*169 Decision will be entered under Rule 50.
The decedent discovered a gypsum deposit during a period covered by an oral agreement that he could mine the property so long as gypsum was produced, as well as during a two-year written lease, which was renewed for an additional two years. The oral agreement was made with a lessee from the owner, with the owner's approval, and the discovery and development were at all times with the consent and approval of the owner. In a later year the owner so confirmed in writing. Held, the decedent had such economic interest in the gypsum deposits as to give right to depletion on a discovery basis.
*1045 These proceedings, consolidated for hearing and disposition, involve deficiencies in income tax liabilities as follows:
| Petitioner | Docket No. | Year | Amount |
| Estate of H. M. Holloway, deceased, | 1943 | $ 24,228.85 | |
| Harvey S. Holloway, Executor | 11426 | 1944 | 23,838.08 |
| Mary L. Holloway | 11428 | 1943 | 24,228.85 |
| 1944 | 23,998.08 |
The only issue to be determined is whether the petitioners are entitled to deduct discovery depletion from their income for the years 1943 and 1944.
In accordance with a motion announcing the death on or about October 4, 1947, of H. M. Holloway (hereinafter sometimes referred to as decedent), the duly appointed executor of his estate, Harvey S. Holloway, was substituted for the decedent as the petitioner herein.
A stipulation of facts was filed. We adopt same by reference and find the facts therein set forth. Such parts thereof as it is considered necessary to set forth are included in our findings of fact, together with other facts found from evidence submitted at the hearing.
FINDINGS OF FACT.
At all times material hereto decedent and*171 Mary L. Holloway lived together as husband and wife. For the taxable years here in question, *1046 they filed separate income tax returns with the collector of internal revenue for the sixth district of California.
During the year 1932 decedent moved to Lost Hills, California, where he was employed as a watchman at an oil derrick. At that time he was 63 years of age. Mary L. Holloway, his wife, joined him at Lost Hills in February 1933. They lived in a shack on the floor of the derrick. Decedent's employment as a watchman at the oil derrick terminated late in 1934 or early in 1935. He and his wife continued to live in the shack on the derrick floor until the middle of 1941, when they built a five- or six-room house on an adjoining property.
During 1934 decedent began mining gypsum from surface outcroppings on land owned by the Theata Oil & Land Co. This was not an extensive operation, the mining being done in the early stages with a pick and shovel.
The Occidental Land & Development Co., Ltd. (hereinafter sometimes referred to as Occidental), a foreign corporation, organized in the Isle of Guernsey and owned by French stockholders, was during the years material herein *172 the owner of large tracts of land in Santa Barbara and Kern Counties, California.
By an instrument in writing executed December 14, 1940, Occidental leased to E. Lang the property for a period of two years from and after June 1, 1940. As lessee, Lang had "the right to use the property for pasture, or sublet the same for pasture or for extraction of minerals or gypsum but not oil and gas." As rental Lang agreed to cause all taxes and expenses of Occidental, of any kind, nature or description, with respect to said property, to be paid before delinquency, except taxes upon oil, gas, and other hydrocarbon substances. Lang was granted the right to terminate the lease on six months' notice, and he agreed that his operations under the lease would not interfere with any operations of Occidental, its agents, or lessees for the development of oil and gas. The lease was made effective as of June 1, 1940, because of its delay in execution due to war conditions.
By an instrument in writing dated June 1, 1940, described as a "sublease" between Lang and the decedent, the parties thereto agreed that Lang was the lessee of certain real property located in Kern County, California, (fully described*173 in the instrument) of which he subleased and demised to the decedent the right to dig for, extract, and remove all gypsum and/or gypsite located upon, in, or under the premises, together with all necessary rights of ingress and egress, for the term of two years from the date of the instrument. The decedent agreed to pay as base rental 40 cents for each ton of gypsum or gypsite extracted and sold during the term of the sublease. The sublease also contained provisions calling for additional payments to Lang if the gypsum or gypsite was sold in excess of a specified price and also other provisions relating to the manner in which the decedent would submit *1047 monthly statements to Lang. The agreement also contained a provision that decedent should not assign the sublease without the written consent of Lang.
