computing depreciation on the asset in the year of sale.

a —_

B. The decision of a majority of the Court of Appeals is based

upon a complete misunderstanding of fundamental accounting

principles of depreciation which are embodied in the basic

statutory provision and which have been recognized, enunciat-

ed, refined, and followed by this Court.

Two entirely distinct concepts of the term “depreciation”

are often confused. Under the dictionary definitions’ as used

in relation to problems not here involved, the term “deprecia-

tion” is the converse of appreciation and thus means a de-

cline in value not necessarily attributable either to use or to

lapse of time. A majority of the Court of Appeals applied

this meaning to the word as used in the applicable income tax

statute. Its conclusion that, as a matter of law, deprecia-

tion is not allowable in the year of the profitable sale of a

depreciable asset springs from its premise, unsupported, as

we shall see, by statutory, judicial or accounting authority,

that “the purpose of the depreciation allowance is to enable

the taxpayer to recover the net cost of a wasting asset used

in his trade or business by charging the diminution in the

asset’s value each year against the gross income for that

year’’® and that “all that is required is a comparison of the

asset’s selling price with its adjusted basis” to determine

whether or not the asset “costs a taxpayer” anything in the

year of sale and, therefore, has “depreciated” in that year for

tax purposes.”

Accounting authorities have developed recognized con-

cepts of “useful life” and “salvage value” for depreciation

purposes. “The useful life of depreciable assets is based on

their period of usefulness to the company and not their in-

5Wenstenr’s Seventn New Coivieciate Dictionary 222 (1963) defines “de-

preciate” as “. . . to lower the price or estimated value of” and “to fall in

value”.

®R. 80. Italics supplied.

TR. 81.

herent life.’”" A “cycle of life is comprehended in the whole

period of usefulness of an article in a given position.” “Use- t

ful life may be less than physical life because of such factors

as obsolescence and inadequacy.”'® The service lives of plant

and properties may be limited by a variety of physical and

functional factors."'

“Salvage value” is the “value an article possesses for some

use other than that to which it has been devoted.”'? This

will be merely junk or scrap value unless the article possesses

“another cycle of life.""* The article “depreciates until it

reaches its salvage or scrap value, as the case may be,” be- '

yond which point “there is no further depreciation because

it enters a second cycle of life or is broken up... .”"*

“Original cost is usually the only factor known definitely

which is employed to compute the depreciation charge for a

given period. Useful life and salvage value must be esti- '

mated.""®) The accounting recognition of depreciation is |

“necessarily . . . based upon an estimate of useful life.*'*

“Salvage value”, like “useful life’, should be estimated at

w1T

the time of acquisition. Accounting authorities recognize

§8Monreomeny, Avprrinc 271 (Sth Ed. 1957) (hereinafter cited as “Mownr-

GOMERY” ),

*Sauiens, Depnectation; Principnes & Appuications 74 (hereinafter cited

as “Sauiens” ),

'OMonTCOMERY at 268,

1tParon, AccounTaANnts® Hanpnoox 720 (3d Ed, 1944) (hereinafter cited as

“PATON” ),

'8Sauiens at 72.

‘bid.

MI bid.

Sariens at 150,

18Monrcomeny at 268,

1d. at 271.

AO AH) A APE INT RN APIA EAA RAC OITA SOUNR OR ————

_ —————s

that “past recoveries on similar assets may provide the basis

for an estimate.”"*

Depreciation accounting is from the outset a process of

dead reckoning. However, the accounting authorities recog:

nize that the “useful life” of an asset, and thus the deprecia-

tion rate, is subject. to correction—prospectively—when the

evidence clearly indicates that correction is required.’ Sig-

nificantly, although the accounting authorities specifically

contemplate appropriate prospective changes in estimated

“useful life”, the authorities do not contemplate changes in

the original estimates of “salvage value”. To the contrary,

they make it abundantly clear that changes in “salvage

value” should not be dictated by or be based upon changes

in price levels or market values, whether or not realized

through sale of the asset.*°

Accountants strenuously object to changes in depreciation

accounts to reflect current values. The objections are, in

part, based on impracticability,?" awkwardness and the de-

sire to avoid “radical and tedious adjustments.”** But the

fundamental objection is that. the adjustment of depreciation

to differences in value at the beginning and end of the ac-

counting period “violates the basic concept of depreciation

because it does not fairly allocate the cost of depreciable

"Id. at 272.

1®MonTCOMERY at 271; Paton at 279; Saiers at 130, 152; Braunstein &

Johnson, Public Utility Depreciation and the Income Tax, 52 Harv. L. Rev.

1077, 1087-88 (1939).

20] Dewtnc, Toe Financia, Poutcy or Corrorations 537 n. f (5th Ed.

1953) (hereinafter cited as “Dewinc”); Saviers at 61, 68-69.

21Accounting Research Bulletin No, 48, ch. 9(A) (Committee on Accounting

Procedure, American Institute of Certified Public Accountants, 1953).

22SaLiens at 974.

property to income over its useful life.”’** For depreciation

accounting is “a process of allocation, not of valuation.”** '

An equally serious objection is that recognition of changes |

in fair market value would introduce extraneous elements in- |

to the depreciation equation. Depreciation for the year “is

not intended to be a measurement of the effect of all .

occurrences.”*> Various elements “to be considered in de-

termination of fair value” are “not necessarily reflected in

correct accounting practice. . . .”*® One such extraneous

element is the appreciation resulting from changing price

levels or from increased demand or productivity. A valua- ‘

tion may “show that present value of plant is as much as or

greater than cost . . . not because depreciation does not

exist, however, but because appreciation in some parts has

occurred or because a going-concern value has been estab-

lished.”2*7_ “The impropriety of offsetting depreciation by ;

appreciation is regarded as axiomatic by most. account- [

ants.”’28

Clearly, increase in value does not necessarily reflect. over-

depreciation. And it is equally clear that the sale or other

disposition of depreciable property at a profit does not neces-

, sarily reflect over-depreciation. “The treatment of the prop-

erty account in the case of a sale should conform precisely to

the treatment required in the case of any retirement. .. .

The amount in the depreciation allowance applicable to the

particular unit retired should be charged off, and the balance

Nt Altay OD

23MONTGOMERY at 273.

24See note 35 infra and accompanying text.

25 Ibid. }

26Sa.iers at 71.

271d. at 46-47.

28Paton at 718.

a—

should be treated as a special profit . . . item.”** If, for

example, a machine having a cost of $1,100, a 10-year esti-

mated “useful life” and an estimated “salvage value” of $100

is retired at the end of the ninth year, nine full years’ depre-

ciation ($900) should be charged.*° The profit or loss upon

retirement should be reflected in a “special profit or special

loss account” rather than in the depreciation account, so that

it “can be excluded from the current expense and revenue

data.”*? Some modification of this treatment of retirements

might be justified only “where the loss or profit appears to be

due to the understatement or overstatement of depreciation

throughout the elapsed life rather than to some current

and unusual development.’’*?

These principles have peculiar force with respect to dis-

positions in the middle of the estimated “useful life’, where

the sale price may reflect increased earning capacity.

“[P ]otential excess of earning capacity may be represented

in the accounts . . . when a business is ... sold. ...

But this has nothing to do with accounting for deprecia-

tion,”

Accounting authorities recognize that the annual charge

for depreciation cannot accurately be measured in terms of

a year’s actual exhaustion, wear, tear, and obsolescence,

since, in the usual case, the monetary impact of these factors,

either alone or in combination, cannot for a given year be

291d. at 685.

30[d. at 742. The author also notes the Internal Revenue Service practice of

requiring calculation of depreciation to the day of retirement. Id. at 773.

31]d, at 777.

821 bid.

83Dewinc at 581 n. mmm. Italics supplied.

— a . — wavs meni

expressed with reasonable certainty.** Thus, these author-

ities, recognizing that an asset in fact deteriorates with use

and the passage of time, hold that the cost of the asset (less

its estimated “salvage value”) must be allocated over its

estimated “useful life,” in the expectation that the portion

of the cost allocated to and charged against income for a par-

ticular year will, as nearly as possible, approximate the av-

erage monetary impact on the business of physical and func-

tional deterioration for that year. Accordingly, the well-

established accounting concept of depreciation is expressed

as follows:

Depreciation accounting is a systein of accounting which

aims to distribute the cost or other basic value of tan-

gible capital assets, less salvage (if any), over the esti-

mated useful life of the unit (which may be a group of

assets) in a systematic and rational manner. It is a

process of allocation, not of valuation. Depreciation for

the year is the portion of the total charge under such a

system that is allocated to the year. Although the allo-

cation may properly take into account occurrenves dur-

ing the year, it is not intenled to be a measurement of

the effect of all such occurrences.*®

34See Accounting Terminology Bulletin No. 1, {54 (Committee on Terminol-

ogy, American Institute of Certified Public Accountants, 1953), republished

in Accounting Terminology Bulletin No. 1, Review and Resume, Account-

ING RESEARCH & TERMINOLOGY BuLLFtTins § 54, at 24-25 (American Insti-

tute of Certified Public Accountants, Final Ed. 1961).

35Accounting Terminology Bulletin No. 1, {56 (Committee on Terminology,

American Institute of Certified Public Accountants, 1953), republished in

Accounting Terminology Bulletin No. 1, Review and Resume, ACCOUNTING

REsEARCH & TERMINOLOGY BULLETINS § 56, at 25 (American Institute of

Certified Public Accountants, Final Ed. 1961); Finney & MrLLer, Priv-

CIPLES OF ACCOUNTING—INTERMEDIATE 440 (4th Ed. 1951); KaAreENBROCK

& Smons, INTERMEDIATE AccouNTING 315 (3d Ed. 1958); Montcomery.

Aupitinc 260 (7th Ed. 1949). Italics in original. For other authorities

recognizing an almost verbatim accounting principle, see, e.g... Cranstoun,

Tangible Fixed Assets, CONTEMPORARY ACCOUNTING 2, 5 (1945); CuRRENT

PRACTICE IN ACCOUNTING FOR DEPRECIATION: NATIONAL ASSOCIATION OF

AccounTANTsS ResEARCH Report 3-4 (1958); KENNEDY & McCuLLEN,

FINANCIAL STATEMENTS—ForM, ANALysis & INTERPRETATION 159 (4th Ed.

1962).

SEE TS SAYLES EGET ———

—_ es — -

The conclusion is clear. Under well-established accounting

principles which, as we shall see, have been embodied in the

basic statutory provision, and previously applied by this

Court, the sales price received by a taxpayer on the sale of

his depreciable assets is not an element in the determination

of the taxpayer’s deduction for depreciation for the year of

sale, regardless of the amount of the sale price, and the gain

(or loss) realized on the sale is accounted for separately.

The meaning of the term “depreciation” for income tax

purposes is plainly expressed in the basic statutory provi-

sion, Section 167(a) of the Internal Revenue Code of 1954,

which provides as follows:

(a) GENERAL RULE.—There shall be allowed as a

depreciation deduction a reasonable allowance for the

exhaustion, wear and tear (including a reasonable allow-

ance for obsolescence )—

(1) of property used in the trade or business, or

(2) of property held for the production of income.**

The present statutory language flows uninterruptedly*’

from the Revenue Act of 1918, which authorized deduction

of a “reasonable allowance for the exhaustion, wear and tear

of property used in the trade or business, including a reason-

able allowance for obsolescence.”** Allowing for minor varia-

tions in phraseology, the statutory deduction for deprecia-

tion dates back even further, to the origin of the modern in-

come tax in the Revenue Act of 1913, which gave individuals

a “reasonable allowance for the exhaustion, wear and tear

of property arising out of its use or employment in the busi-

38]talics supplied.

87INT. Rev. Cope or 1954, §167(a); Int. Rev. Code of 1939, §23(1); Rev.

Acts of 1934, 1936, and 1938, §23(1); Rev. Acts of 1928 and 1932, §23(k);

Rev. Acts of 1921, 1924, and 1926, §214(a)(8). Rev. Act of 1942, §121(c),

expanded the scope of this provision to include property held for the pro-

duction of income.

38Rev. Act of 1918, §214(a)(8).

ness” and corporations a “reasonable allowance for deprecia-

tion by use, wear and tear of property, if any”.*®

Neither Section 167(a) nor its legislative antecedents de-

fine depreciation in terms of valuation. On the contrary,

these statutory provisions take into account the obvious fact

that property deteriorates physically and functionally with

time and use and define depreciation as an allowance for “ex-

haustion, wear... tear . . . [and] obsolescence.” Each

year, twelve months’ worth of “exhaustion, wear and tear”

is totalled up. This is the price the taxpayer pays for own-

ing and using property in his trade or business. This occurs

regardless of the market value of the property. Whether that

value goes up or down, the elements do their work. More-

over, most property becomes obsolete at varying rates with

the passage of time, wholly apart from its physical deteriora-

tion.

