                        T.C. Memo. 2005-34



                      UNITED STATES TAX COURT



   MAGUIRE/THOMAS PARTNERS FIFTH & GRAND, LTD., MAGUIRE/THOMAS
PARTNERS GRAND PLACE TOWER, LTD., TAX MATTERS PARTNER, Petitioner
         v. COMMISSIONER OF INTERNAL REVENUE, Respondent

  MAGUIRE/THOMAS PARTNERS LIBRARY SQUARE, LTD., MAGUIRE/THOMAS
   PARTNERS, HOPE PLACE, LTD., TAX MATTERS PARTNER, Petitioner
         v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 9834-00, 9835-00.      Filed February 28, 2005.


     Brian J. Seery and David H. Benz, for petitioners.

     Bradley T. Stanek and Michelle Leichtman, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     COLVIN, Judge:   Respondent issued two notices of final

partnership administrative adjustment, in which respondent

determined the following adjustments to the losses of
                                - 2 -

Maguire/Thomas Partners Library Square, Ltd. (Library Square) and

Maguire/Thomas Partners Fifth & Grand, Ltd. (Fifth & Grand):

       Year                       Adjustments
                      Library Square       Fifth & Grand

       1989            $1,468,471                --
       1990               863,015                --
       1991             1,973,438           $2,854,831
       1992             1,783,227              561,975
       1993             1,616,793                --
       1994             1,474,134              561,975
       1995             1,331,648              561,975
       1996             1,212,751              561,975

     Library Square built and operates Library Tower, a 73-story

building in Los Angeles, California.    Fifth & Grand built and

operates Grand Place Tower, a 55-story building in Los Angeles.

Both of these buildings were built pursuant to a development

agreement reached in 1985 between Maguire/Thomas Partners, Ltd.

(MTP) and the Community Redevelopment Agency (CRA) of the City of

Los Angeles.   To develop the Library Tower building, MTP paid CRA

$33,192,567 for certain land and development rights.     To develop

the Grand Place Tower building, MTP paid CRA $17,700,000 for

development rights.   MTP obtained the right to develop the

property at greater density (i.e., to build larger buildings)

than would have otherwise been permitted.    Library Square and

Fifth & Grand are the successors-in-interest to the rights and

obligations of MTP under that agreement.

     After concessions, the issues for decision are:
                               - 3 -

     1.    Whether Library Square may deduct depreciation it

claimed for the cost of obtaining development rights for 1989

through 1996.   We hold that it may to the extent discussed below.

     2.    Whether Fifth & Grand may deduct depreciation it

claimed for the cost of obtaining development rights for 1991,

1992, 1994, 1995, and 1996.   We hold that it may to the extent

discussed below.

     References to petitioners are to petitioner Maguire/Thomas

Partners, Hope Place, Ltd. (Hope Place), the tax matters partner

of Library Square, and petitioner Maguire/Thomas Partners Grand

Place Tower, Ltd. (Grand Place), the tax matters partner of Fifth

& Grand.   Section references are to the Internal Revenue Code in

effect for the years in issue, unless stated otherwise.   Rule

references are to the Tax Court Rules of Practice and Procedure.

                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

A.   Petitioners and Their Limited Partnerships

     1.    Petitioners

     When the petitions were filed, the principal place of

business for each partnership and its tax matters partner was Los

Angeles, California.

     2.    The Limited Partnerships

     Library Square and Fifth & Grand are limited partnerships

organized under California law.   Library Square operates Library
                               - 4 -

Tower, a 73-story office building in Los Angeles.    Fifth & Grand

operates Grand Place Tower, a 55-story office building in Los

Angeles.

B.   The Community Redevelopment Agency, Rehabilitation of the
     Central Library, and the Library Square Development Project

     1.    The Community Redevelopment Agency

     CRA is an independent administrative agency formed under the

Community Redevelopment Law, Cal. Health & Safety Code secs.

33000-33800 (West 1999 & Supp. 2000), to implement redevelopment

plans in the City of Los Angeles (the City).    CRA is not a

division or department of the City.    Cal. Health & Safety Code

sec. 33122 (West 1999).   CRA is subject to local zoning laws.

Cal. Govt. Code sec. 53091 (West 1997 & Supp. 2004).

     2.    Bunker Hill Redevelopment Plan and Central Business
           District Redevelopment Plan

     The property involved in these cases was subject to the

Bunker Hill Redevelopment Plan (BH Plan) and the Central Business

District Redevelopment Plan (CBD Plan).    The City enacted

ordinances in 1970 and 1975 approving the BH Plan and the CBD

Plan.

     3.    Library Square Development Project

     The City’s Cultural Heritage Board designated the Los

Angeles Central Library (Central Library) as an historical

building in 1967.   In 1981, the City gave to CRA the task of

rehabilitating the Central Library at no cost to the City.
                                - 5 -

     CRA’s plan to rehabilitate the Central Library became a part

of the Library Square development project.    We refer to the

parcel of land on which the Central Library is located and four

other parcels on which private development was planned as the

Library Square tract.   The Library Square tract consists of:    (1)

The Library Tower parcel, (2) the Garage Plaza parcel, (3) the

Grand Place Tower parcel, (4) the One Bunker Hill parcel, and (5)

the Central Library parcel.   These five parcels are contiguous or

separated only by public streets or rights of way.

