*157 Decision will be entered under Rule 50.
1. Held, that a royalty interest owned by petitioner became worthless prior to 1944 when petitioner's right of redemption therein expired and that its loss with respect to the royalty is therefore not deductible in that year.
2. Held, that $ 1,179.33 of $ 3,537.98 expended by petitioner for legal services in a lawsuit and subsequent settlement was attributable to its claim for an accounting and is deductible.
3. Held, on the facts, that depletion allowable on an oil lease in Kentucky computed by the cost method was greater than allowed depletion as computed by petitioner by the percentage of income method and petitioner's adjusted basis in the property was properly reduced by the respondent.
4. Held, that six nonproducing oil royalties owned by petitioner became worthless prior to their purported sales for nominal sums.
5. Held, that five oil and gas royalties which had had producing wells on them during the time petitioner held them, but which had been abandoned prior to the purported sale of the royalties by petitioner for nominal sums, were worthless prior to such purported sale. Held, further, that one of these*158 royalties which was still producing nominal quantities of oil when petitioner sold it for $ 10 was almost fully depleted prior to sale, and respondent's determination in adjusting petitioner's basis with respect to this property is sustained.
*509 The respondent determined deficiencies in income tax against the petitioner for the years 1946, 1947, and 1948 of $ 1,109.03, $ 3,918.43, and $ 4,437.43, respectively. The questions presented are (1) whether petitioner sustained a deductible loss in 1944 as a result of the expiration*159 of its right in that year to redeem a royalty interest then owned by it, (2) whether legal expenses paid by petitioner in 1944 were deductible *510 in that year as ordinary and necessary business expenses, (3) whether petitioner properly computed depletion allowances with respect to an oil lease in Kentucky, (4) whether six nonproducing oil royalties became worthless prior to their purported sale by petitioner, and (5) whether petitioner properly computed depletion allowances with respect to six oil royalties, or in the alternative, whether these royalties became worthless prior to their purported sale.
The issues with respect to the losses and expenses claimed in 1944 and 1945 are raised as a result of the disallowance of carry-over losses during the years in which deficiencies were determined.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found as stipulated.
Petitioner is a Delaware corporation organized in 1927. It filed its income tax returns for the years involved with the collector of internal revenue for the district of Oklahoma.
Petitioner was in the business of dealing in oil properties. Wade H. James, its president, had been a practicing attorney*160 prior to entering the oil business in 1916. Shortly thereafter, he became general counsel for the Independent Oil and Gas Company of Tulsa, Oklahoma, and later became vice president in charge of operations of that company. While in this position he directed the drilling of the discovery well in the Seminole field in Oklahoma. Upon the merger of the Independent Oil and Gas Company with Phillips Petroleum Company, James left Independent and became president of the Seminole Royalty Company, which dealt in oil properties for a year or more before selling out to Phillips Petroleum in about 1926. Upon petitioner's organization in 1927, Wade James became vice president in charge of operations, and has been in complete charge of all operations of petitioner since that time. He has been its president since 1930.
The petitioner has always carried its oil properties on its books at cost less adjustments for depreciation and depletion until the properties were disposed of by sale, and in making its income tax returns has treated such cost as its basis for such properties. In the years when depletion allowances were taken, such allowances were always based on a percentage of income.
Gilbreath*161 Royalty.
In May of 1929, petitioner purchased a royalty interest in Pottawatomie County, Oklahoma. It received rentals from this property of $ 2.50 for each of the years 1930 and 1931. Sometime subsequent to the purchase of this royalty by petitioner, but prior to March 1, 1930, a dry hole was drilled on adjacent land in an attempt to strike oil. *511 On November 3, 1930, the property was placed on public auction and was purchased by Grace Gilbreath, who received a treasurer's certificate of tax sale on November 4, 1930. Grace Gilbreath paid the taxes on the property from 1930 to 1942, inclusive. On December 9, 1942, petitioner received a "Notice of Application for Tax Deed," wherein the above facts pertaining to the property were set forth, together with a notification that unless redemption was made by payment of the assessed taxes paid by Grace Gilbreath, with the interest thereon, within 60 days of the date of service of the notice, a tax deed would be demanded, and would be issued to her by the county treasurer of Pottawatomie County "as provided by law." Petitioner submitted the notice to its counsel, A. C. Saunders, in Tulsa, Oklahoma. On April 11, 1944, Saunders*162 received a letter from Arrington & Miller, attorneys in Shawnee, Oklahoma, which read as follows:
Apr. 11, 1944
Dear Sir:
Re: Gilbreath v. Pouder, et al.
Mrs. Gilbreath, the plaintiff in this case, is the daughter of C. B. Billington of Shawnee, Oklahoma. I have known the family something over forty years. If there is any relationship whatever between her and the Pappans, or anyone else who were owners of the surface rights, I have never heard of it. I am quite sure she has never either. This is certainly not one of those cases where the owner of the surface is endeavoring to set out the royalty holders.
Sincerely yours,
Arrington & Miller
By -- /s/ R. C. Arrington
RCA/c
On the bottom of this letter was a penciled note initialed by Wade James, president of petitioner; it bore no date and read as follows:
Case disposed of by letting judgment go for plaintiff. We to get a deed for our royalty upon payment of our proportionate part of past taxes.