What happens when a depreciable asset is sold in the

middle of a year for an amount in excess of its depreciated

basis at the beginning of the vear of sale? Does this mean

that the property has not sustained any “exhaustion, wear

and tear” during the year of sale? Does this mean that even

though the property was used during the year prior to its

sale and was somewhat older than it was at the beginning of

the year the elements as of the beginning of the year of sale

suddenly ceased to take their toll?) Of course it does not.

The asset has continued to depreciate and it always will. The

sale price received for the asset does not change the wear and

tear upon it.

The emphasis of this Court has been on the taxable year

as a unit, and depreciation is to be taken in each vear of the

depreciating asset's “useful life’. In Virginian Hotel Corp.

89Rev. Act of 1913, §§ ITB and TIG, respectively.

v. Helvering, 319 U.S, 523, 526, 528 (1943), this Court stated

thet:

Congress has elected to make the year the unit of taxa-

tion. . . . Thus the amount “allowable” must be taken

each year. . . . Congress has provided for deductions

of annual amounts of depreciation which, along with

salvage value, will replace the original investment of the

property at the time of its retirement.

Moreover, in Massey Motors, Inc, rv. United States, 364 U.S.

92, 104 (1960), and /lerts Corp. v. United States, 364 U.S.

122, 126 (1960), this Court recognized that “it is the primary

purpose of depreciation accounting to further the integrity of

periodic income statements. . Finally, in Detroit Edi-

son Co, v. Commissioner, 319 U.S, 98, 101 (1948), this Court

observed that “it is sound accounting practice annually to

”

accrue” an aliquot part of the total depreciation allowable

over the estimated “useful life” of the depreciating asset.

The effect of the decisions of the lower courts in this case

is to destroy the integrity of the periodic income statements

through offsetting allowable depreciation in the year of sale

against realized appreciation without giving to each class of

item the special recognition and treatment intended by the

tax statute.

In early cases interpreting the Corporation Excise Tax

Act of 1909, this Court announced that the statutory depre-

ciation allowance was for depreciation as “charged in prac-

tical bookkeeping.”** In the Court's view, Congress used the

expression “depreciation of property” (which in the 1909

statute was not given any definition similar to that provided

49This view, first discussed by this Court in Stratton’s Independence, Ltd. v.

Howbert, 231 U.S. 399, 423 (1913), was decisively adopted in Von Baum-

bach v. Sargent Land Co., 242 U.S. 508, 524 (1927).

. —

in 1913 and subsequent years*') in the tax statute in “its

ordinary and usual sense as understood by businessmen.”’*?

The Court added that it “is common knowledge that business

concerns usually keep a depreciation account, in which is

charged off the annual losses for wear and tear, the obso-

lescence of structures, machinery and personalty in use in

the business,” and reiterated that “Congress . . . used the

term ‘depreciation’ in its ordinary and usual significance.”**

This Court has more recently observed, in a case involving

the modern statutory language, that the connotations of the

income tax allowance for obsolescence are those of “account-

ing and engineering terminology.’** Since “depreciation is

fundamentally an accounting postulate,”** the accounting

authorities reviewed above are as relevant to this case as the

judicial and administrative precedents.

This Court, in interpreting the Revenue Act. of 1916*° in

United States v. Ludey, 274 U.S. 295 (1927), reviewed the

fundamental principles that control the income tax allow-

ance for depreciation. The Court observed that the depre-

ciation allowance “permitted as a deduction from the gross

income in determining the taxable income for any year rep-

resents the reduction, during the year, of the capital assets

through wear and tear of the plant used.’*? The measure of

41Corp. Excise Tax Act of 1909, §38 (Second), permitted deduction of a “rea-

sonable allowance for depreciation of property, if any.”

42Von Baumbach v. Sargent Land Co., 242 U.S. 503, 524 (1927).

43]d. at 524-25.

44Real Estate Title Co. v. United States, 309 U.S. 13, 16 (1940).

45Dewinc at 535 n. a.

46The 1916 Act authorized deduction of “a reasonable allowance for the ex-

haustion, wear and tear of property arising out of its use or employment in

the business or trade.” Rev. Act of 1916, §§5(a) (Seventh) and 12(a)

(Second ).

47274 U.S. at 300.

DON Seip NOI Sy gE : SUSE I ————

—— —_ =

this allowance “is the sum which should be set aside for the

taxable year, in order that, at the end of the useful life of

the plant in the business, the aggregate of the sums set aside

will (with salvage value) suffice to provide an amount equal

to the original cost.”** Mr. Justice Brandies then neatly sum-

marized the concept on which depreciation accounting rests:

. . . The theory underlying this allowance for deprecia-

tion is that by using up the plant a gradual sale is made

of it. The depreciation charged is the measure of the

cost of the part which has been sold. When the plant is

disposed of after years of use, the thing then sold is not

the whole thing originally acquired. The amount of the

depreciation must be deducted from the original cost of

the whole in order to determine the cost of that disposed

of in the final sale of the properties.*®

See also Detroit Edison Co. v. Commissioner, 319 U.S. 98,

101 (1943).

It was not until 1960 that this Court had the occasion to

analyze the concepts of “useful life” and “salvage value” in

terms of the depreciation formula first enunciated by the

Court in Ludey. In that year the Court handed down its de-

cisions in Massey Motors, Inc. v. United States, (decided

with Commissioner v. Evans) , 364 U.S. 92 (1960), and Hertz

Corp. v. United States, 364 U.S. 122 (1960). The Massey and

Hertz decisions determined the depreciation allowable to tax-

payers whose past experience had clearly indicated a consist-

ent utilization of assets for a substantially shorter period

than their full physical or economic life. The two decisions

covered five fact situations, all involving depreciation of new

automobiles.

In each of the five fact situations, the automobiles were

regularly sold long before the end of their full physical or

481d. at 300-01.

491d. at 301.

‘ na wae

economic life. They were sold after the described limited use

because demands by customers or other users for later models

rendered unsuitable the continued use of the older models in

the taxpayers’ businesses. In each case the resale price regu-

larly obtainable at the end of such limited use was substan-

tial.

The issue before this Court in the Massey and Hertz cases

was the proper estimated “useful life’ and “salvage value”

to be used under such circumstances in computing deprecia-

tion on the automobiles from the outset of their use. The

taxpayers claimed depreciation on their tax returns on the

basis of a “useful life” measured by the “estimated physical

life” of the automobiles and on the basis of no “salvage

value” at the expiration of such period. The Government, on

the other hand, defined the term “useful life” for purposes

of computing depreciation on the automobiles as “the period

during which the taxpayer anticipates actually retaining

the” automobile in the business."°

This Court upheld the Government’s position and held

that the “useful life” of the automobiles for depreciation pur-

poses was the period of their reasonably expected use in the

business, as shown by the taxpayers’ prior experience with

similar automobiles, rather than the full economic or physi-

cal life of the automobiles, because the automobiles were “not

acquired with intent to be employed in the business for their

full economic life.”*' The Court made it clear that the intent

not to use assets in the business for their full economie life

could be inferred from the practice of the taxpayers of con-

sistently selling such assets prior to the end of such economic

life, when it stated that “It is this type of asset, where the

erperience of the tarpayer clearly indicates a utilization of

50364 U.S. at 109. Italics’ supplied.

‘17d. at 96-97, 105, 107.

the assets for a substantially shorter period than its full

economic life, that we are concerned with in these cases.’®*

In terms of “useful life’ for depreciation purposes, the

Court made it clear that its holding was expressly limited

by the definition of “useful life’ urged by the Government

to a situation where assets are acquired “with intent” that

such assets will be “employed in the business” for a period

less than the full economic life of such assets and where such

intent can be inferred from the consistent practice of the

taxpayer of selling such assets substantially prior to the end

of their full economic life. For the Government contended,

and the Supreme Court agreed, that “useful life’ means “the

period during which the taxpayer anticipates actually re-

taining the assets” in the business.®*

Consistently with its holding on the issue of “useful life,”

this Court also held that the “salvage value” of the automo-

biles was the amount which could be expected to be obtained

by the taxpayers on resale when the automobiles were no

longer useful as rental or company cars. This Court said

that Congress “intended that the taxpayer should, under the

allowance for depreciation, recover only the cost of the as-

set less the estimated salvage, resale or second-hand value”

and that “salvage value must include estimated resale or

second-hand value.’** We believe it is clear that the Court

was thus discussing the estimation of “salvage value” for a

new asset; its use of the words “estimated . . . resale or

second-hand value” appears to convey the Court’s view that

521d. at 96-97. Italics supplied.

‘81d. at 109. See also The Motorlease Corp. v. United States, 215 F. Supp.

356, 360 (D. Conn. 1963), rev'd, 334 F.2d 617 (2d Cir. 1964), petition for

cert. filed (No. 685, 1964 Term; renumbered No. 24, 1965 Term); Andrew

J. Easter, 23 CCH Tax Ct. Mem. 413, 417 (1964); Katherine Slider, 20

CCH Tax Ct. Mem. 1327, 1329 (1961); John W. Roddy, 20 CCH Tax Ct.

Mem. 1129, 1131 (1961).

54364 U.S. at 107. Italics supplied.

“salvage value” should not be set at scrap value where the

taxpayer's habitual past practice has been to resell the as-

sets for substantial sums for further use. It appears from

the Court’s opinion in Massey that the Court fixed the “sal-

vage value” of the rental and company cars as the resale

price which it might be anticipated would be obtainable at

the end of the properly estimated “useful life” of the cars

when the cars were no longer useful as rental or company

pan

The Court noted in Massey that the traditional accounting

formula for depreciation had had the Court’s approval since

United States v. Ludey.** Indeed, the Court built its Massey

and Hertz opinions upon the depreciation formula of the

Iadey case. The Massey and Hertz opinions do nothing more

than refine that formula by making it clear that “useful life”

and “salvage value” of newly-acquired assets must be re-

lated, where possible, to the taxpayer's past experience with

respect to similar assets.

Thus, the depreciation formula adopted and refined by this

Court is clear: The allocable sum is original cost less the

amount which the taxpayer estimates at the time of acquisi-

tion will be the value of the property at the end of its esti-

mated “useful life,” and the rate of allocation is the period

for which the taxpayer, again at the time of acquisition, rea-

sonably anticipates the property will be useful in the busi-

ness.

If this Court were to approve the contentions of the re-

spondent the results in many cases would be highly mechani-

eal and arbitrary. For example, a taxpayer on a calendar

vear basis who negotiates and completes a sale of depreciable

property in January would suffer little or no penalty com-

pared to that he would have suffered if he had negotiated and

‘3Id. at 104,

completed the sale in the previous December. In the former

case, the depreciation disallowed would be that attributed

to a fraction of a month, and in the latter case it would be

the depreciation attributed to 11 and a fraction months. And

if two depreciable assets are sold, one at a profit and one at a

loss, depreciation would be disallowed on the profitable sale

and allowed on the loss sale thus decreasing the gain and

leaving the loss unchanged, despite the fact that Congress, ‘1

Section 1231(a) of the 1954 Code, has made special provision

requiring taxpayers to offset net losses against net gains in

computing gains or losses recognizable under that provision.

C. The lower courts in this case misinterpreted two decisions of

this Court and a decision of the Court of Appeals for the Sixth

Circuit.

The Tax Court in this case concluded that the “old, well

established rules relating to depreciation allowances” had

been discarded by this Court in Massey and Hertz and by the

Court of Appeals for the Sixth Circuit in Cohn v. United

States, 259 F.2d 371 (6th Cir. 1958) ,5* and a majority of the

Court of Appeals concluded that respondent’s new theory,

while admittedly “logically inconsistent”,®*’ was “strongly

suggested”®* and “adequately supported’*® by the Cohn de-

cision, although it conceded that the Cohn decision “could

have been more explicit”.