     In September 1983, CRA requested proposals under which the

City and CRA would sell the Garage Plaza land and the development

rights to the Central Library parcel and part of the Central

Library parcel to a developer to facilitate development of an

adjacent or nearby site.    CRA hoped to finance the rehabilitation

of the Central Library through that sale.

     4.   Ownership of the Five Parcels

     During 1984, MTP and CRA negotiated the proposed Library

Square development project.   MTP then owned parts of the Library

Tower and Grand Place Tower parcels.    An entity related to MTP

owned the One Bunker Hill parcel.   The City owned the Central

Library and Garage Plaza parcels and part of the Library Tower

parcel and the public streets and rights of way to be included in

the Library Square tract.   MTP proposed to build an approximately

71-floor building on the Library Tower parcel, an approximately
                               - 6 -

65-floor building on the Grand Place Tower parcel, and an

underground parking garage on the Garage Plaza parcel.

C.   Building Density Limitations for the Library Square Tract

     1.   Floor Area Ratio Limits

     The Library Square tract was subject to the CBD Plan.      A

small part of a public right of way in the tract was subject to

the BH Plan.   During 1984 and 1985, the CBD and BH Plans

generally restricted development of parcels in the Library Square

tract to a maximum building density or floor area ratio (FAR) of

six times the buildable area1 of that building site.    The maximum

FAR under the CBD Plan was 6 to 1.     The BH Plan restricted

development to a maximum FAR of 5 to 1.

     Under section 437 of the CBD Plan and section 814 of the BH

Plan, CRA could grant a variation (i.e., a variance) to a

landowner to build a building exceeding the maximum FAR that

otherwise would have applied to that property.      The CBD and BH

Plans generally permitted one landowner to sell the unused

building density for that landowner’s property to a second

landowner, which would allow the second landowner to build a

higher density building.   See, e.g., sec. 418 of the CBD Plan.

Transferred building density was called transferred FAR (TFAR).



     1
       Under the CBD Plan, buildable area is based on a parcel’s
area less any public streets, sidewalks, or rights of way to
which the parcel is subject.
                                  - 7 -

Id.2    The transfer of building density typically was accomplished

by the first landowner’s recording a covenant running with the

land against the first landowner’s property in favor of the

second landowner’s property.3      Neither the City nor CRA

transferred FAR to MTP in connection with Phases I, II, and III

of the Ownership Participation Agreement (OPA)4 between CRA and

MTP under section 418 of the CBD Plan.

       2.     Buildable Area Limits Imposed by the Los Angeles City
              Charter

       In addition to the maximum FAR imposed by the CBD and BH

Plans, the Los Angeles City Charter (City Charter) restricted

development to 13 times the buildable area of the building site.

CRA could grant a landowner a variation to exceed the maximum FAR

limits of the CBD and BH Plans; however, CRA could not permit by

variation construction of a building in excess of the City

Charter’s 13-to-1 limitation.

       3.     Treatment of the Library Square Tract as One Building
              Site

       Under the City Charter, the Library Tower and Grand Place

Tower parcels were separate building sites.      If the Library Tower

and Grand Place Tower parcels were treated as separate building


       2
      See Mitsui Fudosan (U.S.A.), Inc. v. County of Los Angeles,
268 Cal. Rptr. 356, 357-359 (Ct. App. 1990).
       3
           See id. at 358.
       4
           See discussion at par. D of the Findings of Fact below pp.
9-11.
                                       - 8 -

sites, the FAR for each of the proposed Library Tower and Grand

Place Tower buildings would exceed 23 to 1.

     During MTP’s and CRA’s negotiation of the Library Square

development project in 1984, it was proposed that the City enact

an ordinance treating the Library Square tract as a single

building site.      Under this ordinance, CRA would issue variations

to MTP permitting MTP to build Library Tower and Grand Place

Tower buildings as follows:

                                      Table 1

                  Buildable Area                       Total Permitted Net Floor Area
                    Sq. Footage                                  Sq. Footage
Parcel           Gross       Net       Permitted        Without Ord. &    With Ord. &
                                          FAR            CRA Variation   CRA Variation
Library           69,277    55,600      6.0 : 1              333,600        1,300,000
Tower
                                        1                                      2
Garage Plaza      75,000    75,000       7.5 : 1            562,500            6,000
Grand Place       60,500    52,500       6.0 : 1            315,000        1,200,000
Tower
                                        3
One Bunker        30,384    30,400       7.2 : 1            220,000          240,000
Hill
Central
                                        1
Library          147,211   147,211       7.5 : 1           1,104,083         361,000
Totals           382,372   360,711                         2,535,183       3,107,000


                                                   4
                                   Overall FAR:     8.12

     1
       Includes a 25 percent density bonus for rehabilitation and expansion
  of the Central Library.

     2
       To be built within a building footprint not exceeding 3,000 square
  feet.

     3
         The square footage of the existing building.
     4
       Computed on the basis of gross buildable area square footage
  (3,107,000 divided by 382,372, i.e., about 8.12). The City’s Central City
  Community Plan provides for calculating FAR based on gross buildable square
  footage, and the CBD Plan provides for calculating FAR based on net
  buildable square footage. Overall FAR with respect to the five parcels
  would be 8.61 if computed on a net buildable square footage basis.
  (3,107,000 divided by 360,711, i.e., about 8.61.)
                               - 9 -


     The City and CRA wanted MTP to build the Library Tower and

Grand Place Tower because these buildings would enhance the value

of the Library Square project, thereby increasing the fee that

CRA could charge MTP for the Garage Tower parcel land and the

Central Library parcel density rights.   CRA would use that higher

fee to finance the rehabilitation of the Central Library.