Occidental's New York attorney knew nothing of any understanding by Lang with the stockholders of Occidental and would give him (Lang) a written lease for only two years. Lang, with the approval of Occidental, assured decedent that he had the right to sublease the property for an indefinite period and that he (decedent) could remain in possession and mine the gypsum as long*174 as it could be produced in paying quantities.
As a result of his exploration on this land, decedent made a discovery of a gypsum deposit. Within the meaning of section 114 (b) (2) of the Internal Revenue Code, the date of the discovery was January 1, 1942. A reasonable estimate of the recoverable tons of gypsum in the deposit on the date of discovery was 926,295 tons. The fair market value on that date of Holloway's working interest in the gypsum deposit, after royalty payments, was $ 266,500, or at the rate of $ 0.2877 per ton for 926,295 tons.
Decedent's son-in-law left a job in Redwood City, paying approximately $ 600 a month, to move to Lost Hills to help decedent with the gypsum business at a salary of $ 300 a month. He began working for the decedent December 16, 1941. The son-in-law knew at the time of his change of employment that decedent had a written sublease which would expire May 31, 1942. However, before he (the son-in-law) had begun his employment with decedent, he had been told by Lang that the decedent could continue mining there (on the Lang property) as long as gypsum was mineable. The Lang property was the only property decedent was working at that time, *175 although he had one other small lease.
Lang's written lease from Occidental was renewed for an additional two years from and after May 31, 1942, by an agreement dated April 14, 1942, which reads, in part, as follows:
Whereas, by an instrument dated the 14th day of December, 1940, the said Occidental Land & Development Company did lease the aforesaid land so owned by it to Etienne Lang; and
Whereas, said Etienne Lang is now desirous of obtaining a renewal of the aforesaid lease which expires the 31st day of May, 1942.
Now, Therefore, * * *
1. Occidental Land & Development Company, Ltd., does hereby renew the aforesaid lease to Etienne Lang of all the lands belonging to it in Kern and Santa Barbara Counties, in the State of California, in the United States of America, for a period of two years from and after May 31, 1942, subject to the terms and conditions hereinafter mentioned.
The terms and conditions of the renewal were essentially identical to the terms and conditions of the lease dated December 14, 1940.
A new written sublease, dated June 1, 1942, identical to the June 1, *1048 1940, sublease, except for the date, was executed by Lang as sublessor and decedent as sublessee, *176 for the term of two years from June 1, 1942.
On August 1, 1944, the gypsum mining business was incorporated and thereafter the actual mining on the Lang property, which was still the principal property, was done by the corporation under an operating agreement with the decedent. At that time decedent's son Harvey left his position, as assistant secretary of Hancock Oil Co. and manager of its export and fuel oil sales departments, to become president of the Gypsum Corporation. He had been with Hancock for 15 1/2 years and his salary upon leaving the company was $ 7,500 per annum. He knew that decedent's sublease had expired, but was made aware of an oral understanding between decedent and Lang that decedent could continue to mine gypsum from the Lang property as long as he could do so commercially.
Decedent remained in possession of the Lang property from June 1940 to the date of his death on October 4, 1947.
