## Facts

- A regulated gas distributor operated in Fall River, Massachusetts, under an exclusive retail franchise and formed a wholly owned subsidiary to lease and install gas appliances to increase gas usage.
- The subsidiary installed leased hot water heaters and conversion burners; the disputed expenditures were installation costs (labor and materials) to connect appliances to customers’ plumbing, venting, and furnaces.
- Average installation costs were approximately $65 per water heater and $90 per conversion burner.
- Leases were formally short-term: appliances were leased for an initial one-year period, and conversion burners were removable at the customer’s will on 24-hour notice.
- Upon termination, the company removed the equipment, capped lines, and restored furnaces; removal labor largely prevented meaningful recovery of original installation costs through salvage.
- Despite terminable arrangements, the companies anticipated rental income and sustained increases in gas consumption from the program.
- From 1954–1959, average gas consumption per customer more than doubled while the number of customers remained roughly stable; 9,088 water heaters were installed and 1,650 removed, and 962 conversion burners were installed and 121 removed.
- For tax years 1957–1959, the taxpayers deducted installation costs as ordinary and necessary business expenses; the Commissioner treated them as capital expenditures subject to depreciation.
- The Tax Court held the costs were capital expenditures depreciable over a 12-year life; the taxpayers sought appellate review.

## Issues

1. Whether installation costs for leased gas appliances and conversion burners were currently deductible as ordinary and necessary business expenses under I.R.C. § 162.
2. Whether those costs instead had to be capitalized under I.R.C. § 263 and recovered through depreciation because they produced benefits extending beyond the taxable year.
3. Whether a 12-year depreciation period for the installation expenditures was supported by the record.

## Decision

- The First Circuit affirmed the Tax Court.
- The court held the installation expenditures were capital outlays because they were incurred to secure an economic advantage expected to extend substantially beyond one taxable year.
- The court rejected reliance on the short, terminable lease terms where the record showed a realistic expectation of continuing rental income and sustained increased gas consumption.
- The court accepted the Tax Court’s 12-year depreciable life determination as a supported factual finding.

## Legal Principles

- An expenditure is capital if made to bring into being an asset or economic advantage expected to last beyond the taxable year, even if the benefit’s duration is not legally guaranteed.
- The capital-versus-expense inquiry focuses on the nature and expected duration of the economic benefit, not merely on the formal terminability of customer arrangements.
- Costs integral to placing income-producing property in service, or to obtaining a continuing revenue-producing advantage, may be capitalized and recovered through depreciation over a reasonable useful life.

## Conclusion

The installation costs for leased gas appliances and conversion burners were not deductible in full when incurred because the taxpayers reasonably expected multi-year benefits in the form of rental income and sustained increases in gas consumption; the expenditures had to be capitalized and depreciated over 12 years.


Fall River Gas Appliance Co. v. Comm’r, 349 F.2d 515 (1st Cir. 1965)