'incomes, from whatever source derived' -- the essential thought being expressed with a conciseness and lucidity entirely in harmony with the form and style of the Constitution."
In the light of this authoritative definition I have reached the conclusion that the value of a building erected by a tenant on his own initiative and without any obligation to do so, which by reason of its being annexed to the freehold becomes the property of the landlord, is not income of the landlord until the land is sold or otherwise disposed of. I am not passing upon the question whether the value of such a building would be taxable income to the landlord if erected by the tenant pursuant to a definite obligation to do so contained in the lease. In such a case it might well be argued that the increased value of the leased premises represented an additional rental to the landlord which was reserved by him and agreed upon when the lease was executed. Such is not this case, however.
In the present case it seems clear to me that the value of the building permanently added to the land by the tenant was at the most, in the words of Mr. Justice Pitney, but "a gain accruing to capital, * * * a growth or increment of value in the investment." It was not "something of exchangeable value, proceeding from the property, severed from the capital, * * * and coming in, being 'derived,' that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal."
My view is fully supported by Hewitt Realty Co. v. Commissioner, 2 Cir., 76 F.2d 880, 98 A.L.R. 1201, which is the only case in which this precise question has been squarely presented to a Circuit Court of Appeals for a decision. In that case Circuit Judge Hand of the Second Circuit said, page 884: "We concede that in a situation like that at bar a lessor need not receive money to be taxable; if improvements to land be portable -- detachable machinery for example, which he can take off and sell as separate chattels -- he receives income either when the lease is made, or when the term ends; for present purposes we need not say which.On the other hand, if the lease requires the lessee to drain the land, or set out shade trees, or pave it, or grade it, or build a golf course, or a race track on it, we can see no difference between the resulting increase in its value and that arising from the growth of the surrounding neighborhood, or the increase in value of a share of stock. The question as we view it is whether the value received is embodied in something separately disposable, or whether it is so merged in the land as to become financially a part of it, something which, though it increases its value, has no value of its own when torn away."
His conclusion was that the value of such a building becomes income to the landlord only when the land is sold and then only in so far as it increases the amount realized at that time.
The following cases are cited by the government as sustaining the contrary view: Miller v. Gearin, 9 Cir., 258 F. 225, 226; Cryan v. Wardell, D.C., 263 F. 248; United States v. Boston & Providence R. R. Corporation, 1 Cir., 37 F.2d 670; Crane v. Commissioner, 1 Cir. 68 F.2d 640; Kentucky Block Coal Co. v. Lucas, D.C., 4 F.Supp. 266; Scott v. Commissioner, 9 B.T.A. 1219; Alexander v. Commissioner, 13 B.T.A. 1169; Cataract Ice Co. v. Commissioner, 23 B.T.A. 654; Martin v. Commissioner, 24 B.T.A. 813; Slack v. Commissioner, 35 B.T.A. 271; Morphy v. Commissioner, 35 B.T.A. 289; Sloan v. Commissioner, 36 B.T.A. 370.
The first of these cases and the one principally relied upon by the others was Miller v. Gearin, decided by the Circuit Court of Appeals for the Ninth Circuit in 1919. That case, however, is not authority for the contrary view. It there appeared that the building in question had been erected by the tenant in 1907. In 1916 the lease was forfeited and the lessor resumed possession and then acquired possession of the building. The government sought to assess an income tax against the lessor in 1916, upon the value of the building in that year. This the court held it could not do because "the lessor acquired nothing in 1916 save the possession of that which for many years had been her own. The possession so acquired was not income. It was not a gain, but was a loss." The court then went on to say, "assuming that the building was income derived from the use of the property, we think it clear that the time when it was 'derived' was the time when the completed building was added to the real estate and enhanced its value." It is this last statement which the government cites as authority for its present position. It will be seen, however, that the court was very careful not to commit itself upon this proposition. All that it did decide was that the value of a building erected by a tenant was not income to the lessor at the termination of the lease. With this proposition I am in full accord, and the case is authority for nothing more.
Cryan v. Wardell, decided by the District Court for Northern California in 1920, was a similar case. In that case the building was erected by the tenant in 1910. In 1916 the tenant defaulted, the lease was canceled, and possession surrendered to the lessor. Here also the government sought to assess an income tax against the lessor upon the value of the building for the year in which the lease terminated. The court held, however, that title to the building vested in the lessor when it was built, and that whatever accession of the value resulted to her property from the erection of the building accrued and became vested in her in 1910 and not upon the termination of the lease. Since this was prior to the enactment of the Income Tax Law, the court held that this increase in the value of her property could not be made subject to income tax. It will thus be seen that this case likewise is not opposed to the view I have taken and is in no sense authority for the position of the government that the value of such a building when erected represents income derived from real estate.
The other cases relied upon by the government and cited above rely upon the authority of Miller v. Gearin and Cryan v. Wardell. In United States v. Boston & Providence R.R. Corporation the matter is referred to purely by way of obiter dictum, and in none of them is the question discussed whether the value of a building erected by a tenant under the circumstances here disclosed is income within the meaning of the Sixteenth Amendment. In Crane v. Commissioner, Kentucky Block Coal Co. v. Lucas, and the cases decided by the Board of Tax Appeals which did involve the decision of the point now before me, it seems to me that the definition of income was extended beyond the limits laid down by the Supreme Court in Eisner v. Macomber, supra, and I am therefore unable to follow them.
Being in accord with the view taken by the Circuit Court of Appeals for the Second Circuit in Hewitt Realty Co. v. Commissioner, supra, I have reached the following conclusions of law:
The value at the expiration of the lease of the building erected by plaintiffs' tenant was not income to them in 1933, the year of erection, and an aliquot part of the depreciated value of the building at the expiration of the lease was not a part of plaintiffs' gross income in 1934 or subject to income tax in that year.
Income tax in the sum of $36.29 was erroneously assessed against and collected from the plaintiffs for the year 1934.
The plaintiffs are entitled to the refund of $36.29, with interest on $8.54 from September 12, 1935, and on $27.75 from December 11, 1935.
I accordingly find in favor of the plaintiffs and against the defendant in the sum of $36.29, with interest on $8.54 from September 12, 1935, and on $27.75 from December 11, 1935.
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