D.   The Ownership Participation Agreement, the Cooperation
     Agreement, the MTP Designated Building Site, and the Library
     Tower and Grand Place Tower Variations

     The City, CRA, and MTP reached two principal agreements

relating to the Library Square project in 1985:   (1) The Owner

Participation Agreement (OPA) between CRA and MTP, and (2) the

Cooperation Agreement between the City and CRA (the Cooperation

Agreement).   The final Cooperation Agreement was virtually

identical to the draft cooperation agreement attached to the OPA.

     1.   The Ownership Participation Agreement

     Library Tower and Grand Place Tower were developed under the

OPA reached by MTP and CRA on July 9, 1985.5

     MTP’s obligations under the OPA were conditioned on

designation of the Library Square tract as a designated building

site pursuant to Ordinance No. 159802 (the MTP designated



     5
       Library Square and Fifth & Grand are successors in
interest to the rights and obligations of MTP under the OPA.
Robert F. Maguire III (Maguire) and James A. Thomas (Thomas) were
the principals of MTP, and they controlled Library Square and
Fifth & Grand.
                                - 10 -

building site).6   Attachments to the OPA included: (1) A draft

MTP designated building site application, and (2) drafts of the

variations that the City, CRA, and MTP expected CRA to issue to

MTP with respect to the planned Library Tower and Grand Place

Tower buildings.   MTP’s obligations under the OPA were also

conditioned on CRA’s showing that the variations for the Library

Tower and Grand Place Tower buildings had been approved and were

in effect.

     The OPA provided for development of the Library Square

project in three phases.   Phase I covered the development of the

Library Tower building.    Phase II covered the development of an

underground parking garage and a garden plaza on the Garage Plaza

parcel.   Phase III covered MTP’s option to develop the Grand

Place Tower building on the Grand Place Tower parcel.

     During Phase I, CRA conveyed to MTP the Garage Plaza parcel

and other land (including part of the Library Tower parcel), all

of which CRA had obtained from the City pursuant to the

Cooperation Agreement.    CRA transferred the Garage Plaza parcel

subject to a permanent easement retained by the City to maintain

a garden plaza on the parcel.    MTP paid $33,192,567 to CRA to

acquire development rights and land in connection with Phases I

and II.   MTP paid $17,700,000 to CRA to acquire development



     6
       We discuss Ordinance No. 159802 at Findings of Fact par.
B-3, below pp. 12-14.
                                - 11 -

rights in connection with Phase III and to develop the Grand

Place Tower building.    The Grand Place Tower parcel was assembled

from land that MTP owned.

     2.     The Cooperation Agreement

     A general purpose of the Cooperation Agreement was to

preserve and rehabilitate the Central Library.     Under the

Cooperation Agreement, CRA pledged to spend up to $110,400,000

($48,975,000 of which CRA would obtain from MTP pursuant to the

OPA) for that purpose.     CRA made the pledge to the City in

consideration for land and other rights it would receive from the

City under the Cooperation Agreement.     CRA, in turn, would convey

this land and other rights to MTP pursuant to the OPA.

     The City conveyed the Garage Plaza parcel, part of the

Library Tower parcel, and other land to CRA.     CRA conveyed that

land to MTP pursuant to the OPA.     Under the Cooperation

Agreement, CRA agreed to reserve the same easements, rights, and

covenants that the City had reserved in its conveyance to CRA.

     Under the Cooperation Agreement, the City agreed to record a

covenant running with the land for the benefit of the City and

CRA against the Central Library parcel limiting the Central

Library building to 361,000 square feet and prohibiting further

development of the Central Library parcel.     The City executed and

recorded this covenant with the Los Angeles County Recorder in

1987.     The covenant is binding on the owner of the Central
                              - 12 -

Library parcel and any future owners until released by the City

Council and CRA.   Under the Cooperation Agreement, the City also

agreed to record a covenant running with the land for the benefit

of the City against the Central Library parcel which met the

requirements of the MTP Designated Building Site Application and

Ordinance No. 159802.7

     3.   The MTP Designated Building Site

     The City enacted Ordinance No. 159802 on April 30, 1985.

Ordinance No. 159802 defines a “designated building site” as an

area of real property, located within the CBD and/or BH Plan

area, which consists of parcels that are contiguous or separated

only by public streets or rights of way, and which is designated

by the City Council to implement the preservation of a City-owned

and operated historic structure.   This ordinance permitted parts

of the designated building site to be owned by different parties,

and it required an application for such designated building site

to be filed with the City Planning Commission.