It is obvious that the problem before this Court in Massey

and Hertz had absolutely nothing to do with a subsequent

redetermination of “salvage value” upon sale in the middle

of “useful life’. But respondent apparently views this

Court’s decisions in those cases as supporting his new theory

that “useful life” is the period of actual use and that “sal-

vage value” is sale price whenever obtained. However, in

those cases the Government urged, and the Court agreed,

that “useful life’ means “the period during which the tax-

payer anticipates actually retaining the assets” in the busi-

ness.** This view, in complete negation of respemdent’s new

“actual use” theory in determining “useful life’,®? was re-

iterated in the opinion written in dissent in Massey and in

concurrence in Hertz:

“In examining the cases, it must be borne in mind that

even the Commissioner does not contend that a taxpayer

who happens to dispose of some asset before its physical

exhaustion must depreciate it on a useful life equal to

the time it was actually held. It is only when the asset

“may reasonably be expected” to be disposed of prior

to the end of its physical life that the taxpayer must

base depreciation on the shorter period. Reg. Section

1.167(a)-1(b). Therefore, the only cases relevant in this

regard are those in which the taxpayer’s past experience |

indicated that. assets would be disposed of prior to be-

coming junk, thus presenting the issue whether the short-

er or longer period should control for purposes of de-

preciation.™

Furthermore, it is equally clear that in Massey and Hertz

the Court did not hold that “salvage value” is conclusively

61364 U.S. at 109.

®2]t is worth noting that respondent himself did not initially interpret. this x

Court’s decision in Masseu to equate “useful life” with actual use. In John

W. Roddy, 20 CCH Tax Ct. Mem. 1129 (1961), respondent contended, and

the Tax Court agreed, that this Court’s decision in Massey supported re-

spondent’s determination that the taxpayer’s depreciation deductions with

respect to a total of 623 automobiles sold in 1953, 1954, and 1955 should be

computed on the basis of an estimated “useful life” for 18 months, even

though the taxpayer’s actual holding periods for the automobiles sold ranged

from 3 months to 43 months.

63364 U.S. at 113. Italics in original.

———

fixed by sale price whenever obtained. The Government did

not even argue such a proposition in either case. Indeed, in

calculating the tax deficiencies of one of the two taxpayers

involved in the Massey decision,** respondent used an esti-

mated “salvage value” of $1,325 for 140 automobiles sold in

the same year for $1,380, thereby permitting the automobiles

to be depreciated during the year of sale to levels beneath the

sales prices received for them. The minor dollar point as-

sumed or conceded by respondent in Massey now becomes

the sole issue in this case, but clearly the Court in Massey

did not state or even hint at agreement with respondent’s

present position, This Court, not having been faced in Mas-

sey and Hertz with the unanticipated sale of an asset sub-

stantially prior to the expiration of its properly estimated

“useful life”, could not possibly have passed on the issue

here. It is clear from the Court's opinion in Massey that it

fixed the “salvage value” of the automobiles as the resale

price which it might reasonably be anticipated at the time

of acquisition would be obtainable at the end of the properly

estimated “uv ful life” of the automobiles when they were no

longer usefv! in the business, and not the amount which

might be received on a sale at a prior time.

It is clear that the decision of the Sixth Circuit in Cohn rv.

United States, 259 F.2d 371 (6th Cir. 1958), neither departed

from the “old, well established rules relating to depreciation

allowances” nor supports the opinions of the lower courts in

this case. In Cohn, the taxpayers commenced the operation

of three flying schools for the Army Air Corps in 1941. In

1942 taxpayers reconsidered the “useful life” of its assets,

and in the taxpayers’ return for 1942 it was asserted that

“useful life” would terminate on December 31, 1944, and ad-

84Evans v. Commissioner, 264 F.2d 502 (9th Cir. 1959). rev'd sub nom.,

Massey Motors, Inc. v. United States, 364 U.S. 92 (1960),

ditional depreciation was claimed in returns for the years

1942, 1943 and 1944 on that basis. The taxpayers in their

returns did not take “salvage value” into account, although

operators of similar schools customarily computed deprecia-

tion on the basis of an estimated “salvage value” equal to 10

percent of original cost. Respondent set up deficiencies for

1942, 1943 and 1944 by lengthening the estimates of “useful

life” but without requiring the taxpayers to take “salvage

value” into account. The district court upheld the taxpayers’

revised estimates of “useful life” as claimed in their returns,

but it also held that in computing depreciation for the year

of sale the taxpayers should use a “salvage value” equal to

the sale prices received when the assets were sold in 1944.

The taxpayers appealed the latter determination to the Sixth

Circuit.

In the light of these facts, the scope and meaning of the de-

cision of the Sixth Circuit in Cohn are readily discernible:

“salvage value” could be redetermined because, at the tax-

payers’ insistence, the “useful life’ had been redetermined.

The following passage from the brief which the Government

filed with the Sixth Circuit in that case makes this at once

apparent:

“Here, tarpayers sought an adjustment of their deprecia-

tion deduction to correct an error in their estimate of

the useful lives of the assets in question and the court

made this correction in their favor. At the same time,

however, taxpayers seek to cut off any adjustment of an

obvious error in their estimate of salvage value. Surely,

when the correctness of the amount of a depreciation de-

duction for a particular year or years is placed in issue,

the Commissioner and the Courts are not precluded from

looking to all of the factors involved in the computa-

tion of the deduction in order to make any adjustment

necessary to reach the correct amount of depreciation

for that, and future, years. Taxpayers’ contention seeks

to obtain an adjustment only insofar as it aids them and

TAGES Danie mcs

————————

to preclude an adjustment in the Commissioner’s favor,

thereby preventing the court from determining the cor-

rect amount of the deduction. If tarpayers can adjust

the length of the assets’ estimated useful lives to fit the

realities of the situation, no logical reason presents it-

self as to why the Government and the court cannot do

the same with respect to estimated salvage value. . . .

Although the cited Regulations (Section 1.167(a)-1(c),

promulgated under the Internal Revenue Code of 1954),

state that salvage value may not be changed merely be-

cause of a change in price levels, they also provide that,

if there is a redetermination of useful life, the salvage

value may be redetermined, based upon facts known at

the time the useful life is redetermined and, further-

more, they provide that in no event shall the asset be

depreciated below a reasonable salvage value. That is

precisely the rule of this case; the useful life was rede-

termined by the court, and at the time, the salvage value

was redetermined in light of the facts known at the end

of the tax year involved; upon this redetermination,

the court disallowed any depreciation in excess of the

reasonable salvage value found by it.®

Presumably in response to the above statement by counsel

for the Government, the Sixth Circuit stated :

But the Government is not contending that salvage

value should be adjusted annually in order to conform

with current market values, or that it should be ad-

justed at all on account of “mere fluctuation in market

value”. In so far as this case is concerned the issue is

whether salvage value can be adjusted at or near the end

of the useful life of the asset when it is shown by an

actual sale of the asset that there is a substantial dif-

65Brief for the Appellee, pp. 24-26, in Cohn v. United States. 259 F.2d 371

(6th Cir. 1958). Italics supplied. In addition to the remarks contained in

the passage of the Government’s brief quoted above, the Government also

argued that “the District Court did no more than find that the reasonably

estimable salvage value was, on the facts of this case, equal to the amounts

actually received on the sale of the assets involved”, and expressly recog-

nized that the district court’s “finding was solely predicated on the facts of

this case and, on a different set of facts, it is. of course, possible that an en-

tirely different finding would result.” Brief for the Appellee, p. 32, in Cohn

v. United States, supra.

neal

ference between what was estimated and what it actual-

ly is. We are not concerned with mere fluctuations or

with any fluctuations from year to year. On the con-

trary, we have a single and final adjustment in the clos-

ing of the books on the asset involved. Under such cir-

cumstances the practical difficulties urged upon us are

largely nonexistent.®*

The Sixth Circuit reviewed the “well settled principles

governing depreciation deductions.” “Useful life”, said the

Court, “is the period over which the assets may reasonably

be expected to be useful to the taxpayer in his trade or busi-

ness”; because the “property may still have some value when

it has completed its usefulness to the business, which will be

realized by the taxpayer by its sale at the end of its useful

life, it is necessary that this salvage value be deducted from

the cost in order to find the net amount which is to be amor-

tized over the years the property is to be used in the busi-

ness”; and “useful life” and “salvage value” are necessarily

estimates “made at the time when the property is first put

to its business use.”’*

The Sixth Circuit, after reviewing these settled principles,

then considered taxpayers’ “fundamental contention” that

“salvage value”, having been determined at the time of ac-

quisition, cannot be redetermined at any time thereafter.

The Sixth Circuit decided that the district court could change

“salvage value” because it had redetermined “useful life”,

and then restated and adopted the argument made in the

Government's brief. Acknowledging that, in appropriate

circumstances under the rule in Section 1.167(a)-1(c) of

the Treasury Regulations, depreciation based on estimates of

“useful life’ and “salvage value” could “be reconsidered

through a redetermination of useful life,” and that “at least

66959 F.2d at $78. Italics supplied.

871d. at 377.

{

at the same time, a reconsideration and redetermination of

salvage value” could be made,** the Court of Appeals con-

cluded that:

Appellants, in filing their actions in the District Court,

put in issue the depreciation deductions claimed by them

and disallowed by the Commissioner. In deciding that

issue under the circumstances of this case, we are of the

opinion that the District Judge was not in error as a

matter in law in considering both useful life and salvage

value. If so, his findings of fact with respect to salvage

value are fully supported by the evidence, are not clearly

erroneous, and must be sustained.®

For respondent now to seize the Cohn decision and seek to

transform what plainly was a narrow finding of fact into an

absolute and sweeping rule of law is obviously unjustified.

His reliance on the Cohn case recuires him to equate “sal-

vage value” at the end of originally estimated “useful life”

with actual sale price at mid-life. Respondent thus assumes

his conclusion, a conclusion not justified by the holding of

the case itself. Under the circumstances in Cohn, viz., a rede-

termination of “useful life’ and a sale at or near the end of

such “useful life”, the court’s treatment of the proceeds of

such sale as “salvage value” provides no support for the prop-

osition that sale price, irrespective of when obtained, neces-

sarily equals “salvage value”. The equivalence of these two

concepts, which a majority of the Court of Appeals in this

case erroneously considered to be “strongly suggested” and

“adequately supported” by Cohn, remains respondent's un-

supported assumption, and in view of the holding of the

Sixth Circuit, narrowed in accordance with the Government's

own urging, this supposed equivalence appears to be an er-

ratic afterthought on the part of respondent.

®8]d. at 378. Italics supplied.

897d. at 379. Italics supplied.

- —_

It seems clear that the courts in the Cohn case would not

have permitted a redetermination of “salvage value” which

(a) did not occur at or near the end of the “useful life” of

the asset, and (b) was not made under circumstances in

which a redetermination of “useful life’ was permitted.

While it might be argued that the district court in the Cohn

case should have redetermined “salvage value” in the light of

the facts known in 1942 when “useful life” was redetermined

and without regard to the facts known in 1944, this error (if

it be one) obviously does not have any application to the

facts in this case where the sale was made at mid-life, and

neither petitioner nor respondent had sought or are seeking

a redetermination of “useful life’. In the light of this com-

ment, the holding of the Sixth Circuit in Cohn as quoted

above is particularly pertinent in that the Court of Appeals

held that the district judge was not in error as a matter of

law in considering both “useful life’ and “salvage value”.

Having made this holding, the determination of the precise

“salvage value” was clearly a fact question and, as stated by

the Sixth Circuit, the value found by the district court was

not clearly erroneous and must be sustained.

The essence of petitioner's position in this case is that in

the facts of this case “useful life’ and therefore “salvage

value”, as a matter of law, mav not be redetermined, and

therefore the Tax Court should never have reached the fact

question as to what the “salvage value” of the Feuer was at

the time of sale. If it be assumed that contrary to all of the

principles recognized by accounting authorities and the

courts, the lower courts in this case can redetermine “useful

life” and “salvage value” because of the sale, it does not fol-

low that the sale price ‘st mid-life) is trustworthy evidence

of “salvage value”, inasmuch as the sale price in this case

was not received at or near the time as of which “salvage

value” is to be estimated, riz., at the end of estimated “useful

life”.

OE OS Sas a ee

D. The Treasury Regulations are entirely consistent with well-

established principles of depreciation accounting and were

misinterpreted by the lower courts in this case.

The Treasury Regulations promulgated under Section 167

(a) simply mirror the well-established accounting concepts

of depreciation accounting and adopt the depreciation formu-

la of the Ludey case as refined by this Court in Massey and

Hertz. The pertinent provisions of these regulations are re-

printed in the Appendix. It will suffice here to summarize

the thrust of these provisions. In Section 1.167(a)-1(a) the

purpose of the depreciation allowance is expressly recognized

to be to provide “for the erhaustion, wear and tear, and ob-

solescence of property used in the trade or business or of

property held by the taxpayer for the production of in-

come”” and it is stated that “the allowance is that amount

which should be set aside for the taxable year . . . so that

the aggregate of the amounts set aside, plus the salvage value,

| will, at the end of the estimated useful life of the depreciable

property, equal the cost or other basis of the property”.”

