*2296 Loss. - Upon the evidence, held that the loss of the cost of an oil lease was properly allowable as a deduction in 1923 when sustained through expiration of the lease rather than in 1922 when charged off to profit and loss by direction of the secretary-field manager, whose judgment is not sustained by the evidence.
*940 This is a proceeding for the redetermination of a deficiency in income tax for 1925 amounting to $6,829.72.
The petitioner alleges that the amounts of losses attributable to worthless oil leases numbered 118 and 119 were properly deductible in 1923, but they have not been so allowed. Consequently, it claims that the amount of net loss for 1923 allowed by the respondent as a deduction in the taxable year should be increased in the amount of $20,007 with respect to lease No. 118, and $40,032 with respect to lease No. 119.
At the hearing the petitioner abandoned the issue relative to lease No. 118.
FINDINGS OF FACT.
The petitioner is a Delaware corporation organized in May, 1920, having its principal place of business at New*2297 York, N.Y. It is engaged in the business of buying and selling oil leases and royalties and of developing oil properties.
During 1920 the petitioner purchased for a cash consideration of $40,000 an oil lease, hereinafter referred to as lease No. 119, to the south half, northeast quarter, section 8, township 20, range 6, east, Pawnee County, Okla., containing approximately 80 acres. This lease was executed on October 1, 1919, for a term of 3 1/2 years from that date or as long thereafter as oil or gas was produced from said land by the lessee. It was provided further that if an oil well was not commenced on or before May 6, 1920, the lease would terminate as to both parties unless the lessee, on or before that date, paid to the lessor the sum of $160 as a rental to cover the privilege of deferring *941 commencement of a well for 12 months from said date. In like manner and upon like payments the commencement of a well would be further deferred for similar periods successively during the life of the lease.
The cost of an abstract of title, of recording, and of internal revenue stamps amounted $32to, making the total cost of the lease to the petitioner, $40,032.
During*2298 1921 and 1922 there was a very heavy overproduction of oil throughout the entire county, and prices for oil were low. In these years the petitioner had invested its cash capital in the acquisition of a number of leases, and was short of the cash necessary for commencing a well on lease No. 119. Petitioner, therefore, endeavored to interest someone having the necessary capital in the drilling of a well on this property, but it was not successful. However, the rental payments provided for in the lease for deferments of drilling were paid each year when due. The last rental payment was made when due in May, 1922, and operated to defer drilling until the termination of the lease in 1923, if the petitioner so elected. The petitioner, however, was approached by the lessor, who was desirous of having a well started, and was orally promised an extension of time provided the well was begun prior to the expiration of the lease.
In a tract adjoining lease No. 119 a well was started by another party in February, 1922, on a location about 200 feet from the property line, and this well was finished prior to July 4, 1922, coming in with an initial flow amounting to about 40 barrels a day. *2299 This well is still producing about two or three barrels a day.
In closing the books at the end of 1922 the book costs of 10 leases were charged off to profit and loss in an aggregate of $99,672.26, which amount included the cost of $40,032 for lease No. 119. In the journal entry the purpose was thus stated: "To charge off Bad and Expired leases." This charge-off was made by the accountants employed by the petitioner to close the books for the year, and was authorized by the secretary-field manager of the petitioner.
A well was never commenced by the petitioner on lease No. 119. After the lease expired a new lease was acquired to the same property by the Magnolia Petroleum Co., and that company drilled a well on the property in 1924, which came in with an initial production of some 40 to 45 barrels a day, and this well is still producing two or three barrels a day.
The returns filed by the petitioner reported as follows: for 1922, a loss of $104,563.35, arrived at after deducting the charge-off of $99,672.26 above described, which included the cost of lease No. 119 in the amount of $40,032; for 1923, a loss of $16,927.59; for 1924, *942 a loss of $108,549.87; for*2300 1925, gross income, $285,779.81, less various deductions, $109,903.82, less operating losses for 1923, $76,966.59; for 1924, $108,549.87; leaving a loss in the amount of $9,640.47.
In computing the deficiency the respondent computed net income as follows:
| Net income reported | $175,875.99 | |
| Add depreciation disallowed on lease No. 116 | 2,137.79 | |
| Net income as adjusted | 178,013.78 | |
| Less: | ||
| Adjusted net loss for 1923 | $16,927.59 | |
| Net loss for 1924 | 108,549.87 | |
| Losses for the years 1923 and 1924 applied against the income for 1925 in accordance with section 206(b) of the Revenue Act of 1926 | 125,477.46 | |
| Balance subject to tax | 52,536.32 |
OPINION.
TRUSSELL: In the return filed by the petitioner for the taxable year deductions were claimed for net losses forwarded from 1923 and 1924. The deduction for the net loss for 1924 has been allowed by the respondent, and is not in dispute. The net loss for 1923 was deducted in the return for 1925 as $76,966.59. The respondent has reduced this to $16,927.59, which is the amount of net loss for 1923 which was reported in the return filed by the petitioner for 1923. The discrepancy in the returns in this regard*2301 is attributable to the cost of two leases, No. 118, $20,007, and No. 119, $40,032, which cost was originally claimed by the petitioner as a deduction in the return filed for 1922. The amounts of the cost are not in controversy. It is undisputed that net losses for 1923 and 1924 are properly to be forwarded and deducted in the taxable year. See section 206(e) and section 286 of the Revenue Act of 1926. The petitioner has abandoned the issue relative to lease No. 118. We are required to decide in which year the loss of the cost of lease No. 119 should be allowed as a deduction from income.
We are satisfied that lease No. 119 could not have been deemed altogether worthless in May, 1922, when the petitioner saw fit to pay another annual installment of the "delay" money, a rental charge under the provisions of the lease, securing the privilege of a deferment of drilling for 12 months. There can be no question but that in April or May, 1923, when the lease expired, without a well having been started, the cost was definitely gone. There is no evidence to show that during the interim the petitioner surrendered its leasehold or declared forfeiture or abandonment, and since there *2302 *943 was no drilling or other development under way there is no act of physical abandonment which may be availed of to evidence an intention to abandon the lease as in , and . If there were no further considerations the deduction of the lease would be allowable as definitely sustained when the lease expired in 1923.
But there are further considerations. The cost of the lease was charged off on the books at the end of 1922, and, therefore, prior to its expiration, and the journal entry classified the lease with others described as "bad and expired." If it was in fact worthless and abandoned, the loss should be allowable as a deduction in 1922, even though the lease had not yet expired. ; . The bookkeeping entries, of course, are merely evidentiary as probably reflecting a determination by the petitioner that the lease was then worthless. However, after a careful consideration of the record, we think the entry should be disregarded for the reason that the conclusion of the secretary-field manager is*2303 not supported by the facts. It is true that the outlook was not very favorable; times were exceedingly hard in the oil business, and the petitioner had not succeeded in interesting someone in the development of the lease. On the other hand, an offset well closely adjacent to the property had been successfully completed and was producing. The lessor was anxious to cooperate. In our opinion lease No. 119 may not at that time have been worth the amount of the cost to the petitioner, but it certainly was not entirely worthless at the end of 1922, and this being so, the loss was not yet definitely "sustained." A loss is only allowable when sustained. Section 234(a)(4) of the Revenue Act of 1921, and section 206(e) of the Revenue Act of 1926.
We conclude that the net loss for 1923 which has been allowed as a deduction in the taxable year by the respondent should be increased in the amount of $40,032, the loss attributable to lease No. 119.
Judgment will be entered pursuant to Rule 50.