1930 BTA LEXIS 1786">*1786 The petitioner has failed to establish that he is entitled to an allowance for depletion based on discovery value.
21 B.T.A. 829">*830 The respondent has asserted a deficiency in income tax for 1921, in the amount of $286.66, which arises from the disallowance of a deduction for depletion based on discovery value.
FINDINGS OF FACT.
The petitioner is an individual who resides in Kansas City, Mo. On the 17th of July, 1917, he acquired an oil and gas lease on 40 acres of land in Butler County, Kansas. Among the conditions and terms of such leases there were provisions that petitioner should pay the lessor $2 per acre to cover rental and the privilege of deferring drilling operations; that the lessor should receive a royalty of one-eighth of the oil and gas produced; and that if drilling operations were not commenced within one year, an additional royalty of one-twentieth should be paid to the lessor.
On October 11, 1920, petitioner entered into an agreement with Merriam & Findeiss, hereinafter referred to as the drillers, by1930 BTA LEXIS 1786">*1787 which the latter were to develop and operate the lease. In exchange for a one-half interest in and to the lease, the drillers agreed to pay the petitioner $5,000, bear one-half the cost of certain litigation relating to title to the property, and assign to the petitioner a lease on a certain 40 acres near a well described as the "Cedar Point Well." The agreement provided that a well should be commenced on the property as soon as the title was cleared and the same diligently drilled to the "Liggett Sand." If the first well was a producer the drillers were to fully equip the same and place it upon the pump, and in such case the petitioner and the drillers should each own a one-half interest in the rig, casing, and all equipment left in or used in connection with the well.
The agreement also provided that from the first and all subsequent wells, the petitioner should receive one-third of the net production after the payment of the one-eighth and one-twentieth royalties and that the drillers should receive two-thirds thereof until such time as the oil received by them should pay in full for the development and operation of the property, except the cost of drilling the first well, and1930 BTA LEXIS 1786">*1788 that when the amount received in excess of the cost of development should equal the amount received by the petitioner, the two parties should thereafter each receive one-half the oil and each should bear one-half the operating expenses. The drillers never recovered the cost of development and the petitioner continued to receive one-third of the oil until he sold his interest in the property in 1926 for $10,000.
The lease was developed and operated according to the agreement between petitioner and the drillers. Three wells were brought in 21 B.T.A. 829">*831 within 30 days after June 28, 1921. On November 5, 1926, petitioner sold his interest for $10,000, after having received and sold oil therefrom as follows:
| Year | Barrels produced | Price per | Amount received |
| barrel | |||
| 1921 | 9,681.77 | $1.4021 | $13,574.70 |
| 1922 | 11,162.52 | 1.9941 | 22,259.20 |
| 1923 | 4,447.96 | 1.7540 | 7,801.85 |
| 1924 | 2,860.96 | 1.6272 | 4,655.38 |
| 1925 | 2,183.78 | 1.9210 | 4,195.19 |
| 1926 to Nov. 5, 1926 | 1,691.10 | 2.2757 | 3,848.48 |
| Total | 32,028.09 | 56,334.80 |
In his income-tax return for 1921 the petitioner deducted $5,851.67 from his gross income as depletion, based upon an alleged discovery value1930 BTA LEXIS 1786">*1789 of $77,309.10. Upon audit of such return the respondent disallowed depletion based on discovery value, and allowed depletion in the amount of $1,074.70, based on cost.
OPINION.
LANSDON: Petitioner claims an allowance for depletion based on discovery value. Section 214 of the Revenue Act of 1921 provides in part:
(a) That in computing net income there shall be allowed as deductions:
* * *
(10) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case, based upon cost including cost of development not otherwise deducted: * * * Provided further, That in the case of mines, oil and gas wells, discovered by the taxpayer, on or after March 1, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the depletion allowance shall be based upon the fair market value of the property at the date of the discovery, or within thirty days thereafter. * * * In the case of leases the deductions allowed by this paragraph shall be equitably1930 BTA LEXIS 1786">*1790 apportioned between the lessor and lessee; * * *
The controversy between the parties arises from different interpretations of the above provisions of the Act. The respondent has disallowed depletion based on discovery value on the ground that the fair market value at the date of discovery was not materially disproportionate to the cost. He has taken the property as a whole in comparing the cost and fair market value and has determined that cost, including development expense, approximates the fair market value of the tract as a whole. The petitioner contends that each interest should be considered separately in determining whether cost is materially disproportionate to the fair market value.
21 B.T.A. 829">*832 It is unnecessary for us to determine which of the above positions correctly applies the statute, for in either event the petitioner has failed to establish the facts which will entitle him to depletion based on discovery value. We do not know the cost, the development expense, or the fair market value at date of discovery. Even adopting the petitioner's theory that each interest must be considered separately, we are unable to determine whether or not cost, including cost1930 BTA LEXIS 1786">*1791 of development, is materially disproportionate to the fair market value at date of discovery.
In his opening statement counsel for petitioner says the lease was acquired in exchange for corporate stock of a par value of $10,000, but that fact is not proven and to establish cost it would be necessary to show the value of the stock at the date of the exchange. The petitioner has established that he received twenty-two eightieths of the net oil runs, free from any of the development or operating expenses, which is one-third of the oil after deducting the lessor's royalties. He owned a one-half interest in the lease, however, and one-sixth of his oil went to reimburse the drillers for expenditures in developing the lease. The evidence does not disclose the development cost.
To establish fair market value of his interest at date of discovery or within 30 days thereafter, the petitioner produced an operator and owner of similar property in the same field, who testified that producing property near that of petitioner sold at prices ranging from $1,250 to $2,000 per barrel of settled daily production. The record does not disclose what is considered settled daily production or the1930 BTA LEXIS 1786">*1792 amount, if any, from petitioner's property at the date of discovery or within 30 days thereafter. Neither is there any showing as to the estimated oil reserve. We know that three wells were brought in within the first 30 days, which were rated at 100, 200, and 300 barrels per day, respectively, and that from June 28, 1921, when the first well was completed, until the end of the taxable year, 9,681.77 barrels of oil were produced. If the production at date of discovery or within 30 days thereafter can be called "settled" and if petitioner had established the daily amount thereof, we might have been able to determine a fair market value as of that date. The petitioner having failed to establish cost of the lease, cost of development, amount of oil reserves, settled daily production or value at date of discovery or within 30 days thereafter, there is no evidence to support the claim for depletion based on discovery value.
Judgment will be entered for the respondent.