     CRA and MTP filed the MTP Designated Building Site

Application with the City Planning Commission.   In the

application, they requested that the five Library Square parcels

be designated as a building site under Ordinance No. 159802.    The

application described the development that would be permitted on


     7
       That covenant and related covenants executed by MTP’s
successors and a related entity against the four other Library
Square parcels are discussed below pp. 12-13.
                              - 13 -

the five parcels, and the Library Tower and Grand Place Tower

variations that CRA would issue to MTP.   This development to be

permitted was the same as shown in Table 1, supra p. 8.    The City

Council approved the MTP application on August 13, 1985.

     Ordinance No. 159802 required that the terms, limitations,

and controls imposed by the City Council be placed into written

agreements describing:   (1) The MTP Designated Building Site, (2)

each of the individual parcels in the MTP Designated Building

Site, (3) the buildable area and total permitted floor area of

each parcel, and (4) any other matters which are desirable.   The

ordinance required that those terms, limitations, and controls be

designated as “covenants running with land” of each parcel.

     In compliance with the ordinance, the City and the owners

of the other four Library Square tract parcels executed and

recorded against their parcel(s) an “Agreement Containing

Covenants [Designated Building Site]”.    Each covenant ran with

the land and was binding on the owner and future owners until

released by the City.    The covenants also provided as follows:
                                 - 14 -

                                Table 2

                                 Buildable Area       Maximum Permitted
                                   Sq. Footage          Net Floor Area
     Covenant                     Gross      Net         Sq. Footage

     Library Tower Parcel         69,277     55,600       1,300,000
     Garage Plaza Parcel          75,000     75,000           6,0001
     Grand Place Tower            60,550     52,500       1,200,000
       Parcel
     One Bunker Hill Parcel       30,384     30,400         240,000
     Central Library Parcel      147,211    147,211         361,000
     1
     With a building footprint up to 3,000 square feet.

E.       The Library Tower and Grand Place Tower Variations

         MTP’s obligations under the OPA were conditioned on

issuance by CRA to MTP of variations under section 437 of the

CBD Plan permitting the Library Tower and Grand Place Tower

buildings to be built.      Section 437 of the CBD Plan provides

that no variation issued by CRA is effective until any necessary

zoning changes have been obtained.        The Library Tower and Grand

Place Tower variations issued by CRA to MTP were not effective

until the MTP Designated Building Site Application had been

approved by the City.

         On June 17, 1985, CRA adopted resolution No. 3548 to permit

MTP to exceed FAR limitations in developing the Library Tower

building, the Garage Plaza underground parking garage, and the

garden plaza.      In conjunction with Ordinance No. 159802 and the

MTP Designated Building Site, this variation increased allowable

floor area by 413,900 square feet, permitted MTP to develop the

Library Tower building with floor area up to 1.3 million square
                              - 15 -

feet, and restricted development by MTP of the Garage Plaza

parcel to no more than 6,000 square feet of floor area.    This

variation would be voided if the OPA were terminated because MTP

defaulted, but it would become unconditional and irrevocable if

CRA certified to MTP that construction and development of the

property had been completed satisfactorily.

     CRA adopted a resolution permitting MTP to exceed FAR

limitations for the Grand Place Tower building.     This variation,

in conjunction with Ordinance No. 159802 and the MTP Designated

Building Site, increased the amount of allowed floor area by

885,000 square feet and permitted MTP to develop the Grand Place

Tower building with floor area up to 1.2 million square feet.

This variation was conditioned on MTP’s paying all amounts it

owed under the OPA, including $17,700,000 for Phase III.     This

variation would be nullified if the OPA were terminated by

reason of default by MTP.   It would become irrevocable if CRA

certified to MTP that construction and development of the

property had been completed satisfactorily.

     Library Tower was placed in service in 1989.    Grand Place

Tower was placed in service in 1991.   On March 18, 1998, CRA

certified to MTP that all construction and development required

by Phases I, II, and III of the OPA had been completed

satisfactorily.
                              - 16 -

F.   Development Rights That MTP Obtained Under the OPA; Zoning
     Change Made for the Library Square Tract by Ordinance No.
     159802

     As stated at paragraph D-1 above, MTP obtained certain

development rights and/or land in exchange for MTP’s specified

payments to CRA.   Ordinance No. 159802 and the MTP Designated

Building Site covering the Library Square tract represented an

important part of those development rights that MTP obtained.

     Without Ordinance No. 159802 and treatment of the Library

Square tract as a Designated Building Site, CRA by variation

alone could not have authorized MTP to build the Library Tower

and Grand Place Tower buildings.   The effect of Ordinance 159802

and treatment of the Library Square Tract as a Designated

Building Site was to make a zoning change which (1) treated the

five Library Square parcels as one building site in order to

comply with the City Charter’s 13-to-1 building density

limitation; and (2) provided a mechanism (i.e., the covenants

running with the land) whereby the unused building density of

the Central Library and Garage Plaza parcels could be used for

the Library Tower and Grand Place Tower parcels.

