                         111 T.C. No. 10



                     UNITED STATES TAX COURT



        U.S. BANCORP AND ITS CONSOLIDATED SUBSIDIARIES,
   Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent




     Docket No. 27342-96.1             Filed September 21, 1998.



          P, a bank holding company, leased a mainframe
     computer from ICC, a finance corporation, for a 5-year
     term. Less than 1 year later, P decided that the
     computer was no longer adequate for its needs. P
     thereupon entered into a “rollover agreement” with ICC,
     whereby the lease was terminated upon the condition,
     among other things, that P commit to finance the

     1
       On Nov. 18, 1997, the Court granted petitioner's motion to
consolidate this case for trial, briefing, and opinion with the
case at docket No. 6544-97. The issue herein is not related to
the issues in docket No. 6544-97 and does not involve the tax
years at issue in docket No. 6544-97. Therefore, the Court, by
order dated Sept. 15, 1998, denied petitioner’s motion for
partial summary judgment and respondent’s cross-motion for
partial summary judgment on the IBM lease issue in the case at
docket No. 6544-97. The order pursuant to this opinion will be
issued only in docket No. 27342-96.
                                   - 2 -


        replacement equipment with ICC. The rollover agreement
        provided for a $2.5 million rollover charge to be paid
        by P. Shortly thereafter, pursuant to the rollover
        agreement, P leased a more powerful mainframe computer
        from ICC for a 5-year term. ICC financed P's
        obligation to pay the $2.5 million rollover charge over
        the 5-year term of the second lease.

             Held: The $2.5 million rollover charge P incurred
        is not currently deductible in the year of termination
        of the first lease but must be capitalized and
        amortized over the 5-year term of the second lease.



        Richard A. Edwards and David W. Brown, for petitioner.

        William P. Boulet, Jr. and Virginia L. Hamilton, for

respondent.

                                  OPINION

        BEGHE, Judge:    This matter is before the Court on the

parties' motions for partial summary judgment filed under Rule

121.2       Petitioner's principal office was located in Portland,

Oregon, when it filed the petition.

        The sole issue for decision is whether the charge incurred

by a lessee in terminating a lease of a mainframe computer and

simultaneously initiating a new lease of a more powerful

mainframe computer with the same lessor is deductible in the year

incurred or must be capitalized and amortized over the 5-year




        2
       All Rule references are to the Tax Court Rules of Practice
and Procedure. All section references are to the Internal
Revenue Code in effect for the years at issue.
                               - 3 -


term of the new lease.   We hold that the charge must be

capitalized and amortized over the term of the new lease.

     The background facts set forth below are derived from the

pleadings in this case, petitioner's request for admissions,

respondent's responses to petitioner's request, affidavits and

exhibits attached to petitioner's motion for partial summary

judgment, respondent’s cross-motion for partial summary judgment,

the declaration and exhibits attached to respondent's response to

petitioner's motion, the exhibits attached to petitioner's reply

to respondent's response, and the exhibits and affidavits

attached to petitioner's first and second supplemental replies to

respondent's response.   The background facts do not appear to be

in dispute and are set forth solely for purposes of deciding the

motions and are not findings of fact for this case.   Fed. R. Civ.

P. 52(a); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520

(1992), affd. 17 F.3d 965 (7th Cir. 1994).

Background

     Petitioner is a successor in interest by merger of West One

Bancorp.   Moore Financial Group, Inc. (Moore Financial), was a

national bank holding company incorporated in the State of Idaho

in 1981.   In 1989, Moore Financial changed its name to West One

Bancorp (West One).   In 1995, West One merged into U.S. Bancorp

(Old Bancorp), a bank holding company incorporated in the State

of Oregon.   In 1997, Old Bancorp merged into First Bank System,
                                - 4 -


Inc., a bank holding company incorporated in the State of

Delaware, which then changed its name to U.S. Bancorp

(petitioner).   West One was a calendar year taxpayer that used

the accrual method of accounting for 1989 and 1990, the tax years

in issue.

