Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 72-81

1972-1 C.B. 98

Sec. 162
Sec. 263

IRS Headnote

Annuity payments payable out of income from farm property distributed by a probate court to the decedent's son in exchange for the release of the widow's dower interest in the property are nondeductible capital expenditures.

Full Text

Rev. Rul. 72-81

Advice has been requested whether payments made under the circumstances described below are deductible business expenses under section 162 of the Internal Revenue Code of 1954, or are nondeductible capital expenditures under section 263 of the Code.

The taxpayer's father died intestate leaving a wife and a son (the taxpayer). The probate court in ordering distribution of the decedent's property ruled that the taxpayer was to receive his father's farm and that the decedent's widow was to receive an annuity in lieu of her dower interest in the farm. The widow's dower interest in the farm was a one-third fee simple interest. The annuity was to be payable annually out of the income produced by the property.

In accordance with the court order, an agreement and a deed were executed between the taxpayer and his mother under which the taxpayer agreed to pay to his mother a cash annuity of $5,000 in exchange for the release of all of her dower rights and interest in the farm.

Thereafter, the taxpayer managed the operation of the farm and received all the income from the property with $5,000 being paid to his mother each year in accordance with the annuity arrangement.

Section 162 of the Code allows as a deduction in computing adjusted gross income all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Under the Code, such expenses are distinguished from capital expenditures which, pursuant to section 263 of the Code, are nondeductible.

Generally, an expenditure will not be treated as one in the nature of an ordinary and necessary business expense if it results in the acquisition of an asset having a period of useful life in excess of one year. United States v. Akin, 248 F. 2d 742 (1957).

In Robert Hoe Estate Company, Inc. v. Commissioner, 32 B.T.A. 903 (1935), affirmed per curiam, 85 F. 2d 4 (1936), Ct. D. 1177, C.B. XV-2, 217, (1936), the testator left a will which made no provision for his wife's dower. His devisees, Mr. Hoe's children and their heirs, wishing to manage the property jointly, formed a company to which they conveyed their interests. The widow then agreed to release her dower interest on the condition that the company would pay her annually, for and during the period of her natural life, an amount equal to one-third share of the net annual income received annually by the corporation from several plots. The corporation did not report in its income the one-third share of the income that it paid to the widow.

The Board of Tax Appeals held that the payments to the widow were made to her in consideration of the release of her dower right in the property and were capital items that were not deductible in computing net taxable income. The Board stated that the annual payments to the widow were in fulfillment of the contractual obligation assumed by the corporation and were part of the purchase price which the corporation paid for the property it acquired.

The principles enunciated in Hoe are equally applicable to the instant case. Accordingly, it is held that the annuity payments made in the instant case are not deductible business expenses under section 162 of the Code, but are nondeductible capital expenditures under section 263 of the Code. The taxpayer's basis in the farm for purposes of depreciation prior to the death of his mother is its fair market value at the time he received it, less the fair market value of his mother's dower interest in the property plus the present value of the prospective payments to be made. However, any payments in excess of the computed present value should be added to the basis of the property for depreciation purposes. In addition, an allocation of basis must be made between depreciable structures and nondepreciable farmland computed on their respective fair market values. In the event that there is a disposition of the property, see Revenue Ruling 55-119, C.B. 1955-1, 352, for the proper method to determine basis for the computation of gain or loss.