For this purpose, Section 1.167(a)-1(b) of the regulations

defines estimated “useful life” of an asset as “the period over

7°[talics supplied. Respondent’s interpretation of the term “depreciation” for

income tax purposes as physical and functional deterioration of property, as

opposed to a reduction in value, finds ample precedent on the first page of

respondent’s Bulletin “F” (as revised in January, 1942):

_ . . The production of net income usually involves the use of capital

assets, which wear out, become exhausted, or are consumed in such use.

The wearing out, exhaustion, or consumption usually is gradual, extend-

ing over a period of years. It is ordinarily called depreciation, and the

period over which it extends is the normal useful life of the asset.

[Italics supplied.]

71Italics supplied. The depreciation formula set forth in the quoted portion of

respondent’s regulations clearly recognies depreciation accounting as a

process of cost allocation, not of asset valuation, and respondent has made

his position in this respect crystal clear in Rev. Proc. 62-21 (Part IT), 1962-2

Cum. Bull. 418, 429, where he stated:

. The purpose of the allowane ‘for depreciation] is to permit tax-

payers to recover through annual deductions the cost (or other basis)

of the property over its useful economic life.

which the asset may reasonably be expected to be useful to

the taxpayer in his trade or business”."? In determining his

reasonable expectation of use of depreciable property, the

taxpayer is specifically required by Section 1.167(a)-1(b)

to consider, inter alia, “wear and tear and decay or decline

from natural causes”, “the normal progress of the art, eco-

nomic changes, inventions and current developments with-

in the industry and the taxpayer’s trade or business,” and

the taxpayer’s experience with similar property. Finally,

Section 1.167(a)-1(c) defines “salvage value” as “the amount

(determined at the time of acquisition) which is estimated

will be realizable upon sale or other disposition of an as-

set”? at the end of its estimated “useful life”.

Section 1.167(a)-1(c) makes three things clear. First,

“salvage value” means the anticipated value (“determined at

the time of acquisition”) of an asset at the end of its an-

ticipated “useful life’, also estimated at the time of acquisi-

tion, and is thereafter to be redetermined only in extraordi-

nary circumstances. Secondly, in a negative manner, the reg-

ulations make it clear that a fluetnation in price levels does

not constitute such a circumstance by stating that “salvage

value” is not to be redetermined merely because of changes

in price levels. In other words, a taxpayer may not increase

his annual depreciation deductions to reflect a drop in price

levels resulting in a lower estimated “salvage value”.™ In

fact, this is expressly forbidden in Section 1.167(a)-1(a) of

the regulations where it is stated that the annual “allowance

T2Italics supplied.

T8Italics supplied.

7™4The law is clearly established at the insistence of the Internal Revenue Serv-

ice that if depreciable assets are sold at a loss, the depreciation deduction is

not increased to the extent of the loss. Engineers Ltd. Pipeline Co., 44 T.C.

_. No, 25, CCH Tax Ct. Rep., Dec, 27.411 (May 28, 1965); Thos. Gog-

gan & Bro., 45 B.T.A. 218, 224, 225 (1941). See also Rev. Rul. 62-92,

1962-1 Cum. Butt. 29.

arr ore — 1 Ty See _—

[for depreciation] shall not reflect amounts representing a

mere reduction in market value.” It follows, of course, that

the annual allowance for depreciation cannot reflect amounts

representing a mere increase in market value, yet this is pre-

cisely the position of a majority of the Court of Appeals and

of respondent. If mere changes in market value do not affect

the determination of the annual allowance for depreciation,

the added fact that the change in market value is proved by

a sale rather than by some other means should be immaterial.

Thirdly, and finally, the regulations state positively that “if

there is a redetermination of useful life’ under the rules con-

tained in Section 1.167(a)-1(b), “salvage value” may be

redetermined on the basis of “facts known to exist at the

time of such redetermination of useful life.”

Plainly, therefore, once “salvage value” is estimated at the

time of acquisition, subsequent events become relevant to

justify a change in the originally estimated “salvage value”

only in connection with a redetermination of “useful life”,

and a change in originally estimated “salvage value” is quite

clearly forbidden under any other circumstances.

The parenthetical emphasis in Section 1.167(a)-1(c) upon

the time when “salvage value” must be determined and the

statements as to when it may and may not be redetermined

are strengthened when viewed in historical perspective. The

originally proposed depreciation regulations under the In-

ternal Revenue Code of 1954, published on September 28,

1954,"° were followed by the second propoved regulations on

November 11, 1955," and thereafter by those finally adopted

on June 11, 1956." Significantly, neither the parenthetical

statement nor the other italicized portions of Section 1.167

™19 Fed. Reg. 6229 (1954).

7620 Fed. Reg. 8454 (1955).

TT.D. 6182, 1956-1 Cum. Butt. 98, 21 Fed. Reg. 3985 (1956).

sanmancn i

(a)-L(e) set forth in the Appendix, as finally adopted, ap-

peared in the earlier proposals. It would be hard to find

more explicit evidence of the Treasury's opinion that “sal.

vage value” must be estimated at the time of acquisition and

that “salvage value” thus estimated cannot thereafter be re-

determined except in connection with a redetermination of

originally estimated “useful life”.

It is apparent from the foregoing that the estimated “sal-

vage value” of a depreciable asset cannot be redetermined

unless there is some “clear and convincing basis” for rede.

termining the originally estimated “useful life” of the asset

in accordance with the rules contained in Section 1.167(a)-

1(b). Nothing contained in Section 1.167(a)-1(b) justifies

the conclusion that the sale of a depreciable asset in and of

itself constitutes a factor to be considered in determining

“useful life” of the asset sold. It is true that the regulation

purports to set forth merely “some of the factors” to be con-

sidered in making such a determination, but it is significant

that the sale of an asset is not listed among the factors to

be considered. The majority of the Court of Appeals in this

case did not discuss or even cite Section 1.167(a)-1(b) or

Section 1.167(a)-1(c) of the regulations.

The Tax Court in this case quoted™ the portion of Section

1.167(a)-l(c¢) which states that an “asset shall not be de-

preciated below a ieasonable salvage value”, and it appar-

ently accepted respondent's argument that, assuming the cor-

rectness of respondent's equivalence of “actual sales price”

and “salvage value”, this provision alone barred petitioner's

claimed deduction for depreciation in the year of sale. The

assumed equivalence of “actual sale price” and “salvage

value” where the sale occurs at mid-life seems such an ob-

vious distortion of the use of words and such a disregard for

TR. 18.

the obvious fact that the value at the time of sale has no rela-

tion to the value some time later at the end of the estimated

“useful life’, that it seems absurd to argue the point. In

8S € A Co, v, United States, 218 F. Supp. 677, 684 (D. Minn,

1963), aff'd, 388 F.2d 629, G40 (Sth Cir, 1964), petition for

cert. filed (No. 862, 1964 Term; renumbered No. 50, 1965

Term), both the district court and the Court of Appeals for

the Eighth Circuit flatly rejected this assumed equivalence

’ or identity of “actual saie price” and “salvage value”.

A similar flaw is present in the Court of Appeal’s use™ of

the statemeiit in Section 1.167(b)-0(a) of the regulations

that the “reasonableness of any claim for depreciation shall

be determined upon the basis of conditions known to exist at

the end of the period for which the return is made.” The

majority expressed its conclusion that this provision entitled

respondent to substitute a “known” sale price for a previous:

ly estimated “salvage value”.“° However, this conclusion is

i valid only if it be assumed that the proceeds of an unantici-

pated sale of depreciable assets, which sale takes place well

before the termination of the “useful life” of those assets in

the business, constitute the “salvage value” of such assets.

By permitting respondent to assume the point he was re-

quired to demonstrate, the Court of Appeals accepted re

spondent’s contention that when an asset is sold the “salvage

value” becomes “known” and can be substituted for a “less

reliable” previous estimate, Such a substitution wonld be

proper, however, only if the automatic equivalence of sale

price and “salvage value” were established,

The Treasury Regulations, therefore, far from establishing

the equivalence of “salvage value” and actual sale price when-

TYR, 80-81,

SOR. 81.

ever obtained, all reflect the traditional view of depreciation

established by over 40 years of judicial and administrative

authority. “Useful life”, it will be recalled, is defined as “the

period over which the asset may reasonably be expected to

be useful to the taxpayer in his trade or business or in the

production of his income,” and not, as respondent and a ma-

jority of the Court of Appeals apparently would have it, as

“the period over which the asset may reasonably be expected

to be useful to the taxpayer or the period during which it is

actually held by the tarpayer, whichever is less.” “Salvage

value” is defined as “the amount (determined at the time of

acquisition) which is estimated will be realizable upon sale

of other disposi ‘ion of an asset when it is no longer useful in

the taxpayer’s trade or busiuess . . . and is to be retired

from service by the taxpayer.” It is not defined as “the

amount (determined at the time of acquisition} which is

estimated will be realizable upon sale . . . of an asset when

it is no longer useful . . . or the amount which is actually

realized on sale at any time, whichever is greater.”

E. The majority of the Court of Appeals ignored the relationship

between depreciation, on the one hand, and gain or loss on

sale, on the other hand, and the clearly-defined dichotomy be-

tween these concepts which is expressed in the tax statute and

in the Treasury Regulations and which has been recognized in

long-standing judicial precedents and administrative practice.

The accounting authorities discussed above recognize a

clearly-defined dichotomy between depreciation of an asset

during its period of use in the business and the realization of

gain or loss on the subsequent disposition of the asset. The

dichotomy, ignored by the majority of the Court of Appeals

in this case, is firmly imbedded in the basic statutory provi-

sion.

The statutory provisions of the 1954 Code relating to the

LE LATIMER THOT I SPEEA EEN ELI RI Fatt RAS __-

—

determination of gains and losses on property (Sections 1001

and 1002) require downward adjustments in basis for depre-

ciation allowed or allowable (Sections 1011 snd 1016(a)

(2)).** Therefore the gain taxed on a profitable sale is in-

creased to the extent of any depreciation deductions allowed

for periods prior to the date of sale.

Section 167 of the Code was intended to require and in

fact requires only an accounting for an allocation of depre-

ciation during the period an asset is used in the trade of

business, and Section 1231 of the Code was intended to deal

with the method of taxing gain or loss (determined in ac-

cordance with Sections 1001, 1002, 1011 and 1016(a)(2))

resulting from market fluctuations on the subsequent disposi-

tion of the asset. Surely, both respondent and a majority of

the Court of Appeals would accept the proposition that (ex-

cept to the extent Section 1245 or Section 1250 now applies)

all gains or losses recognizable** on the disposition of depre-

ciable assets used in the trade or business for more than six

months are accountable for under Section 1231, and nowhere

else, including all gain resulting from the deduction for de-

preciation in years prior to the vear of sale in amounts in

81Section 1001(a) provides that “the gain from the sale or other disposition of

property shall be the excess of the umount realized therefrom over the ad-

justed basis provided in section 1011 for determining gain”; Section 1001

shall be determined under section 1002”; and section 1002 states that, ex-

cept to the extent otherwise provided, “the entire amount of the gain . . .

determined under section 1001, shall he recognized.” Section 1011 provides

that the adjusted basis for determining gain or loss shall be the basis “ad-

justed as provided in section 1016.” And section 1016(a)(2) requires that

basis be reduced “for exhaustion, wear and tear. obsolescence, amortization,

and depletion” previously allowed or allowable with respect to the asset sold.

Int. Rev. Cone or 1954, §§ 1001(a). 1001(c), 1002, 1011, and 1016(a)

(2).

*2Congress has not seen fit to provide for the “recognition” of all gains or losses

“realized” on the disposition of property. For example, where, as in this case,

a corporation adopts a plan of complete liquidation and within 12 months

thereafter distributes all of its assets in complete liquidation, the corporation

recognizes none of the gains and losses which it realizes on the disposition of

property within that 12-month period. Iwr. Rev. Cone or 1954, §337(a).

Phy REP EE I$ et

excess of the actual “exhaustion, wear ... tear... [and]

obsolescence” experienced with respect to the property. The

fact that Section 1231 provides a mechanics for adjusting or

compensating for such “excessive” depreciation in prior

years does not justify using a different method, viz., reduc-

tion of the depreciation allowance for the current year, for

adjusting and compensating either for year-of-sale deprecia-

tion (whether or not excessive) or for factors such as appre-

ciation in market value. On the contrary, the mere existence

of Section 1231 with its provisions for adjusting and correct-

ing for excessive depreciation and for reaching appreciation

in market value is some evidence that Congress intended that

all such items be reached by this device. This obviously does

not prevent correcting errors in depreciation for the year of

sale directly, but as already apparent it basically is the posi-

tion of taxpayers that the depreciation claimed in this case

in the year of sale does not involve any error for the year of

sale in that there was “exhaustion, wear ... tear ..