     The leases at issue in this case were between West One as

lessee and IBM Credit Corp. (ICC) as lessor.      For purposes of

leasing computer equipment, ICC uses a document captioned "Term

Lease Master Agreement" (the Master Agreement), which contains an

umbrella set of terms.   Customers of ICC sign the Master

Agreement, whose terms then govern all future lease transactions

between ICC and the customer.   When a customer enters into an

individual lease transaction, it signs a document captioned "Term

Lease Supplement" (Supplement), which expressly incorporates the

terms of the Master Agreement and contains a description of the

leased equipment, price terms, financing arrangements, and other

factors unique to the transaction.      The Master Agreement

explicitly provides that the lease cannot be canceled and does

not provide for a specific charge in case of early termination of

the lease or for a formula for computing any such charge.

     West One, at the time still named Moore Financial, executed

the Master Agreement with ICC in March 1989.      In August 1989,

West One leased an IBM 3090 mainframe computer (the 3090) from

ICC (the First Lease).   The lease term commenced August 30, 1989,
                               - 5 -


and was to end on June 28, 1994, and called for monthly payments

of $128,701.   The Supplement for the First Lease has not been

provided to the Court.

     During 1990, West One determined that the 3090 was no longer

adequate for its needs and that an upgrade to a more powerful

mainframe computer would be required.   Accordingly, in October

1990, West One and ICC executed a document captioned the

"Rollover Agreement" (the Agreement).   Under the Agreement, ICC

released West One from its obligations under the First Lease on

several conditions, including that West One finance its

replacement computer equipment with ICC (“Lessee commits to

finance the replacement Equipment with IBM Credit Corporation”).

Under the Agreement, the termination of the First Lease took

effect on November 15, 1990, at which time the payments yet to be

made under the First Lease in accordance with its terms would

have amounted to approximately $5,662,844.   However, the

Agreement required West One to pay a "Rollover Charge" of $2.5

million, which was financed by ICC over the 5-year period of the

new lease (discussed in the next paragraph).   The Agreement

concludes with the following statement:

          This Agreement is valid when accepted by both
     parties and payment in full (Rollover charge plus all
     lease payments due through the Rollover Date) or a
     signed Term Lease Supplement financing the Rollover
     charge is received by Lessor on or before November 15,
     1990. This supercedes [sic] any prior Rollover quote
     for this equipment.
                               - 6 -


     On October 31, 1990, West One executed a lease with ICC for

an IBM 580 mainframe computer (the 580) for a 5-year term (the

Second Lease).   Under the Second Lease, West One was required to

make 60 monthly payments, each in the total amount of $182,484,

consisting of $128,709 for the Second Lease and $53,775 for the

rollover charge.   The form of Supplement used by ICC refers, as

does the Supplement for the Second Lease, to the charge for

canceling an old lease as a rollover charge that is to be billed

monthly along with the lease payments under the Second Lease.

     Under the description of the equipment to be leased, the

Supplement for the Second Lease provides:    "Option S financing

for ICC lease termination of the 3090/74299 complex is contingent

upon ICC financing of the 9021/580.    If the 9021/580 is not

financed via ICC, the ICC lease termination charges for the 3090

complex will be due under quote #E320999A" (the document

containing this alternative quote has not been located).

Although ICC does not have a fixed formula for calculating a

termination charge and takes a number of factors into account in

determining its negotiating position with the terminating lessee,

the termination charge is generally less if the lessee agrees to

obtain financing from ICC for replacement equipment.3


     3
        The consistent terminology of the Agreement and the
Supplement lead us to conclude that the references therein to
financing the replacement equipment include entry into a lease
therefor.
                               - 7 -


     Although the Supplement does not expressly so state, it

implies, consistently with the concluding paragraph of the

Rollover Agreement, that if the replacement equipment had not

been financed through ICC, whatever termination charge the

parties had agreed upon would have been immediately due and

payable.

     On its 1990 Federal consolidated income tax return,

petitioner claimed a deduction of $793,753 as an expense of

terminating the First Lease.   In the statutory notice of

deficiency issued to petitioner on September 20, 1996, respondent

disallowed the deduction and increased petitioner's income for

the 1990 taxable year by $793,753.     The explanation of

adjustments section of the notice stated that the termination

charge was a capital expenditure under section 263 because

petitioner entered into a lease with ICC for replacement

equipment, and that, because no payments under the new lease were

made until 1991, no amortization deduction would be allowed for

1990.

