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but keep it in an ordinarily efficient operating condition, may be deducted as expense, provided the plant or property account is not increased by the amount of such expenditures. Repairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the life of the property, should be charged against the depreciation

reserve.

The capital sum to be replaced by depreciation allowances is the cost of the property or the value of the property, its fair market value, as of a particular date.

Method of computation. The capital sum to be replaced should be charged off over the useful life of the property either in equal annual installments or in accordance with any recognized trade practice. 102

Rate. The allowance should be computed upon the basis of the cost of the property and the probable number of years constituting its life.

It has been estimated that the average usable lifetime of a frame building is 25 years, a brick building 35 years, a stone building or steel and concrete building, 50 to 100 years.

Very pertinent is the decision on this subject of Judge Grubb in the case of Cohen v. Lowe, 103

Allowance for depreciation. “This allowance (3% for depreciation on an apartment house) is for the wear and tear suffered by the building during the tax year, which means the physical deterioration that the building suffered during that period. It does not take into account depreciation in value due to a loss in rental value because of the construction of more modern buildings with improved facilities, or due to a change in the neighborhood. It is to be based upon the life of the building, in the sense of the number of years the building would remain in a condition to be

102 Federal Income Tax Service, Art. 165, page 96.
103 234 Fed. R. 474, 476 (U. S. Dist. Ct., So. Dist. N. Y.)

habitable for the uses for which it was constructed and used, which was in the instant case for an apartment house, and not merely the number of years it would stand without being condemned and torn down. The annual depreciation would be an amount represented by a fraction having one, the tax year, for the numerator and the number of years, representing the ascertained life of the building, as the denominator. This assumes that there would be an average deterioration suffered each year during the life of the building, and that the plaintiff would keep the building in good repair during the life of it. This the law exacts of him. Upon these assumptions, and giving this meaning to the words of the statute, 'a reasonable allowance for the exhaustion, wear and tear of the property arising out of its use or employment in the business,' the amount of the deduction allowed . . . (3%) is deemed to be reasonable."

The term "useful life" is interpeted to mean the period of time over which an asset may be used for the purpose for which it was acquired. In the case of a new building, this period starts at the time the building is completed and capable of being used. Buildings under construction are not subject to a depreciation allowance for income tax pur

poses. 104

INTEREST ON MORTGAGES

Where the court held it was proper to give the landlord a return on the full market value of his property, it has been decided that:

105

“The landlords should not be allowed to charge as an operating expense the interest paid on mortgages, or expense in negotiating mortgages. The reason for this is apparent. The landlord is getting a return as rent on his total investment, which includes

104 Treasury Office Decision No. 845.
106 Hirsch v. Weiner, 190 N. Y. Supp. 111.

that part represented by the mortgages on the property, which must be paid to save the amount actually advanced."

Under such circumstances, where market value is taken as the basis of computation of return, neither interest on mortgages nor expenses of replacing or extending mortgages are a proper charge against gross income. Where, however, it is held that the landlord is entitled to a return only on his equity in the property, all the foregoing charges are properly allowable as expense.

WHAT IS A PROPER RETURN TO THE LANDLORD? Just what return a landlord should secure is most difficult to define. Speaking generally, he should receive such a return as would tend to make the purchase of property attractive as an investment. This return ought in all propriety to take into consideration the generally prevailing return on money conservatively invested, to which should be added such additions as will compensate the owner for the care, trouble and risk of the investment.

Taking this as a guide, property which requires much care and attention on the part of the owner ought to yield him a greater return than less troublesome property. If these things were not considered and capital invested in housing given adequate return, the result would be that capital would be invested where the trouble and risk were lessened or eliminated, and housing construction would be even scarcer than it now is. Therefore, the return to the owner should be sufficient to make the owning of property attractive. To pursue any other policy would be unfair to the tenants as a class, for the tendency then would be to continue the shortage in housing indefinitely by making the building of and investment in housing unattractive.

This argument is made by the court in Hirsch v. Weiner in

v. the following language:

“In the case at bar the landlords stipulated that they would accept 7 per cent. on the fair value of the premises as the proper amount of net income. We think that this is not only fair, but that a larger rate of net income would be fair. The evidence shows that at the present time one can buy with reasonable safety first mortgage coupon bonds that are producing income at 8 per cent. to 872 per cent. The investor in real estate, if building of houses is to be encouraged, should at least get as much income from real property, with all its attendant trouble, as the investor in mortgages on realty and franchises."

Some of the actual decisions as to what is a fair return may now be referred to.

Ten per cent was held not unreasonable under the evidence in the recent case of Hirsch v. Weiner 106 by the Appellate Term in the Second Department, the court stating:

“If this net rental does not exceed 10 per cent. of the present value of the property, then the rent demanded is not unreasonable. The reasonableness of a rent charge may vary under changing financial conditions. Upon the proof in this record showing the return upon other well recognized and generally accepted forms of investment we think that 10 per cent. as a net return to an owner of real property is not unreasonable. But such a percentage might be excessive if the evidence showed a different situation regarding other investments."

The Appellate Term in the First Department has held substantially the same in somewhat more positive language, 1064 stating that "a ten per cent return upon the value

106 190 N. Y. Supp. 111.
1000 Sperling v. Barton (App. T., 1st Dept.), 188 N. Y. Supp. 857.

a

of the property at a liberal appraisal” is the proper basis for the computation of reasonable rental.

In one case the finding of the trial court of a return of 692 per cent on the first 60 per cent of the value of the property and 10 per cent allowance on the last 40 per cent of value was affirmed without opinion by the Appellate Term of the Supreme Court in the First Department. 107

In another case 10 or 11 per cent was held not an unreasonable percentage of return. This was a case of an apartment house in which the defendant, for his apartment, paid prior to Sept. 30, 1920, a monthly rent of $137.50.108

In another case the Appellate Court held that a rent fixed by the trial court, which would allow less than 5 per cent return upon the owner's investment, was unreasonably low from the owner's standpoint. 109

In a case where, with the increase allowed by the trial court of $2.50 a month, the landlord secured a return of less than 6 per cent on his investment, the court on appeal held this return to be insufficient and allowed an increase of $5 a month and modified the judgment accordingly. 110

In another case, the Appellate Court held a finding of the lower court against the weight of evidence where the finding was that the reasonable rental value of an apartment was $39. It appeared, without contradiction, that the tenant had paid during the two months immediately preceding $49 a month and that the smallest amount of rent received from any

107 Decision of Justice Coleman, Mun. Ct., City of N. Y., 9th Dist., L. K. Schwartz Co. v. Leyendecker, not reported.

108 Marchbanks v. Moore, 113 Misc. 647, 185 N. Y. Supp. 226 (Mun. Ct., City of N. Y., Marks, J.).

109 Stein v. Eckert, 188 N. Y. Supp. 469, 471 (1st Dept.).

110 Auer Real Estate Co. v. Wriggle, 189 N. Y. Supp. 160 (App. Term, 1st Dept.).

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