[or] obsolescence” in such year of sale reflected in the peti-

tioner’s acquisition-time estimates for “useful life” and “sal-

vage value” which are not questioned by the respondent.

It is noteworthy that Congress as a matter of policy has

allowed taxpayers to deduct depreciation in excess of an-

ticipated “exhaustion, wear . . . tear [and] . . . obso-

lescence” in numerous situations including first year depre-

ciation of 20 per cent (Section 167(b) (2), (3), and (4))

and accelerated depreciation (Section 179). In such cases it

would normally be expected that a sale of such assets at mid-

life would result in gain, and vet Congress at no time has

legislated to deny any part of the depreciation deduction.

Clearly the advantage to the taxpayer so specifically pro-

vided by Congress should not be taken away or lessened by

administrative action. As we shall see, when Congress final-

ly decided to recapture part or all of the advantage so

MARC NR Hees SS IT RAE AN NPR 9:5 PENA RE INA ERM FERMI? RAEN, AR OO

Ae Re ERE No

2) TRE!

— ———

granted to taxpayers it did so prospectively, specifically and

by adjusting the method of taxing the gain on the sale and

not by adjusting the deduction for depreciation.

Clearly, then, under the tax law two separate concepts

exist: (1) depreciation under Section 167 during the period

the asset is used in the business, a7.d (2) recognition of gain

or loss under Section 1231 upon disposition of the asset. As

noted, the depreciation allowance provided by Section 167

governs in the determination of the period of time over which

the taxpayer is permitted to allocate the cost of an asset in

the form of annual depreciatien deductions. Section 1.167

(a)-10(b) of the Treasury Regulations specifies in express

terms that this period of cost allocation “shall begin when

the asset is placed in service and shall end when the asset is

retired from service.” Of course an asset is “retired from

service” when if is sold. And in Section 1.167(a)-8(a) (1)

of the regulations it is stated that when a depreciable asset

is “retired from service” by sale, “recognition of gain or loss

will be subject to the provisions of Sections 1002, 1231, and

other applicable provisions of law.” Obviously, Section 167

is not one of the “other applicable provisions of law” to

which the provisions refers. The sharp dichotomy in the tax

law is therefore clearly recognized by respondent in his own

regulations.

The respondent’s unequivocal position a= stated in his

regulations that the period “ cost allocation “shall end when

the asset is retired from service” is entirely consistent with

his practice for over 40 vears of allowing depreciation to the

date of sale in the year of profitable sale. This practice is

amply reflected in long-standing judicial precedents and ad-

ministrative rulings, practice and acquiesyence.

In Eldorado Coal & Mining Co. vr. Mager, 255 U.S. 522

(1921), this Court sustained an assessment arrived at by

“subtracting depreciation and depletion to the date of sale”

————

of a coal mine in May, 1917, and computing profit on the

sale accordingly. Again, in United States v. Ludey, 274 U.S.

295 (1927), this Court upheld a determination of gain on the

sale of properties computed by deducting depreciation and

depletion from March 1, 1913, to the date of their sale in

February, 1917 and by making corresponding reductions in

the March 1, 1913, basis of the properties to the time of sale.

In both of these cases, respondent allowed depreciation on

property in the year of its profitable sale and, with the ap-

proval of this Court, adjusted the basis of the property for

such depreciation in determining the gain on the sale.

The position of the lower courts was just as clear, and they

too reflect respondent’s long-established practice of allowing

depreciation on property in the year of profitable sale. Beck-

ridge Corp. v. United States, 129 F.2d 318 (2d Cir. 1942) ;

Kittredge v. Commissioner, 88 F.2d 632 (2d Cir. 1937);

Clark Thread Co. v. Commissioner, 100 F.2d 257 (3d Cir.

1988) ; Hall v. United States, 43 F. Supp. 130 (Ct. C1.), cert.

denied, 316 U.S. 664 (1942) ; Franklin Lamber & Power Co.,

18 B.T.A. 1207 (1930), rev’d on other grounds, 50 F.2d 1059

(4th Cir. 1931); Maz Fichenberg, 16 B.T.A. 1368 (1929) ;

Louis Kalb, 15 B.T.A. 865 (1929); Parkersburg & Marietta

Sand Co., 11 B.T.A. 87 (1928); Seton Falls Realty Co., 6

B.T.A. 883 (1927) ; Island Line Shipping Co., 4 B.T.A. 1055

(1926) ; Capital City Invest. Co., 4 B.T.A. 933 (1926) ; Cot-

ton Concentration Co., 4 B.T.A. 121 (1926); Walter Frank,

2 B.T.A. 905 (1925); Marchetti Roma Cafe Co., 2 B.T.A. 529

(1925); W. W. Carter Co., 1 B.T.A. 849 (1925); Even

Realty Co., 1 B.T.A. 355 (1925); Grosvenor Atterbury, 1

B.T.A. 169 (1924). See also Thos. Goggan & Bro., 45 B.T.A.

218 (1941) ; Duncan-Homer Realty Co., 6 B.T.A. 730 (1927).

At the urging of respondent, the Board of Tax Appeals

expressly held in Herbert Simons, 19 B.T.A. 711 (1930), that

depreciation had to be computed by tie taxpayer in the vear

ile I ect AE

Sect

——

of the profitable sale of depreciable property. In Wier Long

Leaf Lumber Co., 9 T.C. 990, 999 (1947), acq., 1948-1 Cum.

BULL. 3 (withdrawn), nonacg. 1962-1 Cum. BULL. 5, aff’d and

rev'd on other issues, 173 F.2d 549 (5th Cir. 1949) (the auto-

mobile issue), the Tax Court again so held, this time at the

insistence of the taxpayer, in the only case up to that point

in which respondent had attempted to disallow depreciation

in the year of sale. Respondent promptly acquiesced in this

adverse decision.**

The Court of Appeals for the Eighth Circuit held, in For-

rester Box Co. v. Commissioner, 123 F.2d 225, 229 (8th Cir.

1941), that a taxpayer who sold machinery and equipment

on July 1, 1929, should have “an opportunity to show what

the allowable depreciation on the machinery and equipment

was from the time it acquired it up to July 1, 1929.” And

the Third Circuit earlier had held, in Rieck v. Heiner, 25

F.2d 453, 454 (3d Cir.), cert. denied, 277 U.S. 608 (1928),

that “in computing the gain from a sale of property a deduc-

tion of depreciation during the period of operation shall be

made.”

Respondent’s long-standing administrative practice was

completely consistent with his determinations reflected and

approved by the courts in the above cases. In 1920, in O.D.

753, 3 Cum. BuLL. 171 (1920), respondent ruled that the

sale of plants at a loss did not terminate their “useful life”

and did not permit an increased deduction for depreciation

for the year of sale. The ruling held that the loss sustained

should be deducted as a loss arising: from the sale. In 1922,

in I.T. 1158, I-1 Cum. BULL. 173 (1922), respondent ruled

83Respondent states in the front of every Internal Revenue Bulletin that deci-

sions so acquiesced in should be “relied upon” as “precedents to be used in

the disposition of other cases.” Acquiescence also furnishes taxpayers assur-

ance that they can rely upon the disposition of the issue “without the danger

of being forced to litigate the same question in their own cases.” Stockstrom

ov. Commissioner, 190 F.2d 283, 284 (D.C. Cir. 1951).

- —_

that depreciation on assets disposed of within any taxable

year should be computed for the period from the beginning

of the year of sale to the date of sale. Later in that year, in

I.T, 1494, I-2 Cum. BuLL. 19, 20-21 (1922), respondent ap-

proved depreciation of property to $40,000 in the year of sale

for $47,000, stating that “The real economic result of every

sale of depreciable property is obtained by comparing the

sale price with the cost, depreciated to the date of sale.” In

1924 (A.R.R. 6930, ITI-1 Cum. BuLL. 45 (1924) ) and again

in 1927 (G.C.M. 1597, VI-1 Cum. BULL. 71 (1927) ), respond-

ent approved depreciation in the year of profitable sale. And

in 1928, he published in VII-1 Cum. BULL. 200 (1928) the

decision of the Third Circuit in Rieck v. Heiner, supra.

In 1948, as pointed out above, respondent published in

1948-1 Cum. BULL. 3 his acquiescence in the decision of the

Tax Court in Wier Long Leaf Lumber Co., supra.

In 1951, in T.D. 5851, 1951-2 Cum. BULL. 638, respondent

amended the income tax regulations to conform them to Sec-

tion 117(g) of the Internal Revenue Code of 1939 which Con-

gress added to the 1939 Code in 1950. T.D. 5851 incorpo-

rated in respondent’s regulations (see 1951-2 Cum. BULL. at

73) an example contained in the Conference Report on the

Revenue Act of 1950 specifically illustrating the allowance

of $500 of depreciation in the year of sale of a facility at a

profit of $500. Subsequently, in 1957 respondent issued T D.

6253 1957-2 Cum. BuLL. 547, 562-68, which updated the ox-

ample as part of Section 1.1238-1 of respondent’s regulations

under the 1954 Code, and the example still was part of the

regulations until June 1, 1965, when respondent amended

the example in order to eliminate yvear-of-sale depreciation.

T.D. 6825, 1965 Int. Rev. Bull. No. 26, at 6, 30 Fed. Reg.

7281 (1965).

Respondent cannot argue (as erroneously stated by the

Eighth Circuit in United States r. S € A Co., 338 F.2d 629,

he AIRE =

eee ae

soneme

- *

Di eae way a vin ls 7.

633 (8th Cir. 1964), affirming 218 F. Supp. 677 (D. Minn.

1963), petition for cert. filed (No. 862, 1964 Term; renum-

bered No. 50, 1965 Term) ) that prior to 1942 the deduction

of depreciation in the year of sale was immaterial because

capital gains on the sale of depreciable property were taxed

in the same manner as other income. From 1921 to 1934 all

taxpayers other than corporate taxpayers were permitted to

elect a maximum alternative tax on gain from the sale of

capital assets including depreciable property held over two

years** similar to that now provided by the Code.*® From

1934 to 1938 those taxpayers were taxed on a varying per-

centage of such gain, depending on the period held.** Dur-

ing this period, corporate taxpayers under some circum-

stances also might have derived tax benefit from year of sale

depreciation. See Vol. 3, 1935 Stand. Fed. Tax Serv. 95185,

at 6630-31 (Feb. 27, 1935). From 1938 to 1942, no taxpayers

were entitled to capital gain treatment on the sales of de-

preciable property.*7 However, this preferential treatment

was reinstated for all taxpayers in 1942.°* Thus, except for

the period 1938 to 1942, it has since 1921 been of potential

tax benefit to taxpayers to deduct depreciation in the year of

sale and pay a tax on the increased gain which resulted by

reason of the dichotomy in the income tax laws which has

always existed. Throughout this period, respondent. appar-

ently never asserted that vear-of-sale depreciation was not

84See Rev. Act of 1921, §206(a)(6), (b): Rev. Acts of 1924 and 1926. §208

(a)(8), (b), (c); Rev. Acts of 1928 and 1932, §101(a), (b). (c)(8).

85Int. Rev. Code of 1954, §1201.

86See Rev. Acts of 1934 and 1936, §117(a).(b). The percentage of gain

recognized varied from 100 percent if the property had been held for less

than one year to only 30 percent if the property had been held for over 10

vears.

87Rev. Act of 1938, §117(a)(1) expressly excluded depreciable property from

the definition of “capital asset”.

88See note 89 infra and accompanying text.

deductible (cf. Duncan-Homer Realty Co., 6 B.T.A. 730

(1927) ), issued rulings holding that year-of-sale deprecia-

tion must be deducted, was sustained by the courts in nu-

merous court cases in reducing basis for depreciation allow-

able prior to the date of sale, including year-of-sale deprecia-

tion, and in the only reported case where the issue as to year-

of-sale depreciation was separately raised took the position

(contrary to the position taken by the taxpayer because of a

peculiar interplay in the alternative tax computations) that.

year of sale depreciation must be deducted. In this position

respondent was sustained by the Board of Tax Appeals.

Herbert Simons, 19 B.T.A. 711 (1930).

F. The lower courts in this case ignored clear indicia of Congres-

sional intent as refiected for more than 20 years.

