# Amicus Curiae Brief — Fribourg Navigation Co. v. Commissioner > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386411_0224%3A06 ## Record - **Collection:** Supreme Court brief - **Document type:** Amicus Curiae Brief - **Published:** January 1, 1966 - **Citation:** 383 U.S. 272 ## Text i le 4 i i i ses 2 PEL ALG t ¢ | : Cos ' heed: Tee ‘ K # % % 3 % ae a ; ; a Dg ap Ve fe as 2 ios >, % ~ ‘ % as ee P} f : 3 »* “ 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— 17 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 18 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 — - 19 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). 20 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. 21 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). . — 22 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 24 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. 26 “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, a 27 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 a 28 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), 30 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 ———————— 31 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 32 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. { a 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. - —_ 34 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 ae 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 _— 37 [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 38 (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. | 46 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 __- | — 41 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 (c) provides that “the extent to which gain . . . shall be recognized . . . 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 42 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! — ——— 43 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” ———— 44 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 —— 45 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). - —_ 46 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 om soneme - * Di eae way a vin ls 7. 47 633 (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. aN 48 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 49 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). - . —_ 50 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). an 4 ss ti A ae. be ST | i ee ee .. eee 51 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, 52 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. '©TInt. Rev. Code of 1954, §1250, added by Rev. Act of 1964, §231(a). '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 54 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 __ ——— 57 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 58 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- 60 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 ——————————— = ae 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 Stand. Fed. Tax Rep. (65-2 U.S. Tax Cas.) © 9455 (D. Ore. Mar. 25, 1965); 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. 61 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. - , —— 66 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. (c) Salvage.—Salvage value is the amount (determined 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 68 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 --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386411_0224%3A06. Public record. Not legal advice.