     The OPA and the Cooperation Agreement (1) included the

City’s agreement to the zoning change for the Library Square

tract, and (2) provided for the sale by the City and CRA to MTP

of the unused building density of the Central Library parcel.
                                 - 17 -

     As to the covenants running with the land which the City

would record against the Central Library parcel, the Cooperation

Agreement provided in pertinent part:

                              ARTICLE VIII

                     Covenants on Library Parcel

          8.1 Covenant on Library Parcel Restricting
     Further Development. City agrees to record, among the
     land records of Los Angeles County, a covenant running
     with the land against Library Parcel limiting the
     Floor Area of the rehabilitated and expanded Central
     Library to 361,000 net useable square feet and
     prohibiting the development of any other Floor Area on
     such property. Said covenant shall be recorded
     concurrently with the close of Phase I Escrow and
     shall be for the benefit of City and Agency [CRA].

          *      *        *       *       *    *    *

          8.3 Covenant on Library Parcel to Satisfy
     Designated Building Site Ordinance. City agrees to
     record, among the land records of Los Angeles County,
     a covenant running with the land against Library
     Parcel fulfilling the requirements of the Designated
     Building Site Application and Designated Building Site
     Ordinance defined herein. This covenant shall also be
     recorded concurrently with the close of Phase I Escrow
     and shall be for the benefit of City.

The draft Cooperation Agreement attached to the OPA contained

identical provisions concerning covenants on the Central Library

parcel.

G.   Library Square and Fifth & Grand Tax Returns and
     Respondent’s FPAA Determinations

     Library Square allocated $14,249,918 of the $33,192,567

that MTP paid to CRA to land which MTP acquired from CRA.

Library Square included the remaining $18,942,649 that MTP paid
                                - 18 -

for development rights in the depreciable basis of Library

Tower.     Library Square did not deduct any of the $14,249,918 as

depreciation, and that amount is not an issue in these cases.

Library Square included the remaining $18,942,649 in the

depreciable basis of Library Tower and deducted an amount based

thereon in its tax returns for 1989-96.

      Fifth & Grand included the $17,700,000 that MTP paid to CRA

for development rights in connection with Phase III of the OPA

in the depreciable basis of Grand Place Tower and deducted

amounts based thereon in its tax returns for 1991-92 and 1994-

96.

      In Notices of Final Partnership Administrative Adjustments

(FPAA) issued to Library Square for 1989-96, and to Fifth &

Grand for 1991-92 and 1994-96, respondent disallowed the

depreciation Library Square and Fifth & Grand had claimed with

respect to costs incurred to acquire development rights.

                               OPINION

A.    The Parties’ Arguments

      1.    Petitioners’ Arguments

      Petitioners contend that (a) all of the development costs

in issue were incurred to acquire the variations that allowed

Library Square and Fifth & Grand to construct Library Tower and

Grand Place Tower; (b) Ordinance No. 159802 and the MTP

Designated Building Site added nothing to the rights that
                              - 19 -

Library Square and Fifth & Grand obtained under the variations;

(c) the Library Tower and the Grand Place Tower variations

provided only a one-time right to build Library Tower, the

Garage Plaza’s underground parking garage, and the Grand Place

Tower; (d) the OPA and the Cooperation Agreement gave no

meaningful rights to Library Square and Fifth & Grand extending

beyond the respective lives of the Library Tower and Grand Place

Tower buildings; and (e) Library Square and Fifth & Grand may

depreciate those development costs over a 31.5-year recovery

period.

     2.   Respondent’s Arguments

     Respondent contends that none of the costs that Library

Square and Fifth & Grand incurred for development rights are

depreciable.   Respondent asserts:   (1) Library Square and Fifth

& Grand acquired building density rights or TFAR from other

parcels; (2) their development rights cannot be separated from

their Library Tower parcel or Grand Place Tower parcel and are

interests in land; (3) the MTP Designated Building Site and the

Library Tower and Grand Place Tower variations are akin to a

zoning change, and, thus, are not depreciable; and (4) the

development rights do not have a limited useful life.

B.   Applicable Legal Standards

     Section 167 generally allows as a depreciation deduction a

reasonable allowance for exhaustion and wear and tear of
                                - 20 -

property used in business or property held for the production of

income.     However, land generally is not depreciable because it

has no limited useful life and is not subject to exhaustion or

obsolescence.     Bender v. United States, 383 F.2d 656, 659 (6th

Cir. 1967); sec. 1.167(a)-2, Income Tax Regs.

     In addition, a taxpayer’s cost of obtaining a zoning change

for that taxpayer’s land must be capitalized and is not

depreciable if the benefits resulting from the zoning change are

indefinite and undeterminable in duration.     Galt v.

Commissioner, 19 T.C. 892, 910 (1953), revd. in part and affd.

in part on other issues 216 F.2d 41 (7th Cir. 1954); see Oliver

v. Commissioner, T.C. Memo. 1976-145, affd. 553 F.2d 560 (8th

Cir. 1977); Ackerman Buick, Inc. v. Commissioner, T.C. Memo.

1973-224.

C.   The Expert Testimony

     Petitioners and respondent offered expert testimony.       The

reports prepared by petitioners’ expert and respondent’s expert

were admitted in evidence as their direct testimony.     We may

reject the testimony of an expert witness, in whole or in part,

in the exercise of our sound judgment.     Helvering v. Natl.