Considerable evidence of Congressional knowledge of the

subject at hand is found in its legislative actions over the

past 22 years. In 1942, Congress amended the Internal Rev-

enue Code of 1939 to extend to all taxpayers who sold at a

profit depreciable assets used in a trade or business and held

for more than six months the favorable tax treatment ac-

corded to long-term capital gain.*® After 1942 (and with no

exceptions until 1951) Congress permitted taxpayers to de-

duct depreciation in excess of “exhaustion, wear . . . tear

. . . [and] obsolescence” in many situations including so-

called accelerated depreciation and emergency facility depre-

ciation. For a number of years Congress did not make any

provision to limit such depreciation deductions when the as-

set was sold at mid-life, nor did it make any special adjust-

ments as to the method of taxing the gain on sale even though

such gain necessarily resulted even in the abscence of any ap-

89Int. Rev. Code of 1939, §117(j), added by Rev. Act of 1942, §151(b) (now

Int. Rev. Cone or 1954, §1231).

= 4

ee Pa

ot RBS

SPACE» Ct nat aN EEN Rise va

preciation in value. In 1947, Congress received a report from

the Treasury Department warning against the revenue losses

resulting under this provision from sale of assets subject to

accelerated depreciation and recommending that, to the ex-

tent of the excess of accelerated over normal depreciation,

such gains should be treated as ordinary income.* However,

Congress did not act on this recommendation.

In developing the Revenue Act of 1950, Congress consid-

ered the possibility of taxing gains from sales of depreciable

assets as ordinary income, but rejected the idea because it

presented serious difficulties.** However, Congress did enact

in that Revenue Act a much more limited restriction on the

availability of capital gain treatment for depreciable assets.

In connection with the authorization of 60-month amortiza-

tion of emergency facilities certified as necessary in the in-

terest of national defense,°? Congress provided that gain

from the sale of such facilities should, to the extent that de-

ductions for such amortization exceeded the deduction other-

wise allowable for depreciation, be taxed as ordinary income

Hearings Before the Committee on Ways and Means, House of Representa-

tives, 80th Cong., Ist Sess. on Revenue Revisions 1947-48, Part 5, at 3756

(Report of Business Tax Section, Division of Tax Research, Treasury Depart-

ment ).

*1At the recommendation of the Treasury Department, the House Ways and

Means Committee had proposed, in section 209(b) of the House bill (H.R.

8920, 81st Cong., 2d Sess.), that Section 117(j) of the 1939 Code be

amended to treat losses on sales of depreciable assets as capital, rather than

as ordinary, losses. H.R. Rep. No. 2319, 81st Cong., 2d Sess. 45 (1950).

The Senate Finance Committee rejected this change. (S. Rep. No. 2375,

81st Cong., 2d Sess. 51-52 (1950) ), and its views prevailed. In the discus-

sion on the floor of the Senate, Senator Milliken, in explaining the Commit-

tee’s action, stated that “the reverse procedure which involves conforming

the treatment of gains to losses and taxing the gains on the sale of section

117(j) assets as ordinary income also presents serious difficulties” and,

hence, the “Committee decided that it was best not to change section 117(j)

at this time.” 96 Conc. Rec. 14057 (1950).

82Int. Rev. Code of 1939, §124A, added by Rev. Act of 1950, §216(a) (now

Int. Rev. Cope or 1954, §168).

- . —_

instead of capital gain.** The Conference Report on this pro-

vision contained an example illustrating its operation as fol-

lows:** an emergency facility acquired on December 31,

1950, for $10,000 was sold on December 31, 1952, for $9,500.

Amortization of $4,000 had brought its adjusted basis down

to $6,000 at the date of sale, while regular depreciation (at

$500 a year) to the date of sale would have brought the ad-

justed basis down only to $9,000. Under the amendment,

the Committee of Conference stated in its report, $38,000 of

the gain would be treated as ordinary income and $500 as

long-term capital gain. Obviously, under the Congressional

view, had ordinary depreciation been taken, a $500 deprecia-

tion deduction was allowable for the year of sale even though

the sale price exceeded basis. The same view was until June

1, 1965, reflected in the examples in the Treasury Regula-

tions under this statutory provision.”

In considering the Revenue Act of 1951, Congress was

again concerned with the availability of capital gain treat-

ment on sales of depreciable property. The Internal Revenue

Service had called the attention of Congress to the growing

practice of sales of depreciated assets between related tax-

payers for the purpose of obtaining a combination of capital

gain treatment on the sale and an increased basis for future

depreciation purposes.** Congress forestalled the continued

use of this device by requiring the gain to be treated as ordi-

nary income in the case of sales between an individual and

his controlled corporation or between closely related individ-

®3Int. Rev. Code of 1939, §117(g)(3), added by Rev. Act of 1950, §216(c)

(now Int. Rev. Cove or 1954, $1238).

®4H.R. Rep. No. 3124, 8lst Cong., 2d Sess. 29 (1950).

®5Treas. Reg. §1.1238-1, Examples (1) and (2), amended by T.D. 6825, 1985

Int. Rev. Bull. No. 26, at 6, 30 Fed. Reg. 7281 (1965).

®6H.R. Rep. No. 586, 82d Cong., Ist Sess. 26 (1951).

ti A ae.

be ST

ee ee ..

eee

uals,*’ but again left capital gain treatment otherwise avail-

able to sales of depreciable assets and made no effort to ad-

just the depreciation deduction in the year of sale even

though excessive depreciation may have been allowed to the

taxpayer.

During the development of the Internal Revenue Code of

1954, Congress again received the recommendation that gains

from sales of depreciable assets should be taxed as ordinary

income,”* and again did not adopt it. Congress authorized

new rapid depreciation methods in the Internal Revenue

Code of 1954," which would normally assume the realiza-

tion of gain on sale of the asset at m | \fe, but reenacted

without substantive change the provisiey sv thorizing capital

gain treatment for profits on sales of depreciable assets.’°°

The President’s budget message to the Congress on Janu-

ary 18, 1960, again proposed legislation limiting capital gain

treatment on the sale of depreciable business property. Not-

ing that “administration of the depreciation provisions is

being hampered by the attempts of some taxpayers to claim

excessive depreciation before disposing of their property,”

the President recommended “that consideration be given to a

change in the law which would treat such gain as ordinary

income to the extent of the depreciation previously taken on

87Int. Rev. Code of 1939, §117(0), added by Rev. Act of 1951, §328(a) (now

Int. Rev. Cope or 1954, §1239).

®8Hearings Before the Committee on Finance, United States Senate, 83d Cong..

2d Sess. on H.R. 8300, Part 3, at 1324 (Recommendation No. 180 of Ameri-

can Institute of Accountants ).

®9InT. Rev. Cope or 1954, §§ 167(b)(2), (3), and (4).

100InT. Rev. Cope or 1954, §1231. “This section is derived from section 7

(j) of the present law. There is no substantive change intended. . . .

H.R. Rep. No. 1337, 83d Cong., 2d Sess. A275 (1954). In the floor dis-

cussion, Representative Curtis called the attention of the House to the fact

that the combination of the new depreciation methods and the capital gain

provisions of section 1231 might well “accentuate” already existing capital

gain advantages. 100 Conc. Rec. 3678 (1954).

“ linia,

the property.”"*' The Secretary of the Treasury, by identi.

cal letters dated February 12, 1960, to the Vice President

and to the Speaker of the House of Representatives, trans-

mitted to Congress proposed legislation to implement the

President’s recommendation.'*? In these letters the Secre-

tary of the Treasury said that ensctment of the “proposed

legislation, by eliminating the opportunity which now exists

of converting ordinary income into capital gains, would con-

tribute to the sound administration of the depreciation

laws.” The President renewed his request in a letter to Con-

gress dated April 20, i961, in which he made the cogent ob-

servation that “the statutory rate of depreciation may not

coincide with the actua! decline in the value of an asset."'**

Congress finally adopted a portion of the President's rec-

ommendation by providing, in a 1962 amendment to the In-

ternal Revenue Code of 1954, that in the case of dispositions

of depreciable personal property in 1963 and later vears,

gain to the extent of depreciation deductions taken in 1962

and later years would be ordinary income, and the remainder

would be capital gain.'** The Committee Reports on this

enactment could not more clearly state the Congressional

view that depreciation deductions may exceed the decline in

value of the property and that, but for the new provision,

this excess is recapturable by the taxpayer at capital gain

rates.'°

101THe Buncetr or THE UNtrep States GovERNMENT FOR THE Fiscat Yrar

Envinc June 30, 1961, at MII.

102Treasury Department Release A-761. dated February 15, 1960.

108The letter is reprinted in Hearings Before the Committee on Waus and

Means, House of Representatives. on the President's 1961 Tax Recommen-

dations (H.R. Doc. No. 140, 87th Cong.. Ist Sess.), vol. 1. at 13. The tes-

timony of the Secretary of the Treasury on this recommendation is recorded

at pages 44-45 of those Hearings.

1¢4Inr. Rev. Cope or 1954, §1245, added by Rev. Act of 1962, §13(a).

1O5H_.R. Rep. No. 1447, 87th Cong., 2d Sess. 66-67 (1962); S. Rep. No. 1881,

87th Cong., 2d Sess. 95 (1962).

net

. ee . basil ih | ar

Bits

MPT es.

In 1963, the Administration renewed its request that simi-

lar treatment be accorded to gain on the disposition of de

preciable real property.’’* And in a 1964 amendment to the

Internal Revenue Code of 1954,'°' Congress provided (with

certain modifications) that gain from dispositions in 1964

and later years of depreciable real property (but limited

generally to real property held for less than 10 years) should

be treated as ordinary income to the extent that the gain is

equal to or less than post-163 depreciation, and as capital

gain to, the extent that the gain exceeds such depreciation.’

In neither 1962 nor 1964 did Congress make any attack

on the depreciation deduction as such. Thus, for more than

20 years Congress has been aware that accelerated deprecia-

tion in excess of “exhaustion, wear... tear... [and]

obsolescence” was being deducted and that depreciation was

heing allowed in the year of profitable sale, and until 1962

it made no attempt to limit such deductions, and then the

problem was approached entirely through a change in the

nature of the gain realized and not through an adjustment

of the depreciable deduction. The fact that in the 1962

amendment pertaining to dispositions of depreciable per-

sonal property it limited the application of the amendment

to post-1961 depreciation deductions allowed on the prop-

'06Statement of Secretary of the Treasury Before the Committee on Ways and

Means, House of Representatives, on the President's Special Message on Tax

Reduction end Reform, on February 6, 1963. at 25.

'SThe portion of the gain taxable as ordinary income is a percentage of the

excess of post-1963 depreciation deductions over straight-line depreciation.

The percentage is 100 percent for the first 20 full months the property is

held and decreases | percent per month thereafter until the gain is 100

percent capital gain at the end of 10 vears. Int. Rev. Cove or 1954.

$§ 1250(a)(1),¢2) and 1250(b)(1). The Committee Reports with re-

spect to this legislation for the first time indicate an awareness by Congress

of the controversy exemplified by this litigation, and Congress in effect took

a neutral attitude. See H.R. Rep. No. 749, 88th Cong., Ist Sess. 103

(1964); S. Rep. No. 830, 88th Cong.. 2d Sess. 133 (1964).

iia

erty, 2nd the added fact that in the 1964 amendment pertain-

ing te dispositions of depreciable real property Congress

limited the application of the amendment to post-1963 de-

preciation deductions allowed on property held for less than

10 years, suggest Congressional cognizance of the interrela-

tionship of the depreciation and capital gain provisions and

its awareness of depreciation patterns which can fairly be

changed only prospectively.

The lack of correlation between market value and depre-

ciated cost was specifically brought before Congress on three

occasions prior to the adoption of the 1954 Code, and in

1950,*°* Congress, in dealing with the general problem, speci-

fically recognized the deductibility of depreciation in the year

of sale. This recognition was found in respondent’s Treasury

Regulations until June 1, 1965, was otherwise consistent

with respondent’s practice until June 7, 1962 (the day be-

fore the trial of this case) when respondent announced his |

new position that he no longer would allow depreciation in |

the year of profitable sale of an asset,'’® and is reflected in a |

long series of judicial decisions, including Wier Long Leaf

Lumber Co. in which respondent had acquiesced for 14 years

until June 25, 1962 (one week after the taxpayer had insti-

tuted suit in the S € A Co. case) when such acquiescence was

withdrawn.'"

Under these circumstances, when Congress

reenacted the depreciation provision of the income tax law

at the time it adopted the 1954 Code, it in effect approved

the interpretation of those provisions as found in the exist-

ing judicial interpretation and administrative regulations

and rulings issued by respondent, which thereby acquired the

109See note 94 supra and accompanying text.

