Fribourg Navigation Company v. Commissioner

On December 21, 1955, Fribourg Navigation Company (Fribourg) (plaintiff) purchased a used ship for approximately $470,000. Before Fribourg purchased the ship, the Internal Revenue Service (the IRS) sent Fribourg a letter explaining that the IRS would allow Fribourg to calculate depreciation of the ship over a straight line for three years, with a salvage value of $54,000. Fribourg’s basis in the ship would be adjusted annually to factor in the depreciation. Fribourg filed its 1955 and 1956 income-tax returns with depreciation deductions based on the IRS’s letter. At the start of 1957, the ship’s adjusted basis was approximately $327,000. Due to a series of events related to the Suez Canal, cargo ships were in high demand in 1957, and Fribourg sold its ship for $695,500. By 1958, ships like the one Fribourg had sold were being scrapped for salvage amounts close to the $54,000 that the IRS had initially predicted when calculating Fribourg’s depreciation deductions. On its 1957 income-tax return, Fribourg deducted the depreciation on the ship according to the IRS’s initial calculation. Fribourg also listed a gain of approximately $505,000, the sale price of the ship minus the depreciation. The Commissioner of Internal Revenue (the Commissioner) (defendant) disallowed the depreciation deduction because the ship’s sale price exceeded its adjusted basis at the beginning of the year. The Commissioner based his conclusion on a regulation that stated that the reasonableness of a depreciation deduction should be made based on the condition of the asset at the end of the period for which the deduction is claimed. Because Fribourg knew that the ship had been sold for more than its adjusted basis, the Commissioner reasoned that Fribourg knew the ship had not depreciated the anticipated amount. The Commissioner also reasoned that the increase was due to conditions that were normally associated with capital gain. The tax court and court of appeals upheld the Commissioner’s disallowance of the deduction. Fribourg appealed.