Lang died in January 1945 and the royalty was then paid to his estate. Thereafter, in 1946, a lease covering the property which was embraced in the prior sublease was executed between Occidental as lessor and decedent as lessee. The lease was dated as of June 1, 1946, signed*177 by decedent under date of August 20, 1946, and by the secretary of Occidental under date of September 10, 1946. The lease reads, in part, as follows:
This Indenture of Lease, made and entered into as of the 1st day of June, 1946, by and between Occidental Land and Development Company, Ltd., a corporation, hereinafter sometimes called "Occidental", and H. M. Holloway, hereinafter sometimes called "Holloway",
Witnesseth:
Whereas, under date of June 1, 1940, Etienne Lang, as the representative and lessee of Occidental, and Holloway made and entered into an instrument of sublease wherein and whereby said Lang sublet to Holloway, for the purpose of extracting and removing all gypsum located thereon, the lands hereinafter described (and certain other lands); and
Whereas, although said sublease recited that it was for a term of two years, said Lang (with the approval of Occidental) assured Holloway at the time of its execution and consistently thereafter that if gypsum or gypsite was discovered upon said lands in paying quantities that Holloway would be permitted to extract and remove the same as long as said substances, or either of them, were produced from said land in paying quantities; *178 and
Whereas, Holloway thereafter discovered and developed a large deposit of gypsum upon said lands and has produced gypsum therefrom continuously ever since and is still producing the same therefrom in paying quantities, all with the consent and approval of said Lang until his death in January, 1945, and thereafter with the consent and approval of the administratrix of his estate, and at all times with the consent and approval of Occidental; and
Whereas, in accordance with and to implement the assurances given Holloway as aforesaid, Lang renewed said sublease for an additional period of two years by instrument dated June 1, 1942, and following his death in January, 1945, the *1049 administratrix of his estate confirmed said assurances both before and after the expiration of said additional two year period; and
Whereas, in accordance with arrangements made between Occidental and the estate of said Lang, the interest of his estate in said lands has been terminated as at June 1, 1946, but Occidental has agreed to the fulfillment of said assurances given by said Lang to Holloway as aforesaid, and to evidence by this instrument the continuing right of Holloway to extract and remove*179 gypsum from said lands;
Now, Therefore, in consideration of the premises, and the mutual covenants hereinafter set forth, it is agreed by and between the parties as follows:
1. Occidental hereby confirms to Holloway and hereby leases and demises unto him, the right to dig for, extract and remove all gypsum and/or gypsite located upon, in or under those certain lands in Kern County, California, described as follows:
[Here is set forth the legal description of the property, being the portion of Section 24 upon which the discovery had been made.]
together with all necessary rights of ingress and egress, for the period of two years commencing June 1, 1946, and thereafter, but in no event beyond May 31, 1956, so long as gypsum and/or gypsite are produced therefrom in quantities deemed paying by Holloway; provided, however, that this lease shall continue after said two-year period only as to each ten acre legal subdivision of said lands from which or from some part of which gypsum and/or gypsite is then being produced in quantities deemed paying by Holloway, together with all reasonably necessary rights of ingress and egress to, from and across other parts of the lands first above*180 described.
The remaining provisions are in all respects essentially identical to the provisions of the prior written subleases from Lang.
During the calendar years 1942, 1943, and 1944 the following tons of gypsum were mined and sold by H. M. Holloway from said land:
| Year | Tons |
| 1942 | 110,542.52 |
| 1943 | 209,781.53 |
| 1944 | 232,318.52 |
OPINION.
Both petitioners and respondent are in accord that the question here to be determined is to be governed by section 114 (b) (1) and ( 2) of the Internal Revenue Code. 1 The petitioners contend *1050 that the meaning of these sections turns on the phrase "the property"; that that phrase has reference to the mineral reserves or the physical mine; and that a depletable economic interest was had by H. M. Holloway, not only during the original written lease, as determined by the Commissioner, but at all times during the mining of gypsum.
*181 Respondent contends that the meaning of "property" as used in section 114 (b) of the Internal Revenue Code has been the subject of considerable litigation and that its meaning "has become quite well crystallized," and cites paragraph 24.34, vol. 4, Mertens Law of Federal Income Taxation; Sneed v. Commissioner, 119 Fed. (2d) 767, affirming 40 B. T. A. 1136; reaffirmed, 121 Fed. (2d) 725; G. C. M. 22106, C. B. 1941-1, p. 245; and Berkshire Oil Co., 9 T.C. 903">9 T. C. 903. These decisions and articles, he contends, establish that the term "the property" means each separate interest in each separate tract or parcel, so that petitioner had no depletable interest after the end of the first written lease. We have examined each case and article, but find none of them to go as far as respondent would have us go in this case. It appears to us that the primary thought connected with these cases and articles is the division of a tract into smaller tracts, either by outright sale or by leases. We have found no statement that concerns itself with the length *182 of the lease given; that is, whether a "new interest" is created when an old lease expires and the same parties enter into a mineral lease on the same terms.