110Treasury Information Release 374, dated June 7, 1962, reissued as Rev.

Rul. 62-92, 1962-1 Cunt. But. 29.

1111962-1 Cum. Butt. 5.

—

force of law. Cammarano v. United States, 358 U.S. 498,

509-12 (1959); Hecht v. Malley, 265 U.S. 144 (1924); 1

SUTHERLAND, STATUTORY CONSTRUCTION {1935 (3d Ed.

1943). See also Commissioner v. Brown, _. U.S. _., CCH

1965 Stand. Fed. Tax Rep. (65 U.S. Tax Cas.) 9375, at

95,343 (Apr. 27, 1965). This is particularly true in the light

of the specific, as opposed to the inferred, consideration

given by Congress to the problem. See Commissioner v. P.

G. Lake, Inc., 356 U.S. 260 (1958); United States v. Cala-

maro, 354 U.S. 351 (1957) ; Commissioner v. Glenshaw Glass

Co., 348 U.S. 426 (1955).

It could not be clearer that respondent, failing since 1942

to persuade Congress to change the tax laws in order to cor-

rect so-called “abuses” resulting from favored capital gains

treatment accorded taxpayers on the disposition of depre-

ciable assets, took it upon himself to change the law admin-

istratively, in utter disregard of all precedent and principle.

G. The theory adopted by the lower courts in this case has been

thoroughly discredited by the overwhelming weight of con-

temporary court decisions.

The most comprehensive judicial discussion and analysis

of the application to the issue involved in this case of the

well-settled principles discussed in this brief are found in

the opinion of the Court of Appeals for the Eighth Circuit in

S € A Co. v. United States, 218 F.Supp. 677 (D. Minn.

1963), aff'd, 338 F.2d 629 (Sth Cir. 1964), petition for cert.

filed (No. 862, 1964 Term; renumbered No. 50, 1965 Term).

In the S € A Co. case, the facts were undisputed: the tax-

payer used a taxable year ending August 31, and on April

1, 1956, sold all of its operating assets as part of the sale of

its going business, which was the manufacture and sale of

outboard motors. The purchaser acquired the taxpayer's

business for the purpose of conducting the same business at

_the same location and with substantially the same employees,

and it in fact did so. Included in the assets sold were de-

preciable assets, and the portion of the total sale price allo-

cated to such assets not only exceeded the undepreciated

basis of the assets as of September 1, 1955, but also exceeded

the original cost of such assets as well. On taxpayer’s tax

return for its taxable year ending August 31, 1956, the tax-

payer claimed depreciation of $125,481.77 with respect to

the depreciable assets for the period September 1, 1955, to

April 1, 1956. The taxpayer’s computation of this claimed

deduction for depreciation was based upon the rates of de-

preciation claimed by the tax year and allowed by respond-

ent with respect to such assets on taxpayer’s prior returns.

There was no dispute that the claimed deduction for depre-

ciation of $125,481.77 was a “reasonable aliowance” for de-

preciation for the period September 1, 1955, to April 1, 1956,

with respect to the assets sold on the latter date, unless the

sale in and of itself created a reason for changing the depre-

ciation allowance.

Respondent disallowed the claimed depreciation for the

year of sale only, but did not challenge the taxpayer’s esti- |

mates of “useful life” or “salvage value’, nor did he chal- |

lenge depreciation claimed in prior open years. The district

court found the following facts (in addition to those sum-

marized above): at the times when the taxpayer acquired

the depreciable assets which it sold on April 1, 1956, and at

all times prior to the sale, the taxpayer intended to use such

assets in the business for the full duration of their economic

or physical life; at the times when the taxpayer acquired

the depreciable assets in question, it estimated the period of

usefulness of such assets in the business to be the full dura-

tion of their economic or physical life; at the time when the

taxpayer acquired such assets and at all times prior to the

sale, taxpayer’s expectation that such assets would be useful

__ ———

in the business for the full duration of their economic or

physical life was reasonable and wholly consistent with its

experience with these and similar assets used in its business;

from the times when the taxpayer acquired such assets un-

til the time of sale, the experience of the taxpayer with re-

spect to these and similar assets was wholly consistent with

and reflected taxpayer’s expectation and intention of using

such assets in the business for the full duration of their eco-

nomic or physical life; at no time prior to the sale of such

assets, did the taxpayer have a predetermined plan to sell

or otherwise dispose of such assets prior to the expiration of

the full duration of their economic or physical life; the “use-

ful life” in the business of the depreciable assets did not end

or change on or before August 31, 1956; and as of April 1,

1956, the depreciable assets sold on that date had an average

estimated remaining “useful life” in the business of approx-

imately 10 years.

On the basis of these findings, the district court distin-

guished this Court’s decisions in Massey and Hertz and the

Sixth Circuit’s decision in Cohn and concluded that the

amount of the total sale price realized by the taxpayer on

the sale of its assets on April 1, 1956, which was allocated

by the taxpayer to the depreciable assets sold on that date,

merely refiected the market value of such depreciable assets

at a particular point of time prior to the end of the “useful

life” of such assets in the business; that the excess of such

portion of the total sale price allocated to such depreciable

assets over the undepreciated cost of such assets on Septem-

ber 1, 1955, constituted mere appreciation in value: and that

the amount of the total sale price allocated by the taxpayer

to such depreciable assets did not determine or reflect the

“salvage value” of such assets. Accordingly, the district

court upheld the taxpayer’s claimed deduction for vear-of-

~r incom

sale depreciation. The Government appealed this adverse

decision to the Eighth Circuit.

The Eighth Circuit affirmed the decision of the district

court. The Court exhaustively reviewed the fundamental

concepts of depreciation accounting for income tax purposes,

the long-standing judicial precedents, administrative rul-

ings, practice, and acquiescence, repeated statutory reenact-

ments, and the pertinent provisions of the tax statute and

the Treasury Regulations. Applying the principles estab-

lished by these authorities, the Eighth Circuit turned to the

facts before it and made the following observations :’'?

1. The facts here possess impressive strength. The

taxpayer’s sale of its outboard motor assets was a sale of

a going business. It acquired those assets and continued

to hold them with, at all times, the intent to keep and

utilize them in its business until the end of their eco-

nomic life. It did not intend to dispose of them in the

midst of that life and it had established no practice of

early disposal, as was the situation in both Massey and

Hertz. No challenge is made as to the correctness of

the acquisition estimates of useful life and salvage value

at the end of that life. The Commissioner accepted these

estimates for all prior tax years and would have ac-

cepted them for fiscal 1956 had the sale not taken place

in that year.

* * * * *

6. With no dispute here as to either cost or useful

life, the case hinges on salvage value. But this is to be

determined, not at the time of the asset’s retirement,

but at the time of acquisition. . . . .

7. There is no absolute identity of salvage value with

sales price. The one is not necessarily equivalent to the

other. Neither the statute nor the regulations equate

them or make an exception out of the sale year. The em-

phasis, as has been noted, is, instead, on the estimate of

salvage value, on such estimate at acquisition, on rede-

112338 F.2d at 639-43.

SSPE PIN PN RR GAC RET RIS TN ARE RG RIA RT EET I LC NS EI IT ——

! 59

termination as the exception, on the distinct possibility

of gain or loss on disposition, and on divorcement of sal-

vage value from price level fluctuations.

* * * * a

} 10. On the facts before us those provisions of Reg.

§1.167(b)-(0) (a) which deny depreciation beyond cost

less salvage value and which determine the reasonable-

ness of a claim for depreciation upon “conditions known

to exist at the end of the period” do not defeat this tax-

payer’s claim for depreciation. Of course, a favorable

sale price might, in some instances, be a factor indica-

tive of acquisition-estimate error. But this is not neces-

sarily so and, it seems to us, is distinctly not so where,

as in this case, there has been and still is no challenge

as to cost and as to the useful life and salvage value

acquisition estimates. The propriety of all three factors

is accepted. The lack of challenge to the taxpayer’s

claimed and parallel depreciation deductions in prior

tax years which were still open for audit adjustment is

a concession to their propriety.

* * * # *

11. This is not a situation where the assets are sold

at or near the very end of useful life in the taxpayer's

hands. ...

12. We have here, instead, an unanticipated sale in

midlife. This record contains nothing which discloses

any change in the economic life of the assets. The sale

itself did not change this.

13. There is a logical inconsistency in the govern-

ment’s attack on year-of-sale depreciation and its allow-

ance of the depreciation in preceding years still open for

adjustment when the sale facts became known to the

government. .. .

* * * * *

15. The government’s position seems to emphasize

hindsight and to abandon the concept that depreciation

rests on prospective estimates which, to be sure, must

be reasonable. It would, to use Judge Blumenfeld’s

words in Motorlease, p. 363 of 215 F. Supp., “set up an

automatic hindsight re-evaluation which becomes a self-

executing redetermination of salvage value triggered y

the sale of depreciable assets”.

oe * * * e

19. We have deep respect for the conclusions reached

by the Second Circuit majorities in Fribourg and Mo-

torlease. But we cannot escape the feeling that the re-

sults in those cases underestimate both the law's di-

chotomy of approach to depreciation and to capital gain

and, as well, the fact. distinction, . . . so inherent in

Cohn, between an intended sale of depreciable assets at

or near the end of useful life and an unanticipated sale

in mid-life... .

On the basis of the foregoing, the Eighth Circuit con-

cluded :""8

After earnest consideration of all the arguments which

have been advanced upon us by the contending parties,

we reach the conclusion that, on the facts here presented

—unanticipated and noncustomary sale in mid-life of a

depreciable asset ; acceptance of the correctness and rea-

sonableness of the taxpayer's acquisition estimates of

useful life and salvage value; actual approval of depre-

ciation based on these estimated in prior years, some of

which still remained open; and the inescapable infer-

ence that the claimed depreciation would have been al-

lowed for the sale year had the sale not taken place—

the taxpayer has sustained its burden of proof and is

entitled to the deduction. . . .

113]d. at 639.

PECUR LS TREN PIELER ———————————

Tn a NER RC I

In recent years, in addition to the Eighth Circuit, the

Tax Court'™* (except for a brief period of departure’'*), and

the federal district courts'’® (with one exception’''), have

uniformly applied the well-established principles of deprecia-

tion accounting developed and followed in a long line of ju-

'14Engineers Ltd. Pipeline Co., 44 T.C. _ No. 25, CCH Tax Ct. Rep., Dec.

27,411 (May 28, 1965); L. M. Lockhart, 43 T.C. 776 (1965), on appeal

to Ninth Circuit; Bell Lines, Inc., 43 T.C. 358 (1964); Holder Driv-Ur-

Self, Inc., 43 T.C. 202 (1964), nonacq., 1965 Int. Rev. Bull. No. 30, at 6;

Harry Trotz, 43 T.C. 127 (1964), on appeal to Tenth Circuit; Smith Leas-

ing Co., Inc., 43 T.C. 37 (1964), on appeal to Fifth Circuit: Macabe Co.,

Inc., 42 T.C. 1105 (1964), on appeal to Ninth Circuit; Herschel M. Hays,

CCH Tax Ct. Mem. 1965-213, 24 CCH Tax Ct. Mem. 1103 (Aug. 9, 1965) ;

Specialty Paper & Board Co., CCH Tax Ct. Mem. 1965-208, 24 CCH Tax

Ct. Mem. 1085 (July 28, 1965); W. Lawrence Oliver, CCH Tax Ct. Mem.

1965-83, 24 CCH Tax Ct. Mem. 438 (Apr. 7, 1965); The Covered Wagon,

Inc., CCH Tax Ct. Mem. 1965-79, 24 CCH Tax Ct. Mem. 427 (Apr. 5,

1965); Harry Friend, CCH Tax Ct. Mem. 1965-35, 24 CCH Tax Ct. Mem.

192 (Feb. 23, 1965), on appeal to Fourth Circuit; Melvon C. Miller, 28

CCH Tax Ct. Mem. 1866 (1964); Moses Lake Homes, Inc., 23 CCH Tax

Ct. Mem, 1756 (1964); Palmaneda Adams, 23 CCH Tax Ct. Mem. 1748

(1964), on appeal to Sixth Circuit.

"Randolph D. Rouse, 39 T.C. 70 (1962), overruled, Macabe Co., Inc., 42

T.C. 1105 (1964); Contra Costa Trucking Co., 22 CCH Tax Ct. Mem.

1018 (1963); Fribourg Navigation Co., Inc., 21 CCH Tax Ct. Mem. 1533

(1962), aff'd, 335 F.2d 15 (2d Cir. 1964), cert. granted. U.S. __ (No.

