Motorlease Corp. v. United States (215 F. Supp. 356, 1963)

BLUMENFELD, District Judge.

RULING ON CROSS MOTIONS FOR SUMMARY JUDGMENT

The plaintiff, Motorlease Corporation, seeks to recover payments of income taxes plus interest made in response to deficiency assessments for the fiscal years ended September 30, 1957, 1958, 1959 and 1960. As its name suggests, the plaintiff is in the business of leasing its automobiles to others. For each year, the taxpayer reported gains which arose from the sale of certain of those automobiles at prices in excess of their depreciated basis at the time of sale. In every such instance, the commissioner substituted the selling price for the taxpayer’s basis.

The commissioner’s assessments then were based on the disallowance of depreciation taken by the taxpayer during the year of sale on used automobiles to the extent that the selling price exceeded the depreciated basis at the time they were sold. The basic factual situation in this case is as simple as that. The effect of this action of the commissioner was to prevent the taxpayer from applying that part of the depreciation taken by him in the year of sale as an offset against income taxed at full rates, and accounting for it at a more favorable capital gains rate. The taxpayer contends that the action of the commissioner was unwarranted in law.

Although the parties have not filed a stipulation of facts, as suggested in the Pre-trial Order, the facts set out hereafter as found from the admitted pleadings, affidavits and briefs filed by both parties in support of their cross motions for summary judgment and from the admissions of counsel at the argument upon the motions are uncontroverted. They raise questions with respect to the proper tax treatment of amounts realized by the taxpayer from the sale of some of its depreciable assets which may appropriately be resolved by summary judgment.

The 1954 Internal Revenue Code § 167, 26 U.S.C. § 167(a), permits a taxpayer “as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) — (1) of property used in the trade or business * * What is meant by a reasonable allowance is described in the regulations promulgated by the Treasury Department.

The pertinent regulation, § 1.167(a)-1, provides:

“Reasonable allowance. Section 167 (a) provides that a reasonable allowance 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 uniform 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 de-preciable property, equal the cost or other basis of the property as provided in section 167(f) and § 1.167(f)-1. An asset shall not be depreciated below a reasonable salvage value under any method of computing depreciation. See paragraph (c) of this section for definition of salvage. The allowance shall not reflect amounts representing a mere reduction in market value.”

This taxpayer utilized the common straight line method of depreciation. It was required to estimate useful life at the time of the acquisition of each car in order to compute what proportion of depreciation should be allocated to each year it held it. This it did. The commissioner does not attack the taxpayer’s estimate of useful life. This estimate determines the length of time over which the depreciation may be taken at a uniform rate. The very nature of a straight line depreciation allowance spread over the life of an asset demands the ascertainment of an estimated salvage value. Accordingly, the taxpayer was also required to deduct the estimated salvage value at the end of that useful life from its cost in order to determine what amount was to be so apportioned. This it also did. The commissioner does not attack the taxpayer’s estimate of salvage value.

Regulation § 1.167(a)-l(c) presents the salvage value definition:

“Salvage. Salvage value is the amount (determined at the time of acquisition) which is estimated will be realizable 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 paragraph (b) of this section, salvage value may be redetermined based upon facts known at the lime of such redetermination of useful life. * * * Salvage value must be taken into account in determining the depreciation deduction either by a reduction 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.” (Italics added.)

Thus, it appears that the regulations published by the Treasury Department require only that the taxpayer estimate anticipated salvage value at the time of acquisition.

The parenthetical emphasis in the regulation upon the time when the salvage value must be determined is strengthened when viewed in historical perspective. The originally proposed depreciation regulations under the 1954 Code published in the Federal Register, 19 F.R. 6229, September 28, 1954, barely six weeks after the enactment of the 1954 Code on August 16, 1954, were followed by the second proposed regulations on November 11, 1955, 20 F.R. 8454 et seq., and thereafter by those finally adopted June 11, 1956, 21 F.R. 3985 et seq. Significantly, the italicized material in § 1.167(a)-1(c), infra, as finally adopted, did not appear in the earlier proposals.