There can be no doubt that the term "the property" can and does have various meanings. What Congress had in mind when the term was used in the enactment of section 114 (b) of the Internal Revenue Code must be determined by the surrounding words supporting the term. Petitioner argues that the term "the property" as used in the code means "the physical mineral deposit, rather than the legal or equitable interests therein of the respective parties." To support his argument, the petitioner calls our attention to the statutory language stated, that "The depletion allowance * * * shall not exceed 50 per centum of the net income of the taxpayer * * * from the property upon which the discovery was made * * *." (italics supplied); and argues that "people generally do not think of a discovery as having been made on an intangible lease, or on an intangible royalty interest. The discovery is made 'upon' the 'land'." We concur that the discovery *1051 is made upon the land and not upon the lease on the land. This we think is some*183 indication of the intention of Congress as to the meaning of the term "the property." A better indication of the meaning can perhaps be found in the sentence of the section of the code where it is stated that "the basis for depletion shall be the fair market value of the property at the date of discovery or within thirty days thereafter, if such mines were not acquired as the result of purchase of a proven tract or lease * * *." (Italics supplied.) It is clear that the phrase "such mines" relates back to the term "the property" and limits it to the mines rather than extending the meaning to the interest in the property, as contended by respondent. Palmer v. Bender, 287 U.S. 551">287 U.S. 551, establishes the rule that it is the product rather than the legal interest that gives the basis for depletion. There the Court was considering section 214 (a) (10) of the Revenue Act of 1921, a section containing language similar to that of the section of the code now under consideration. The part of the act referred to is as follows:
* * * Provided further, That in the case of mines, oil and gas wells, discovered by the taxpayer, on or after March 1, 1913, and*184 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 * * *.
Section 114 (b) (2) of the Internal Revenue Code states the "basis for depletion," but in computing the income tax, section 23 (m), Internal Revenue Code, 2 must be applied and that section provides that, "In case of leases the deduction shall be equitably apportioned between the lessor and lessee." Any other conclusion would make useless this part of the code, because, if the word "property" meant the lessee's interest or the lessor's interest, there would be nothing to apportion between lessor and lessee.
*185 Section 114 of the Internal Revenue Code provides that the basis upon which discovery depletion is to be allowed in respect of any property shall be the fair market value of the property at the date of the discovery, if such mines were not acquired as the result of purchase of a proven tract or lease. The decedent did not acquire "the *1052 property," that is, the mines, as the result of purchase of a proven tract or lease. He acquired "the mines" by a lease of June 1, 1940, and the date of the discovery of the gypsum was January 1, 1942. (Italics supplied.) He continued in uninterrupted possession of the mines after that date.
In our view, under the above principles, there was in the decedent such economic interest in the gypsum deposits themselves as to confer depletable interest not only during the first lease, but during the extension thereof on the same terms; but we hold for the petitioner on additional and broader grounds. The decedent had possession of the premises when the discovery was made, not only under a written lease, but under a claim founded on oral assurances from Lang that he could continue mining the gypsum so long as it was mineable. Though the respondent*186 urges that writing was required for validity of such a right, it is obvious that we have here no mere question of enforceability of an executory oral agreement, but a case of possession taken and development improvements made; in short, an executed contract, with the doctrine of part performance applicable.