     In the petition filed December 24, 1996, petitioner alleged

that respondent erred in determining that the termination charge

was a capital expenditure and not an ordinary and necessary

business expense within the meaning of section 162.     On

December 15, 1997, petitioner amended its petition, alleging that

the full $2.5 million charge for termination of the First Lease
                                - 8 -


was deductible as an expense in 1990.    Petitioner explained that

the $793,753 deducted on the 1990 return was the amount of the

lease termination charge recorded on its books for financial

statement purposes, using capital lease accounting rules, but

that for Federal tax purposes petitioner was taking the position

that it was entitled to deduct the full termination charge of

$2.5 million for the taxable year in which it became legally

obligated to pay that amount.

     A supplement to respondent’s response to petitioner's motion

for partial summary judgment partially alters respondent’s

position.    Respondent now concedes that petitioner is entitled

"to an amortization deduction for one month in 1990, or to one-

sixtieth of the total $2.5 million rollover payment" because

petitioner is an accrual basis taxpayer, and because the

obligation to make the first monthly payment for the rollover

charge accrued on December 1, 1990.

Discussion

     Summary judgment is intended to expedite litigation and

avoid unnecessary and expensive trials.    Florida Peach Corp. v.

Commissioner, 90 T.C. 678, 681 (1988).    Summary judgment is

appropriate where there is no genuine issue of material fact and

decision may be rendered as a matter of law.    Rule 121(b);

Sundstrand Corp. v. Commissioner, 98 T.C. at 520; Jacklin v.

Commissioner, 79 T.C. 340, 344 (1982).    In deciding whether to
                               - 9 -


grant summary judgment, the factual materials and inferences

drawn from them must be considered in the light most favorable to

the nonmoving party.   Bond v. Commissioner, 100 T.C. 32, 36

(1993); Naftel v. Commissioner, 85 T.C. 527, 529 (1985).        If the

conditions for summary judgment are otherwise satisfied with

respect to a single issue or fewer than all the issues in a case,

then partial summary judgment may be granted, notwithstanding

that all the issues in the case are not disposed of.     Rule

121(b); Naftel v. Commissioner, supra.

     The parties agree, and we concur, that no issues of material

fact are in dispute.   Consequently, we may render judgment on the

issue in this case as a matter of law.   Rule 121(b).    The issue

for decision is whether the obligation incurred by petitioner to

pay the rollover charge to ICC is deductible as an ordinary and

necessary business expense under section 162, or whether it must

be capitalized under section 263 and amortized over the term of

the Second Lease.

     Whether an expenditure may be deducted or must be

capitalized ultimately depends on the facts and circumstances

of each case.   Deputy v. Du Pont, 308 U.S. 488, 496 (1940).

An expenditure incurred in a taxpayer's business may qualify as

ordinary and necessary under section 162 if it is appropriate and

helpful in carrying on that business, is commonly and frequently

incurred in the type of business conducted by the taxpayer, and
                               - 10 -


is not a capital expenditure under section 263.   Commissioner v.

Tellier, 383 U.S. 687, 689 (1966); Deputy v. Du Pont, supra at

495; Welch v. Helvering, 290 U.S. 111, 113 (1933).   If a cost is

a capital expenditure, the capitalization rules of section 263

take precedence over the deduction rules of section 162, sec.

161; Commissioner v. Idaho Power Co., 418 U.S. 1, 17 (1974),

thereby preventing capital expenditures from being deducted

currently under section 162.

     In determining whether a cost is a capital expenditure, the

Supreme Court in INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84

(1992), noted that deductions are exceptions to the norm of

capitalization.   The Court stated that deductions are

specifically enumerated and thus are subject to disallowance in

favor of capitalization.   Capital expenditures, by contrast, are

not exhaustively enumerated; rather than providing a complete

list of nondeductible expenditures, section 263 serves as a

general means of distinguishing capital expenditures from current

expenses.

