Seitz, Chief Judge, and Rosenn and Weis, Circuit Judges.
This appeal from the Tax Court presents an issue of first impression in this court. The appellants, Midler Court Realty, Inc. and its three wholly owned subsidiaries (Midler), are corporations engaged in the ownership and leasing of commercial real estate. Midler purchased certain land with buildings thereon subject to existing leases which provided relatively high rental for an initial term but also provided that the lessee could renew at substantially reduced rentals. Midler claimed that a portion of its cost in the properties should be allocated to the right it obtained to receive rent in excess of fair rental value during the initial lease terms and that the amount so allocated should be amortizable over the same period. The Tax Court, however, rejected this claim and ruled that Midler was limited to depreciation deductions over the 33 1/3-year useful lives of the buildings. 61 T.C. 590 (1974). We affirm.
The buildings involved in this appeal constitute part of the Syracuse Industrial Park and were constructed by a group of entrepreneurs (the developers) in the early 1950's. General Electric, the intended tenant, initially required only two buildings to be used primarily for warehousing. Before these buildings were completed, however, General Electric's requirements increased, necessitating construction of eight more buildings at an additional cost of approximately $9.5 million.*fn1 The buildings were general purpose structures suitable for offices, manufacturing, warehousing, and laboratory facilities.
In order to enable the developers to finance construction of the buildings, General Electric entered into ten-year leases providing for relatively high rent in an amount sufficient to finance the cost of the buildings. Following the initial terms of the leases, General Electric reserved the right to renew at reduced rentals. The initial leases generally were followed by two-year renewal periods or "tails." General Electric thereafter had options to renew most of the leases for three successive five-year terms at rentals substantially below those fixed for the initial terms.
Utilizing accelerated methods of depreciation, the developers took deductions which would have recovered almost all their depreciable costs by 1963. The net cash flow after this date, however, would have been inadequate to amortize the indebtedness on the property. For this reason, the developers sought additional financing. When their efforts proved unsuccessful, the land and buildings leased to General Electric, as well as other land and buildings constructed in the Syracuse Industrial Park by the developers, were sold to Midler on November 30, 1961.
Midler has filed consolidated corporate income tax returns since 1961 claiming depreciation deductions with respect to the buildings based on useful lives of fifteen years from the date of purchase. Depreciation was calculated using the declining balance method. The Commissioner, however, determined that depreciation deductions should have been taken on the basis of useful lives of forty years. Tax deficiencies totalling more than $1.6 million accordingly were assessed for the years 1962 through 1968.
Midler contends that a portion of the purchase price paid for the properties leased to General Electric should be allocated to so-called "excess" or "premium" rentals.*fn2 It claims that of the $9,695,000 of the purchase price allocated to the properties (exclusive of land), approximately $5 million is attributable to amortizable "premium" rentals. The "premium" rentals, Midler asserts, represent that portion of the purchase price paid in excess of what would have been paid had the buildings been rented at their fair rental value as of the date of purchase. Midler also maintains that the renewal rentals under the General Electric leases were equal to or greater than the fair rental value of the buildings at the time it purchased the property.
Midler's contention that its cost basis in the "premium" rentals could be amortized over the initial lease periods plus any "tails" was first raised in its 1967 protest covering the years 1962 to 1964. It was raised in the Tax Court by way of an amended petition filed after trial. The Tax Court rejected Midler's "premium" rental contention as contrary to the basic concepts of real property law and incompatible with prior Tax Court decisions. The Tax Court further ruled that the useful lives of the buildings were 33 1/3 years. Midler appealed from the decision of the Tax Court, raising only the "premium" rental issue.
The term "premium" rental presents substantial definitional difficulties but Midler's brief in this court defines it as rents paid "substantially in excess of the fair rental value of the Property at the time of purchase." We note preliminarily that the "premium" rent here alleged by Midler is precisely that -- "rent." The record does not indicate a side transaction, other than rental value and the renewal rents were at the leasing of property, to which part of the consideration might be attributed. Cf. Royal Farms Dairy Co., 40 T.C. 172, 187-88 (1963). Thus, since General Electric and the developers dealt at arm's length, we must conclude that the entire amount due under the leases was payment for the use and occupancy of the leased premises.*fn3 Cf. Anderson Dairy, Inc., 39 T.C. 1027, 1043-44 (1963).
For purposes of discussion, we shall treat two possible definitions of "premium" rentals whose applicability might be ...