Grocery Co., 304 U.S. 282, 295 (1938); In re Estate of Williams,

256 F.2d 217, 219 (9th Cir. 1958), affg. T.C. Memo. 1956-239.
                                  - 21 -

     1.     Petitioners’ Expert

     Petitioners’ expert was an attorney with extensive

experience in representing clients engaged in real estate

development projects, including private developers,

redevelopment agencies, cities, and other public and private

entities.   He said that a variation provides project-specific

relief to a property owner from an otherwise applicable zoning

restriction, and that a variation covers only the particular

structure to be built.   He opined that a variation gives a

property owner no right to construct a replacement building on

that property.

     Petitioners’ expert opined that Library Square and Fifth &

Grand obtained no benefits for the Library Tower and Grand Place

Tower parcels other than the Library Tower and Grand Place Tower

variations.   In contrast, he said that the covenants the City

recorded against the Central Library parcel would remain in

effect until released by the City and/or CRA.

     Enactment by the City of Ordinance No. 159802 allowed the

MTP Designated Building Site to be established in order to treat

the five Library Square tract parcels as a single building site

to meet the City Charter’s 13-to-1 building density limitation.

Petitioners’ expert said that ordinance merely allowed CRA to

find and negotiate an agreement with a private developer wanting
                                   - 22 -

the relief that CRA would grant pursuant to the Library Tower

and Grand Place Tower variations.

     2.      Respondent’s Expert

     Respondent’s expert is an attorney with extensive

experience representing developers and landowners in

constructing, financing, buying, and selling commercial and

residential real estate, and in obtaining regulatory approval

for real estate development.       He formerly worked in the Office

of the City Attorney for the City and County of San Francisco.

His duties there included advising the San Francisco Zoning

Administrator on the granting of variations and overseeing San

Francisco’s Transfer of Development Rights program and

negotiations of approvals for developers of large developments.

     Respondent’s expert stated that, if the Library Tower or

Grand Place Tower were to be replaced, the property owner would

be required to obtain a second variation in order to construct

another building of the same density on the property.      He opined

that the existence of the prior Library Tower and Grand Place

Tower variations, the MTP Designated Building Site, and the

restrictive covenants covering the Library Square Tract parcels

would put the owner in a stronger position to obtain a second

variation.    He opined that there would be no certainty that a

second variation permitting a building of similar density would
                                  - 23 -

be granted, but the owner could reasonably expect to be

successful.

     Respondent’s expert disagreed with petitioners’ expert’s

opinion that the Library Tower and Grand Place Tower variations

rendered Ordinance No. 159802 and the MTP Designated Building

Site unimportant.    He said those variations could not have been

granted without Ordinance No. 159802 and the MTP Designated

Building Site.

     3.   Analysis

     Contrary in part to the arguments of both parties, we

conclude that the costs of obtaining the development rights in

issue for Library Square and Fifth & Grand are partly

depreciable.

          a.     The Variations

     Both parties’ experts agreed that the Library Tower and

Grand Place Tower variations would not survive the buildings for

which those variations were granted.       If Library Tower or Grand

Place Tower were to be replaced, the owner could not build

another building exceeding the then-zoning building density

limit for the property without obtaining a second variation.

     Respondent contends that the terms of the variations

support respondent’s position.      We disagree.   The variations by

their terms do not automatically apply to buildings other than

those already placed in service.
                             - 24 -

     The variations, by their terms, become irrevocable when the

CRA certifies that construction and development of the property

has been completed satisfactorily.    Respondent argues that this

means that the variations conveyed a benefit to the landowner

that is either perpetual or indefinite.   We disagree.   Both

parties’ experts testified to the contrary and said essentially

that the variations do not automatically apply to buildings

built after those already placed in service.   Their opinion is

shared by Murray Kane, who drafted the variations for CRA.      When

asked at trial whether the variations would endure forever, he

said: “No, it doesn’t speak to perpetuity.   It merely means that

the redevelopment agency could not revoke the permission to

build this building that was granted by this variation.”

     We conclude: (1) The costs of the Library Tower and Grand

Place Tower variations are allocable to the building that was

the subject of that variation (i.e., Library Tower or Grand

Place Tower) and not to the land; (2) those variations have

limited useful lives equal to the depreciable lives of Library

Tower and Grand Place Tower; and (3) the costs of obtaining

those variations are includable in the depreciable basis of

Library Tower and Grand Place Tower.

          b.   Ordinance No. 159802 and MTP Designated Building
               Site

     We disagree with petitioners’ contention that the

variations were the only meaningful benefits that Library Square
                               - 25 -

and Fifth & Grand obtained.    Without Ordinance No. 159802 and

the MTP Designated Building Site, CRA could not have permitted

by variation MTP’s development of Library Tower and Grand Place

Tower.    This ordinance and the MTP Designated Building Site

effected a zoning change which (1) treated the five Library

Square tract parcels as a single building site in order to

comply with the City Charter’s 13-to-1 building density

limitation,, and (2) provided a mechanism whereby the unused

building density of the Central Library and Garage Plaza parcels

could be used for the Library Tower and Grand Place Tower

parcels.