It is to be noted that there has never been an attack upon the decedent's title or right to mine, though continued after the two written terms without written authority, and even after Lang's death. On the contrary, Occidental, the owner, in 1946 specifically, and in writing, "confirms to Holloway," after reciting that he had discovered and produced the gypsum "at all times with the consent and approval of Occidental" and that Lang had "(with the approval of Occidental) assured Holloway * * * that Holloway would be permitted to extract and remove the same as long as * * * produced from said land in paying quantities." If there was frailty in decedent's title at first, title was in effect ratified by this instrument; but more important, it appears therefrom that Occidental, and Lang for it, did give Holloway the oral assurance that he could produce the gypsum. His operations, *187 therefore, involving discovery and development, in our opinion, gave him a depletable economic interest. The situation is closely parallel to that in Champlin v. Commissioner, 78 Fed. (2d) 905. There Champlin produced oil while his title was being litigated and prior to the time it was finally vindicated. The court allowed discovery depletion, referring to Palmer v. Bender, supra, as a case where depletion was allowed an assignor who retained no reversionary interest in the oil reserves and had no form of legal interest in the mineral content, and stating that income and depletion go hand in hand, that the petitioner had developed the oil in the face of a title hazard and must pay full tax on the income reported, and that no reason could be seen for denying depletion because of the hazard. In Obispo Oil Co. v. Welch, 89 Fed. (2d) 860 (reversed, but on other *1053 grounds, 301 U.S. 190">301 U.S. 190) one with a mere possessory interest in Government lands discovered oil thereon prior to securing a lease from the Government. It was contended that depletion was*188 allowable only from the date of the lease. The court pointed out that possessory right, with claim of title, not finally adjudicated, under placer mining laws had been held sufficient to show economic interest, and held that prior to the lease there was such economic interest in the company in possession as to give right to depletion.
We can see no valid distinction between such cases and the instant situation. Clearly, the respondent's idea that there was here mere license is not tenable and the cases cited do not support it. We hold that this petitioner had such economic interest throughout the taxable years as to be basis for depletion upon a discovery basis. As stipulated in the event of such holding,
Decision will be entered under Rule 50.
Footnotes
1. SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
* * * *
(b) Basis for Depletion. --
(1) General rule. -- The basis upon which depletion is to be allowed in respect of any property shall be the adjusted basis provided in section 113 (b) for the purpose of determining the gain upon the sale or other disposition of such property, except as provided in paragraphs (2), (3), and (4) of this subsection.
(2) Discovery value in case of mines. -- In the case of mines (other than metal, bauxite, coal, fluorspar, flake, graphite, vermiculite, beryl, feldspar, mica, talc (including pyrophyllite), lepidolite, spodumene, barite, potash, ball, sagger, and china clay, phosphate rock, rock asphalt, trona, bentonite, gilsonite, thenardite, or sulfur mines) discovered by the taxpayer after February 28, 1913, the basis for depletion shall be the fair market value of the property at the date of discovery or within thirty days thereafter, if such mines were not acquired as the result of purchase of a proven tract or lease, and if the fair market value of the property is materially disproportionate to the cost. The depletion allowance under section 23 (m) based on discovery value provided in this paragraph shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property upon which the discovery was made, except that in no case shall the depletion allowance under section 23 (m)↩ be less than it would be if computed without reference to discovery value. Discoveries shall include minerals in commercial quantities contained within a vein or deposit discovered in an existing mine or mining tract by the taxpayer after February 28, 1913, if the vein or deposit thus discovered was not merely the uninterrupted extension of a continuing commercial vein or deposit already known to exist, and if the discovered minerals are of sufficient value and quantity that they could be separately mined and marketed at a profit.
2. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * * *
(m) Depletion. -- 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; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. In any case in which it is ascertained as a result of operations or of development work that the recoverable units are greater or less than the prior estimate thereof, then such prior estimate (but not the basis for depletion) shall be revised and the allowance under this subsection for subsequent taxable years shall be based upon such revised estimate. In the case of leases the deductions shall be equitably apportioned between the lessor and the lessee. * * *↩