     The creation of a separate and distinct asset, while

sufficient to classify an expenditure as capital in nature,

Commissioner v. Lincoln Sav. & Loan Association, 403 U.S. 345,

354 (1971), is not necessary to capital classification.   The

Supreme Court stated in INDOPCO that a taxpayer's realization of

benefits beyond the year in which the expenditure is incurred is
                             - 11 -


important in determining whether the appropriate tax treatment is

a current deduction or a capital expenditure.     INDOPCO, Inc. v.

Commissioner, supra at 87-88 (quoting United States v.

Mississippi Chem. Corp., 405 U.S. 298, 310 (1972) (expense that

“`is of value in more than one taxable year’” is a nondeductible

capital expenditure); Central Tex. Sav. & Loan Association v.

United States, 731 F.2d 1181, 1183 (5th Cir. 1984) (“`While the

period of the benefits may not be controlling in all cases, it

nonetheless remains a prominent, if not predominant,

characteristic of a capital item.’”)); see also     FMR Corp. &

Subs. v. Commissioner, 110 T.C. 402 (1998).

     Petitioner argues that as a matter of law it is entitled to

deduct the $2.5 million obligation in the year incurred as an

expense of terminating the First Lease.   Petitioner relies on

Rev. Rul. 69-511, 1969-2 C.B. 24; Hall & Ruckel, Inc. v.

Commissioner, a Memorandum Opinion of this Court dated Dec. 7,

1942; C. Ludwig Baumann & Co. v. Commissioner, a Memorandum

Opinion of this Court dated May 28, 1943; and Denholm & McKay Co.

v. Commissioner, 2 B.T.A. 444 (1925), to argue that the law is

well established that a payment by a lessee to a lessor in order

to terminate a lease is an ordinary and necessary business

expense that is deductible under section 162.   The rationale

underlying these holdings is that payments to terminate a lease

are not made to produce future income but are costs incurred and
                              - 12 -


damages paid in order to be released from an existing

unprofitable arrangement.   See also Cassatt v. Commissioner, 137

F.2d 745, 748-749 (3d Cir. 1943), affg. 47 B.T.A. 400 (1942).

     Respondent, to the contrary, argues that as a matter of law

the obligation to pay the $2.5 million rollover charge must be

capitalized and amortized over the 5-year term of the Second

Lease.   Respondent relies on INDOPCO, Inc. v. Commissioner,

supra, to argue that because the obligation to pay $2.5 million

was incurred not only in terminating the First Lease, but also in

entering into the Second Lease, the $2.5 million obligation is a

cost of obtaining significant future benefits under the Second

Lease and should therefore be capitalized over the term of the

Second Lease.

     Respondent further relies on Pig & Whistle Co. v.

Commissioner, 9 B.T.A. 668 (1927), and Phil Gluckstern's, Inc. v.

Commissioner, T.C. Memo. 1956-9, to argue in favor of

capitalizing the rollover charge.   These were cases of lessees

who had made lump-sum payments to purchase leaseholds, which they

then amortized over the term of the lease.    Thereafter, the lease

in each of these cases was canceled and the parties entered into

another lease on the same property.    In both cases the

unamortized cost of the first lease was held not to be deductible

in the year that the first lease was canceled.    Rather, because

of the relationship between the successive leases, the
                              - 13 -


unextinguished cost of the first lease was regarded as part of

the cost of the second lease that had to be amortized over the

term of the second lease.

     Petitioner argues that terminating the First Lease resulted

in an economic loss in the year of termination and that the

termination provided no future benefit.   Petitioner further

argues that Pig & Whistle Co. v. Commissioner, supra, and Phil

Gluckstern's, Inc. v. Commissioner, supra, in which the

termination fees were capitalized, are distinguishable from the

present case.   Petitioner maintains that in those cases the

lessee canceled a lease only to enter into a second lease of the

same property with the same lessor, and that therefore the second

lease was in substance a modification of the first lease.    In

petitioner’s view, the payments made to cancel the old lease were

therefore actually made to obtain the modifications whose benefit

extended throughout the term of the replacement leases.   Because

the computers covered by the two leases in the case at hand were

different from each other, petitioner maintains that the Second

Lease was not merely a modification of the First Lease.