     Unlike the Library Tower and Grand Place Tower variations,

the zoning change made by Ordinance No. 159802 and the MTP

Designated Building Site produced benefits of an indefinite and

undeterminable duration.    Neither Ordinance No. 159802 nor the

other operative documents for the MTP Designated Building Site

set a time limit on the duration of the MTP Designated Building

Site.    Ordinance No. 159802 provides only that the terms,

limitations, and controls with respect to a designated building

site established pursuant to that ordinance, as determined by

the City Council, be placed into covenants running with the land

recorded against each parcel within such designated building

site.    The covenants running with the land that the City,

Library Square, Fifth & Grand, and another entity related to MTP
                                - 26 -

recorded against their Library Square tract parcels to fulfill

the requirements of the MTP Designated Building Site Application

continue in effect until released by the City.

     Although the City could repeal Ordinance No. 159802 and the

MTP Designated Building Site, that possibility exists for any

zoning change.   A property owner has no vested right to have its

property’s current zoning continued; a local governmental or

zoning authority, in the exercise of its police power, may later

revise the property’s zoning.    See, e.g., Avco Cmty. Developers,

Inc. v. S. Coast Regl. Commn., 553 P.2d 546 (Cal. 1976) (a

governmental authority may not contract away its right to

exercise its police power in the future).

     We conclude that the zoning change made by Ordinance No.

159802 and the MTP Designated Site produced benefits of an

indefinite and undeterminable duration for the Library Tower and

Grand Place Tower parcels and/or the owners of those parcels.

The cost of obtaining this zoning change is thus not depreciable

by either Library Square or Fifth & Grand, but it must instead

be capitalized and allocated to the Library Tower parcel or

Grand Place Tower parcel.   Galt v. Commissioner, 19 T.C. at 910;

cf. Chevy Chase Land Co. v. Commissioner, 72 T.C. 481, 487-489

(1979) (the costs incurred by the taxpayer for an unsuccessful

rezoning effort were deductible as an abandonment loss).    Our

case here is like Galt and is distinguishable from Chevy Chase
                                - 27 -

Land Co.   In Galt, the taxpayer wanted to lease his fairgrounds

for harness racing, and he obtained a zoning change for the

property to permit parking and the sale of beverages thereon.

The taxpayer in Galt then entered into a 20-year lease agreement

for his property and depreciated the cost of obtaining the

zoning change over the 20-year life of the lease.    The Tax Court

noted that the zoning change affected the property beyond the

20-year term of the lease and held that the cost of the zoning

change was not depreciable because the zoning change produced

benefits of an indefinite and undeterminable duration.       Galt v.

Commissioner, supra at 909-910.    In contrast, in Chevy Chase

Land Co., the taxpayer unsuccessfully sought to have its land

rezoned in order to construct a Bloomingdale’s store.       The

taxpayer in Chevy Chase Land Co. had previously reached an

agreement to lease the land to Federated Dept. Stores (the owner

of the Bloomingdale’s chain).    This lease agreement was

contingent upon a favorable ruling on the rezoning application

for the land.   After the rezoning application was denied,

Federated Dept. Stores terminated the lease agreement for the

land.   The Tax Court allowed the taxpayer to deduct the costs of

the rezoning effort as an abandonment loss after Bloomingdale’s

transaction terminated since the Bloomingdale’s lease

transaction was contingent upon obtaining the rezoning.      See

Chevy Chase Land Co. v. Commissioner, supra at 482-488.       The Tax
                                - 28 -

Court in Chevy Chase Land Co. distinguished Galt.      See id. at

487-488.   Unlike Chevy Chase Land Co., in our case MTP obtained

the necessary zoning change for the Library Square tract and

proceeded with the Library Square project and the building of

Library Tower and Grand Place Tower.

           c.   Allocation

     As previously stated, the costs that MTP and its successors

incurred to obtain the Library Tower and Grand Place Tower

variations are includable in the depreciable bases of those

buildings and are depreciable by Library Square and by Fifth &

Grand, but neither Library Square nor Fifth & Grand may

depreciate the costs incurred to obtain the zoning change.

     The record does not show the cost of obtaining the zoning

change separate from the variations.     We suspect those separate

costs may not be readily available.      Because of the difficulty

of separately accounting for those costs, we believe this is an

appropriate situation for the Court to identify a reasonable

method to make an allocation.    See Cohan v. Commissioner, 39

F.2d 540, 544 (2d Cir. 1930).    We conclude that the allocation

between the zoning change and the variations should be based

upon the relative increase in each property’s buildable net

floor area square footage attributable to the zoning change as

opposed to the variations.
                              - 29 -

     The CBD and Bunker Hill Redevelop. Plans generally

permitted a FAR of 6 to 1 with respect to the five Library

Square tract parcels.   The zoning change, among other things,

established a mechanism (i.e., the covenants running with the

land recorded by each Library Square tract owner against its

parcel) whereby the unused building density of the Central

Library and Garage Plaza parcels was used for the Library Tower

and Grand Place Tower parcels.   The record reflects that,

through this zoning change (i.e., with Ordinance No. 159802 and

the MTP Designated Building Site in place), MTP and its

successors obtained an additional 1,557,266 square feet of floor

area for the Library Tower and Grand Place Tower parcels.    The

1,557,266 square footage of floor area is calculated as follows:

                                    Permitted net floor
                                    area sq. footage with
          Parcel                    zoning change

          Library Tower                           X (unknown)
          Garage Plaza                        6,000
          Grand Place Tower                       Y (unknown)
          One Bunker Hill                   240,000
          Central Library                   361,000
                                        1
              Total:                      2,164,266
                                                2
                                 Overall FAR:    6.0
          1
           The total of the amounts for Library Tower and Grand
     Place Tower account for the difference between the numbers
     appearing in this chart and 2,164,266. The net buildable
     area of the five parcels, multiplied by six. 360,711 times
     6 equals 2,164,266. See Table 1, supra p. 8.

          2
            Computed on the basis of net buildable square footage
     as the CBD Plan provides.
                                     - 30 -

     2,164,266 - 6,000 - 240,000 - 361,000 = 1,557,266

     This 1,557,266 of additional net floor area square footage

(attributable to the zoning change) must be allocated between

the Library Tower and the Grand Place Tower parcels.        We

conclude that that allocation may be based on the relative total

net floor area of the Library Tower building and the Grand Place

Tower building.       We further conclude that the zoning change

produced (1) an increase of 809,778 of net floor area square

footage for the Library Tower parcel, and (2) an increase of

747,488 of net floor area square footage for the Grand Place

Tower parcel.       These increases in net floor area square footage

were calculated as follows:

                     Planned total       Allocation of additional net
                    net floor area      floor area sq. footage produced
Building              sq. footage             from zoning change
                                                 1
Library Tower         1,300,000                   809,778
                                                 2
Grand Place           1,200,000                   747,488
  Tower

     1
            1,557,266 x 1,300,000 = 809,778 (rounded).
                        2,500,000
        2
            1,557,266 x 1,200,000 = 747,488 (rounded).
                        2,500,000

        Thus, MTP and its successor Library Square obtained under

their development rights pursuant to phases I and II of the OPA

an increase of 809,7788 square feet in buildable net floor area

for the Library Tower parcel attributable to the zoning change.


    8
            Square footage is sometimes rounded in this opinion.
                                 - 31 -

We also find that MTP and Library Square obtained under their

development rights pursuant to phases I and II of the OPA an

increase of 490,222 square feet (i.e., 1,300,000 minus 809,778)

in buildable net floor area for the Library Tower building

attributable to the Library Tower variation.

     Similarly, we find that MTP and its successor Fifth & Grand

obtained under their development rights pursuant to phase III of

the OPA an increase of 747,488 square feet in buildable net

floor area for the Grand Place Tower parcel attributable to the

zoning change.    We also find that MTP and Fifth & Grand obtained

under their development rights pursuant to phase III of the OPA,

an increase of 452,512 square feet (i.e., 1,200,000 minus

747,488) in buildable net floor area for the Grand Place Tower

building attributable to the Grand Place Tower variation.

     We further find as to the $18,942,649 that MTP paid to

obtain those development rights pursuant to phases I and II of

the OPA that:    (1) $11,799,493 was incurred to obtain the zoning

change,9 and (2) the remaining $7,143,156 was incurred to obtain

the Library Tower variation.10    Similarly, we find as to the

$17,700,000 that MTP paid to obtain those development rights

pursuant to phase III of the OPA that:    (1) $11,025,448 was


    9
         $18,942,649 x    809,778 sq. ft. = $11,799,493.
                         1,300,000 sq. ft.
    10
         $18,942,649 x    490,222 sq. ft. = $7,143,156.
                         1,300,000 sq. ft.
                                - 32 -

incurred to obtain the zoning change,11 and (2) the remaining

$6,674,552 was incurred to obtain the Grand Tower variation.12

     We hold that Library Square may depreciate and include in

the depreciable basis of Library Tower the $7,143,156 that we

have determined is attributable to obtaining the Library Tower

variation.   We further hold that Library Tower may not

depreciate the $11,799,493 that we have determined is

attributable to obtaining the zoning change, as that zoning

change produced benefits of an indefinite and undeterminable

duration with respect to the Library Tower parcel land.    Galt v.

Commissioner, 19 T.C. at 910.

     We hold that Fifth & Grand may depreciate and include in

the depreciable basis of Grand Place Tower the $6,674,552 that

we have determined is attributable to obtaining the Grand Place

Tower variation.   We further hold that Fifth & Grand may not

depreciate the $11,025,448 that we have determined is

attributable to obtaining the zoning change because the zoning

change produced benefits of an indefinite and undeterminable




    11
         $17,700,000 x    747,488 sq. ft. = $11,025,448.
                         1,200,000 sq. ft.
    12
         $17,700,000 x    452,512 sq. ft. = $6,674,552.
                         1,200,000 sq. ft.
                             - 33 -

duration with respect to the Grand Place Tower parcel land.     Id.

     To reflect the foregoing and concessions by the parties,



                                   Decisions will be entered

                              under Rule 155.