It would be hard to find more explicit evidence of the Treasury’s opinion that salvage value must be estimated as of the time of acquisition of a depreciable asset than is revealed by these extensive additions to the originally proposed regulations which are found in it when finally adopted.

Presumably, adequate meaning could not be expressed if these words were left out. The fact that the regulation was not formally adopted until almost two years after the 1954 Code was passed, under the circumstances, does not militate against the weight given to administrative opinion which is “substantially contemporaneous” with the enactment of a governing tax statute. White v. Win-Chester Country Club, 315 U.S. 32, 41, 62 S.Ct. 425, 86 L.Ed. 619 (1942).

Section 1.167(a)-l(c) quite expressly forbids redetermination of salvage value merely to reflect changes in the resale market or even for other causes, except where there has been a redetermination of useful life. There has been no such redetermination of useful life here, and the government does not contend that any was required. Having also conceded that the estimate of salvage value at the time of acquisition (in most cases fourteen months before the sale) was reasonable, the government, nevertheless, argues that there is no further need for giving any effect to an estimate of salvage value once the asset has been sold, for then actual salvage value is known and the amount subject to depreciation must be automatically reduced by the difference between the selling price and the estimated salvage value whenever the selling price exceeds the estimate.

Tax consequences upon depreciation for “exhaustion, wear and tear” are tied to property “used” in the trade or business of the taxpayer. When the property so used is sold, the allowance for depreciation comes to an end. The sale of the used property is another taxable event to which new and different tax consequences attach. To indicate this conceptual change, a sign post in the form of a new sub-sub-section, § 1.167 (a)-8(a), was inserted into the depreciation section of the regulations by the Treasury. It reads, “(1) Where an asset is retired by sale at arms length, recognition of gain or loss will be subject to the provisions of §§ 1002, 1231 and other applicable provisions of law,” all of which provide for the application of capital gains rates. There is merit to the taxpayer’s argument that this constitutes an implicit recognition by the Treasury of the settled administrative practice, that where the taxpayer honestly and reasonably complies with the regulations, the actual sales price may, nevertheless, yield some gain or loss which remains to be accounted for at the rates applicable to an exchange transaction. Certainly, this sub-section does not carry the contrary implication that the Treasury was attempting to impose a radically different procedure, requiring an automatic adjustment of depreciation allowances previously taken every time a sale yielded more than what was “estimated” “at the.time of acquisition,” in order to reconcile every difference in the two amounts. In both Evans and Massey, both of which were considered together sub nom. Massey Motors, Inc. v. United States, 364 U.S. 92, 80 S.Ct. 1411, 1424, 4 L.Ed.2d 1592, 1603 (1960), the actual sale prices of the depreciated assets were in the records before the Supreme Court. The analysis of the facts and of the applicable principles was made with a full awareness of the tax advantage between deductions and capital gains, and of the fact that not only does salvage value usually turn out not to be what a taxpayer might estimate it to be, but that there is a simple way of finding and correcting the error. Despite the lack of any significantly different factual situation in those cases from the facts in this one, so far as the application of principles is concerned, the Supreme Court’s final statement of the correct formula to be applied in such cases did not include any rigid stricture arising from implication, proof or logical necessity that estimated salvage value ahd selling price must be the same. The Supreme Court concluded, p. 107, 80 S.Ct. p. 1419:

“We therefore conclude that the Congress intended that the taxpayer should, under the allowance for depreciation, recover only the cost of the asset less the estimated salvage, resale or second-hand value. This requires that the useful life of the asset be related to the period for which it may reasonably be expected to be employed in the taxpayer’s business. Likewise salvage value must include estimated resale or second-hand valué.” (Italics added.)

The repetition of the same words “the estimated salvage, resale or second-hand value” in the unity of one statement of congressional purpose and of how the taxpayer must go about complying with it leaves no room for ambiguity.

The effects of an estimate which does not later turn out to be absolutely accurate are not such that a taxpayer escapes taxation altogether on the difference. In fact, if his estimate of salvage value is high, so that the depreciation taken by him is less than he might have taken, viewed retrospectively, he is not permitted to recover, regulation § 1.167