Midland Empire Packing Co. v. Commissioner
14 T.C. 635 (Tax Ct. 1950)

  • Midland's basement (where they cured meat), kept getting flooded by a river (that was contaminated with oil). Health inspectors suggested that Midland seal their basement for health reasons. They did.
    • The sealing costs almost $5k.
  • Midland deducted the costs for the sealing as a business expense on their taxes.
    • Midland felt that the sealing was an ordinary and necessary cost of doing business, and so it was deductible under 23(a) of the Tax Code (now 26 U.S.C. 162(a)).
  • The IRS denied the deduction. Midland appealed.
    • The IRS argued that the expense was not a business expense at all, but instead was a capital expenditure.
      • A capital expenditure is like when you buy a new building. That is not immediately deductible as a business expense, but instead must be written off over several years as depreciation (see 26 U.S.C. 263(a)).
  • The Tax Court reversed and allowed the deduction.
    • The Tax Court found that Midland made the repairs in question in order that it might continue to operate its plant. Midland didn't gain capacity or improve their process, it just allowed for continued operations.
      • Plus, the health inspectors told them to do it.
    • "Repair is an expenditure for the purpose of keeping the property in an ordinarily efficient operating condition. It does not add to the value of the property nor does it appreciably prolong its life." On the other hand, depreciable capital expenditures are those "for replacements, alterations, improvements, or additions which prolong the life of the property, increase its value, or make it adaptable to a different use."
    • The IRS argued that even if the sealing was 'necessary', it wasn't 'ordinary' because it was a unique situation and not something Midland (or other businesses) did on a regular basis. However, the Court found that taking steps to protect one's property is a common, normal thing for businesses to do in general.
  • If the sealing had been done when they originally built the building, then it would have been a capital expenditure, and not a business expense.
    • The court has to do a functional analysis and determine whether or not the expense is designed to just allow the continuation of a business as it had been previously running, or to improve the business.