     The cases brought to our attention by petitioner and

respondent occupy opposite ends of a spectrum.   At one end is the

case where a lessee pays a lessor to terminate a lease and no

subsequent lease is entered into between the parties.   In such a

case the termination fee is clearly deductible in the year
                              - 14 -


incurred, as there is no second lease raising the possibility

that the lessee will realize significant future benefits beyond

the current taxable year as a result of the termination payment.

At the opposite end is the case of a lessee that cancels a lease

and then immediately enters into another lease with the same

lessor, covering the same property.    In substance, the first

lease is not canceled but continues in modified form, and any

unrecovered costs of the first lease, or costs incurred to cancel

the first lease, are not currently deductible but rather are

costs of continuing the first lease in modified form.

     The case at hand lies between the two extremes.    It is not a

case of simply terminating a lease without entering into another

lease.   Neither is it a termination of one lease, immediately

followed by entry into a second lease with the same lessor

covering the same property, insofar as the two computers covered

by the two leases are not identical.    Along the range between the

extremes presented by petitioner and respondent, we find the case

at hand is both closer to and qualitatively more similar to the

modification of lease case than to the simple termination.

     We therefore agree with respondent and conclude that

petitioner's obligation to pay the rollover charge4 must be

     4
       Respondent and petitioner characterize the $2.5 million
obligation differently. Petitioner describes the obligation as a
"termination fee", while respondent describes it as a "rollover
charge". Petitioner, through its characterization of the
                                                   (continued...)
                               - 15 -


capitalized as a cost of acquiring the Second Lease.     Our

conclusion is informed by the integrated nature of the agreements

and transactions by which the First Lease was terminated and the

Second Lease was entered into and by the reasoning of Pig &

Whistle Co. v. Commissioner, supra, and Phil Gluckstern's, Inc.

v. Commissioner, supra.

     Petitioner's initiation of the Second Lease and termination

of the First Lease were integrated events that should not be

viewed in isolation.   The Agreement states that the termination

of the First Lease is expressly conditioned on petitioner's

initiation of a new lease with ICC.     In an affidavit attached

to petitioner's motion for partial summary judgment, James R.

Egan, vice president of U.S. Bancorp, stated:     “In 1990, West One

determined that the 3090 IBM mainframe computer was inadequate

for its needs.   West One decided to select a larger capacity

computer and to terminate its 3090 Lease with IBM Credit

Corporation.”    Mr. Egan's representations and the fact that the

     4
      (...continued)
obligation, attempts to emphasize the relationship of the
obligation to the First Lease while attempting to isolate the
obligation from the future benefits provided by the Second Lease.
Respondent describes the obligation as a "rollover charge" in
order to emphasize the relationship of the obligation to both the
First Lease and the Second Lease. We find respondent's
characterization of the obligation more appropriate. The
Agreement executed by the parties was termed a "rollover
agreement", not a "termination agreement", and petitioner's
obligation to pay $2.5 million was expressly termed a "rollover
charge", not a "termination fee". We therefore generally refer
to the obligation throughout as the "rollover charge".
                             - 16 -


First Lease was terminated upon the express condition that

petitioner finance the replacement equipment with ICC indicate

that the termination of the First Lease and the initiation of the

Second Lease were integrated, not isolated, events.   So also, the

Term Lease Supplement covering the replacement equipment carries

out the Agreement by providing that the rollover charge is

financed by being paid with interest over the term of the Second

Lease by a series of level payments along with the rental

payments under the Second Lease for the replacement equipment.

     The rollover charge is therefore properly viewed as a cost

of entering into the Second Lease and not merely as an isolated

fee for terminating the First Lease.   Because the termination of

the First Lease and the initiation of the Second Lease were

integrated events, the obligation to pay the rollover charge was

incurred by petitioner not only to terminate the First Lease but

more importantly, as Mr. Egan explains, to obtain a larger

capacity computer; that is, to replace the equipment covered by

the First Lease with equipment covered by the Second Lease.

Petitioner’s incurring the obligation to pay the rollover charge

therefore is properly characterized as a cost of petitioner's

realization of future benefits provided by the Second Lease.