679, 1964 Term; renumbered No. 23, 1965 Term). Inasmuch as the Tax

Court, in deciding Contra Costa Trucking Co. and this case, considered its

prior decision in Rouse as dispositive of the issue before it. it would appear

that the necessary effect of the Tax Court's overruling of its decision in

Rouse would be implicit repudiation of its prior decisions in Contra Costa

Trucking Co. and this case.

'16Mountain States Mixed Feed Co. v. United States. F. Supp. —.. CCH

1965 Stand. Fed. Tax Rep. (65-2 U.S. Tax Cas.) £9551 (D. Colo. May 26,

1965); R. A. Heintz Constr. Co. v. United States, F. Supp. . CCH

Occidental Loan Co, v. United States, 235 F. Supp. 519 (S.D. Calif. 1964),

on appeal to Ninth Circuit; Wyoming Builders, Inc. v. United States, 227

F. Supp. 534 (D. Wyo. 1964), on appeal to Tenth Circuit; S & A Co. v.

United States, 218 F. Supp. 677 (D. Minn. 1963), aff'd, 338 F.2d 629 (8th

Cir. 1964), petition for cert. filed (No. 862, 1964 Term: renumbered No.

50, 1965 Term); The Motorlease Corp. v. United States, 215 F. Supp. 356

(D. Conn. 1963), rev'd, 334 F.2d GiT (Qd Cir, 1964). petition for cert.

filed (No. 685, 1964 Term; renumbered No. 24, 1965 Term); Kimball Gas

Prods. Co. v. United States, — F. Supp. . CCH 1963 Stand. Fed. Tax

Rep. (63-2 U.S. Tax Cas.) £9507 (W.D. Tex. Nov. 3. 1982), on appeal to

Fifth Circuit.

"Killebrew v. United States, 234 F.Supp. 481 (D. Tenn. 1964), on appeal

to Sixth Circuit.

dicial, administrative, and accounting precedents and receog-

nized in repeated statutory reenactment, and have flatly re-

jected respondent's new theory as a radical departure from

these precedents, The Court of Appeals for the Second Cir-

cuit now stands alone (except for one district court opinion )

in its acceptance of respondent's new theory, a theory which

is no longer accepted even by the Tax Court whose decision

the Court of Appeals affirmed in this case.''*

CONCLUSION

In the light of the principles discussed in this brief which

are embodied in the basic statutory provision and which have

been recognized by the courts, respondent, and well-estab-

lished accounting practice, it becomes apparent that the ques-

tion as to the allowability of a deduction for depreciation in

the year of profitable sale turns en evidentiary matters, In

order to sustain his claimed deduction fer depreciation in the

year of profitable sale, or in any other year for that matter,

the taxpayer has the burden of proving that his acquisition.

time estimates of “useful life’ and “salvage value” were rea-

sonable. If the taxpayer does not carry this burden of proof,

the trier of fact would be justified in concluding that the tax-

payer's claimed deductions for depreciation in all years, not

merely the vear of sale, were excessive. On the other hand,

once the taxpayer has carried his burden of proof on the rea-

sonableness of his acquisition-time estimates, it follows that

the trier of fact would be justified in concluding only that,

as a matter of law, the claimed deductions for depreciation

in cll vears, including the vear of sale, were reasonable and

therefore allowable) Obviously, when, as in this ease, re

TE8See note LES supra, Moreover, ina fully reviewed opinion in Macabe Co.,

Inc, 42 TC) TLOS, ET1O C19G4), the Tax Court expressed its disagreement

“with the rationale relied upon by a nevority of the panel [of the Court of

Appeals for the Secend Cireuit] which decided” Fribourg

2 <2

Petr TIER oy preeitie

spondent has conceded not only that the acquisition-time esti-

mates of “useful life” and “salvage value” were reasonable,

but also that the claimed deduction for depreciation in the

year of sale is reasonable and allowable but for the sole fact

of the unanticipated sale, it follows that the respondent has

conceded himself out of court.

Against respondent's “prior long-standing and consistent

interpretation”——as repeatedly reflected and approved in de-

cisions of this Court and many lower courts—his “more

recent ad hoc contention as to how the statute should be in-

terpreted cannot stand.” United States v. Leslie Salt Co.,

350 U.S. 888, 896 (1956). A principle so thoroughly estab-

lished by the vast body of precedents and by repeated statu-

fory reenactment should not be overturned at this late date

except: by legislative revision, As a majority of this Court

recently has observed, it would be “wise to leave to the

Congress the fashioning of a rule which, in any event, must

have wide ramifications.” Commissioner v. Rrown, US.

» CCH 1965 Stand. Fed. Tax Rep. (65 U.S. Tax Cas.)

T9375, at 95,343 (Apr. 27, 1965), quoting American Auto-

mobile Ass'n v. United States, 367 U.S. 687, 697 (1961).

For the foregoing reasons, the decision of the majority of

the Court of Appeals in this case shonid be reversed by this

Court.

Respectfully submitted,

LELAND W. Scorr

JOHN W. WINDHORST

JOHN S. Hees

2400 First National Bank Bldg.

Minneapolis, Minnesota 55402

Counsel for Amicus Curiae

Of Counsel:

Dorsey, OWEN, MARQUART, WINDHORST & Wret

2400 First National Bank Bldg.

Minneapolis, Minnesota 55402

Treasury Reguiations*

§1.167(a)-1 Depreciation In General. — (a) Reasonable

allowance. — Section 167(a) provides that a reasonable al-

lowance for the exhaustion, wear and tear, and obsolescence

of property used in the trade or business or of property held

by the taxpayer for the production of income shall be allowed

as a depreciation deduction. The allowance is that amount

which should be set aside for the taxable year in accordance

with a reasonably consistent plan (not necessarily at a uni-

form rate), so that the aggregate of the amounts set aside,

plus the salvage value, will, at the end of the estimated useful

life of the depreciable property, equal the cost or other basis

of the property as provided in section 167(f) and §1.167(f)-

1. An asset shal! not be depreciated below a reasonable

salvage value under any method of computing depreciation.

See paragraph (c) below for definition of salvage. The al-

lowance shall not reflect amounts representing a mere reduc-

tion in market value.

(b) Useful life——For the purpose of section 167 the esti-

mated useful life of an asset is not necessarily the useful

life inherent in the asset but is the period over which the

asset may reasonably be expected to be useful to the tax-

payer in his trade or business or in the production of his

income. This period shall be determined by reference to his

experience with similar property taking into account present

conditions and probable future developments. Some of the

factors to be considered in determining this period are (1)

wear and tear and decay or decline from natural causes, (2)

the normal progress of the art, economic changes, inventions,

*As in effect during the calendar years 1956 and 1957.

- , ——

and current developments within the industry and the tax-

payer’s trade or business, (3) the climatic and other local

corditicus peculiar to the taxpayer’s trade or business, and

(4) the taxpayer’s policy as to repairs, renewals, and re-

placements. Salvage value is not a factor for the purpose of

determining useful life. If the taxpayer’s experience is in-

adequate, the general experience in the industry may be used

until such time as the taxpayer’s own experience forms an

adequate basis for making the determination. The estimated

remaining useful life may be subject to modification by rea-

son of conditions known to exist at the end of the taxable

year and shall be redetermined when necessary regardless of

the method of computing depreciation. However, estimated

remaining useful life shall be redetermined only when the

change in the useful life is significant and there is a clear

and convincing basis for the redeiermination. For rules

covering agreements with respect to useful life, see section

167(d) and §1.167(d)-1.

at the time of acquisition) which is estimated will be realiz-

able upon sale or other disposition of an asset when it is no

longer useful in the taxpayer’s trade or business or in the

production of his income and is to be retired from service by

the taxpayer. Salvage value shall not be changed at any

time after the determination made at the time of acquisition

merely because of changes in price levels. However, if there

is a redetermination of useful life under the rules of para-

graph (b), salvage value may be redetermined based upon

facts known at the time of such vedetermination of usefu?

life. Salvage, when reduced by the cost of removal, is re-

ferred to as net salvage. The time at. which an asset is re-

tired from service may vary according to the policy of the

taxpayer. If the taxpayer's policy is to dispose of assets

whick are still in good operating condition, the salvage value

- ;

may represent a relatively large proportion of the original

basis of the asset. However, if the taxpayer customarily

, uses an asset until its inherent useful life has been substan-

tially exhausted, salvage value may represent no more than

junk value. Salvage value must be taken into account in

determining the depreciation deduction either by a reduc-

tion of the amount subject to depreciation or by a reduction

in the rate of depreciation, but in no event shall an asset

(or an account) be depreciated below a reasonable salvage

value. See, however, §1.167(b)-2(a) for the treatment of

salvage under the declining balance method. The taxpayer

may use either salvage or net salvage in determining depre-

ciatiop allowances but such practice must be consistently

followed and the treatment of the costs of removal must be

consistent with the practice adopted. For specific treatment

of salvage value see §$1.167(b)-1, 2, and 3. When an asset

is retired or disposed of, appropriate adjustments shall be

made in the asset and depreciation reserve accounts. For

example, the amount of the salvage adjusted for the costs

of removal may be credited to the depreciation reserve.

[Italics supplied. ]

* * *

§1.167(a)-8. Retirements. (a) Gains and losses on retire-

ments. For the purposes of this section the term “retire-

ment” means the permanent withdrawal of depreciable prop-

erty from use in the trade or business or in the production

of income. The withdrawal may be made in one of several

ways. For example, the withdrawal may be made by selling

or exchanging the asset, or by actual abandonment. In addi-

tion, the asset may be withdrawn from such productive use

without disposition as, for example, by being placed in a

supplies or scrap account. The tax consequences of a retire-

ment depend upon the form of the transaction, the reason

therefor, the timing of the retirement, the estimated useful

I cesarean SE

. ng

Vife weed in computing depreciation, and whether the asset

in accounted for in a separate or multiple amet account, Up

on the retirement of aaeta, the rule in thie eeetion apply in

determining whether gain or low will be reeoguteed, the

amount of auch gain or low, and the laaia for determining

wain or low:

(1) Where an asset is retired by aale at arise length,

recognition of gain or loa will be aubjeet to the provisions

of aeotionsa TQ0R2, 1281, and other applicable proviaions of law

® ” e

PLAAT (AD Obaolewwence, The depreciation allowance

includes an allowance for normal obeoleconce whieh should

be taken fnto account to the extent that the expected urxeful

life of property will be shortened by reason thereat, Ob

leecence may render an dare economically tele fo Che tay

payer regandlow of ite physical condition. Obsolescence is

attributable fo many causes, tneluding Ceehnotagiodl to

provement and reaonably foreseeable eoonomie changes

Among theve catiee are nepal progress of Che artis and

aclences, supervession or inadequacy brought about by devel

opments in the induatey, prodvets, methods, markets, sources

of aupply, and other like changes, and legislative ar regula

tory action, Ta any care in whieh Che taxpayer shows that

the eatimated axetil life previously used should be shortened

by reason of obsoleseenoe greeted Chan had been ageumed tn

computing such eatimated useful life. a change fo a new and

shorter eatimated useful life computed in accordance with

aveh showing will be permitted No eueh change will be

permitted merely becatise fa the anxupported opinion af the

taxpayer the property may become obealete. Por rulers yoy

erning the allowance of a low when the ueefilness of an

nanet ix anddenty terminated, eee section 13 and the regula

tlone thereunder, Tf the extinated useful life and the depre

_—

ciation rates have been the subjeet of a previous agreement,

seo rovtion LOT Cd) and ShleT ody a,

SLUT (ad 10) When Depreciation Deduction Is Allowable.

(a) A taxpayer should deduct the proper depreciable al

lowanice eveh year and may not inerease his depreciation al

lowanees tn later vers by reason of his failure to deduet

way depreciation atlowanee or of hin wetion in deducting an

allowance plainly inadequate under Che Known fete in prior

years, ‘Phe tnadequaey of the depreciation allowance for

property ty prior years shall be determined on Che basta of

the allowable method of depreciation used by the taxpayer

for xteh property or under the straight line method if ne al

lowanoe has ever been chimed for such property, The pre

coding senfonce shall not be construed as precluding: applica

tion of any method provided tn seetion TAT Cb) tf LAX payer's

failure fo claim any allowanee for depreciation was due sole

ly fo erroneously Creating as a deduetible expense an item

property chargaible fo capital account Por rules relating

fo adjustinenta Co vests, see seetion LOT and Che regulations

thereunder,

Cb) The period for depreciation of an asset shall begin

When the asxet ix placed in serviee and shall end when the

asset ix retiped from services A proportionate part of one

year's depreciation is allowable for that part of the dest and

hast year during which Che asset was in service

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.