Appeal from the District Court of the United States for the Eastern District of Pennsylvania; George A. Welsh, Judge.
Before DAVIS and BIGGS, Circuit Judges, and WATSON, District Judge.
The Real Estate-Land Title and Trust Company, a Pennsylvania corporation, the appellee, sued the United States in the court below for a refund of income tax. The cause of action arises out of the fact that in December, 1930, the appellee filed a claim for refund for the fiscal year ending October 31, 1928, in the sum of $153,125, alleging as the basis of its claim that it was entitled to deduct a loss due to obsolescence of a title insurance plant formerly owned by Land Title and Trust Company. The Commissioner of Internal Revenue disallowed the claim. The suit at bar was instituted pursuant to the provisions of Section 128(a) of the Judicial Code, as amended by the Act of February 13, 1925, 28 U.S.C.A. § 225(a). Judgment was entered for the appellee in the sum of $107,270.81, with interest as appears. The appeal at bar is from this judgment.
The question presented for our determination is whether or not the court below erred in finding that the appellee had sustained a loss during the fiscal year commencing upon November 1, 1927, and ending upon October 31, 1928, in the sum of $875,000, this amount purporting to represent the difference between the fair market value of the title plant upon March 1, 1913, and its value upon October 31, 1928. The trial judge found that the appellee was entitled to deduct this amount by way of obsolescence from its gross income for the fiscal year designated. The United States contends that this finding by the trial court was erroncous.
A brief statement of the facts leading to the dispute is necessary. The Real Estate-Land Title and Trust Company, the appellee, was formed by a merger between Real Estate Title Insurance and Trust Company, West End Trust Company and Land Title and Trust Company. The agreement of merger was executed upon October 3, 1927. The merger actually took place upon October 31, 1927, and the new company, the appellee, held its organization meeting upon the same day. The new company opened its doors for business upon November 1, 1927. Land Title and Trust Company prior to the merger and carried on a business of insuring titles to real estate in Philadelphia and for this reason possessed a title insurance plant. Real Estate Title Insurance and Trust Company also had carried on a title insurance business in Philadelphia and likewise possessed a title insurance plant. Prior to the merger Land Title and Trust Company carried its title plant upon its books at a valuation of $275,000, and Real Estate Title Insurance and Trust Company carried its title plant upon its books at a value of $143,000. For the purposes of the merger the value of the title plant of Real Estate Title Insurance and Trust Company was appreciated by $657,000 to a total value of $800,000, and the value of the title plant of Land Title and Trust Company was appreciated by $525,000 to a value of $800,000. When the merger took place the two title plants were transferred to the appellee at a valuation of $800,000 each or at a total valuation of $1,600,000, and the appellee took the two title plants as an asset at a valuation of $1,600,000.
Up to the time of the merger Land Title and Trust Company had issued 342,067 policies of title insurance and Real Estate Title Insurance and Trust Company had issued 436,950 such policies. All of the parties to the merger knew or should have known that the new corporation, the appellee herein, would acquire two title plants designed and intended for the same purpose, namely the searching of titles of properties in Philadelphia. It appears from the evidence that the plant belonging to Land Title and Trust Company was not as efficient a plant as that belonging to Real Estate Title Insurance and Trust Company. The plant of Land Title and Trust Company could be operated effectively with approximately one-third the number of employees required by the other.
A witness for the appellee testified that at the time the merger agreement was signed there was no plan for the disposition of the two plants. After the execution of the merger agreement but prior to the actual consummation of the merger an officer of the Land Title and Trust Company and an officer of the Real Estate Title Insurance and Trust Company examined the title plants and looked into the situation created by possession of two such units. Following this examination, it was decided that the appellee would use the title plant formerly belonging to the Real Estate Title Insurance and Trust Company and the plant formerly belonging to Land Title and Trust Company should be stored. The daily records required to keep the plant up to date were not made after this inspection. The record shows that this failure to keep the plant to date occurred no later than October 31, 1927, and probably took place a few days earlier. The plant however was used in connection with certain sheriff's sales occurring on the first Monday in November, 1927, and certain other information was obtained from this plant and made use of by the appellee from time to time for a period of some weeks thereafter. There is no evidence, however, to show that the plant was used in connection with new searches of properties after October 31, 1927.*fn1 The plant was stored in the basement of a building occupied by the appellee at 517 Chestnut Street, between the second week in October and the end of the first week in November, 1927. Shortly after the consummation of the merger, the plant was offered for sale by the appellee for a price of $1,000,000, but no offer to purchase it was received by the appellee in any amount. It appears also that during the first year after the merger it would have been necessary to have made 227,498 entries in the records of the plant in order to keep it up to date. At the time of the merger there were three title plants in Philadelphia and the appellee acquired two of them by the merger.
The pertinent statute, Section 23 of the Revenue Act of 1928, c. 852, 45 Stat. 791, 799, 800, 26 U.S.C.A. § 23(l) is as follows:
"Deductions from gross income.
"In computing net income there shall be allowed as deductions:
"(k) Depreciation. A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence."
Deductions from gross income cannot be made for obsolescence or depreciation of property unless used in the trade or business of the taxpayer in the taxable year in question. The trial court reached the conclusion that the plant had been used by the appellee within the meaning of the statute. That use at most was very slight. Assuming, however, that the use by the appellee of the plant was sufficient to come within the purview of the statute, it then becomes necessary to determine whether or not the sum of $875,000 claimed by the appellee as deduction from its gross income is a reasonable allowance for obsolescence and whether in fact there was obsolescence.
The fact of the matter is that the appellee, following the merger, had two title plants upon its hands each designed to accomplish substantially the same work. It was economically undesirable to make use of both. The appellee therefore selected and made use of that plant which it felt could be most economically operated. It thereupon failed to keep the other plant up to date by placing the necessary entries in its files. At any time during the taxable year the appellee by the expenditure of funds not incommensurate with the value placed upon the plant at the time of the merger, $800,000, or the price at which it was offered for sale after the merger, $1,000,000, could have brought the ...