     Petitioner's attempt to isolate the rollover charge, as only

relating to the First Lease and not providing any future

benefits, ignores the integrated character of the termination of
                              - 17 -


the First Lease and the entry into the Second Lease.    Petitioner

fails to acknowledge that the rollover charge was incurred not

only to terminate the First Lease, but also to get rid of the

inadequate property covered by that lease in order to obtain the

right to use the more adequate property covered by the Second

Lease.   While petitioner is correct in maintaining that the law

is well settled that a payment to terminate a lease is generally

deductible in the year incurred, that law does not apply to the

case at hand, where the rollover charge is not merely a payment

to terminate the First Lease, but also a payment that results in

the realization of future benefits over the term of the Second

Lease.

     Pig & Whistle Co. v. Commissioner, 9 B.T.A. 668 (1927), and

Phil Gluckstern's, Inc. v. Commissioner, T.C. Memo. 1956-9, which

respondent relies on and petitioner argues are distinguishable,

further support our conclusion that petitioner must capitalize

the amount of its obligation to pay the rollover charge.    In both

those cases, lessees entered into second leases covering the same

real property, and in each case the Court stated that the lessor

would not have agreed to the cancellation of the old lease except

for the execution of the new lease.    In both cases, the Court

held that, due to the continuity of rights and strong

interrelationship between the two leases, the unextinguished cost

of the first lease was part of the cost of the second lease.
                                - 18 -


     Similarly in the case at hand, there is an interrelationship

and continuity of rights between the two leases that require the

rollover charge to be treated as a cost of acquiring the Second

Lease.   The cancellation of the First Lease was expressly

conditioned on the execution of the Second Lease.    The parties to

the Second Lease were the same as the parties to the First Lease.

While, as petitioner point outs, the properties covered by the

two leases are not identical, they are similar in that both are

mainframe computers used for the same purposes in petitioner's

business.   Cf. sec. 1031(a); Redwing Carriers, Inc. v. Tomlinson,

399 F.2d 652 (5th Cir. 1968); Coastal Terminals, Inc. v. United

States, 320 F.2d 333 (4th Cir. 1963); sec. 1.1031(a)-1(c), Income

Tax Regs.; Rev. Rul. 61-119, 1961-1 C.B. 395.

     An analogous case that helps to illustrate the distinction

between the two extremes is Great W. Power Co. v. Commissioner,

297 U.S. 543, 546-547 (1936).    In that case, the taxpayer called

a bond issue at 105 plus accrued interest; under the terms of the

bond issue the bondholders had the option to receive series B

bonds of equal face value, plus 5 percent in cash.   At issue was

the treatment of unamortized discount and expenses associated

with the first issue of bonds as well as the premiums and other

expenses associated with the call of the first issue and the

exchange.   The Commissioner having conceded that the current

deduction of those amounts was proper to the extent attributable

to the bonds redeemed for cash, the Supreme Court held that the
                              - 19 -


remaining amounts had to be capitalized and amortized over the

life of the new bonds, just as we hold the full amount of the

rollover charge must be capitalized and amortized over the term

of the Second Lease.

     There is no ground for concluding that the rollover charge

is currently deductible in full or for making an allocation under

which a portion of the charge would be currently deducted as

attributable to the termination of the First Lease and a portion

capitalized and amortized over the Second Lease.   Although the

apparent paradox--arising from the likelihood that the charge

would have been higher if petitioner had not entered into the

Second Lease with ICC--gives us pause, any doubts are resolved by

the advantage petitioner obtained, by entering into the Second

Lease, of being able to finance the charge over the term of the

Second Lease.

     In sum, we hold that petitioner's obligation to pay the

rollover charge is a capital expenditure that is not currently

deductible and must be amortized over the 5-year term of the

Second Lease.   Respondent has conceded that petitioner, as an

accrual basis taxpayer, had accrued a 1-month liability for the

rollover charge on December 1, 1990.   As we construe respondent's

concession, petitioner is entitled to an amortization deduction

of $53,775 for the year 1990, equal to the first installment,

which accrued in that year, of the obligation to pay the $2.5
                             - 20 -


million rollover charge, with interest, over the term of the

Second Lease.

     To reflect the foregoing,


                                      An order will be issued

                                 granting respondent’s motion

                                 for partial summary judgment

                                 and denying petitioner’s motion

                                 for partial summary judgment.