WHJ
At the very bottom of the letter were two lines of penciled writing also initialed by Wade James which, although partially erased, were still legible. They read:
Property condemned by dry holes. Not worth our part of taxes.
WHJ
*163 On April 10, 1944, a $ 15 expense item was charged against the account of this royalty interest on petitioner's books, the last prior entry to this account was on April 30, 1930, when $ 36.50 was charged to the property. Neither charge carried any explanation of the purpose for which it was made.
Petitioner on its 1944 return took a deduction of $ 977.75, which represented a loss purported to have been sustained in that year as a *512 result of its abandonment of this royalty interest to Grace Gilbreath, by failing to exercise its right of redemption.
Horsting Litigation.
In 1938 the petitioner and W. F. Horsting entered into a joint venture for the development of certain properties believed to contain oil; some of the properties were owned by Horsting and his wife in Jim Wells County, Texas, and other properties were to be acquired by the parties for their joint benefit. Thereafter petitioner advanced a considerable sum of money for the joint operation and in addition loaned nearly $ 7,000 to Horsting personally. Among the properties included in the venture between petitioner and Horsting were certain tracts herein referred to as the Jim Wells properties; petitioner thereafter*164 made an assignment of a part of its undivided interest with respect to these properties to W. A. Richardson, purporting to reserve to itself the remainder thereof. Petitioner subsequently became dissatisfied with Horsting's conduct concerning this venture and brought suit against Horsting and his wife, in which cause it sought the following relief: To recover "damages" against the Horstings in the sum of $ 2,250, as being one-half of all sums of money above $ 25,000 claimed to have been realized by Horsting from the sale of certain mineral interests; to recover "damages" against the Horstings for the sum of $ 117.50 as being one-half of the amount received by the Horstings from a grazing and agricultural lease on a portion of certain lands described in petitioner's petition in its action against the Horstings; to recover "damages" against the Horstings for the sum of $ 4,000 for alleged failure of title as to 80 acres of land; to recover judgment against the Horstings for an undivided one-half interest in and to all of the royalties and surface rights in, upon, and under the Jim Wells properties; to recover judgment against the Horstings for the sum of $ 6,604.80, with interest thereon*165 from March 1, 1941, on a claim for "damages," the particulars of which are not disclosed in the record; and finally, to recover judgment against the Horstings for such sums as might be found to be due and owing upon an accounting of all transactions between petitioner and Horsting prior to the institution of its action against him and his wife.
The Horstings, by their answer and cross-action, sought to recover judgment against petitioner for all right, title, and interest of the petitioner in and to the Jim Wells properties, and more particularly the undivided interest in these properties reserved by petitioner under the terms of a previous assignment of its right, title, and interest by petitioner to W. A. Richardson. The Horstings also sought to recover judgment against petitioner for certain sums of money claimed to be due to W. F. Horsting upon a partnership accounting.
*513 Petitioner and the Horstings, by an agreement dated June 16, 1944, compromised and adjusted the differences existing between them. Under the terms of the agreement, the suit pending between the parties was dismissed with prejudice and the Horstings paid to petitioner $ 3,952.50 as full, complete, and*166 final settlement between the parties "as and for any sums of money or other things of value owing by" the Horstings to petitioner, or by petitioner to the Horstings "for any and all transactions heretofore had between the parties whether the same be for partnership accounts, notes previously executed by the parties, or either of same, accounts receivable, or any other indebtedness of any kind or character." It was further agreed under the terms of the settlement that petitioner was to release, relinquish, cancel, and forever quitclaim unto the Horstings "any and all claims or demands whatsoever asserted by it in its pleadings * * * save, only, the present record right, title and interest" reserved by petitioner in two assignments made by it to W. A. Richardson in the Jim Wells properties. The Horstings in turn released and quitclaimed to petitioner the "present record right, title, and interest" claimed by petitioner and reserved by it in its two assignments in the Jim Wells properties.
In connection with this proceeding and settlement, petitioner paid legal expenses in 1944 of $ 3,537.98, which it entered on its books as capital expenditures. No part of such legal expenses was *167 claimed as a deduction on its 1944 or 1945 returns.
Of the $ 3,537.98 expended by petitioner for legal services in 1944, $ 1,179.33 represented expenses incurred as the result of its claim for an accounting.
Cambron Lease.
In 1936 petitioner acquired a lease of certain oil property in Kentucky called the Cambron lease. The total unadjusted basis of the property was $ 17,945.75 based on a purchase price of $ 263.40, development cost of $ 12,934.50, and equipment cost of $ 4,747.85. Production from several wells drilled on this lease both in barrels and dollar value and the percentage depletion claimed by petitioner on its returns for the years 1936 to 1945, inclusive, was as follows:
| Gross income from sales | |||
| Percentage | |||
| Year | depletion | ||
| Barrels | Amount | ||
| 1936 | 242.51 | $ 310.31 | $ 85.32 |
| 1937 | 5,299.33 | 7,400.72 | 2,035.22 |
| 1938 | 2,235.39 | 2,985.32 | 820.96 |
| 1939 | 792.39 | 831.37 | |
| 1940 | 539.73 | 561.32 | |
| 1941 | 334.78 | 368.26 | |
| 1942 | 148.53 | 196.05 | |
| 1943 | 114.32 | 153.01 | 42.07 |
| 1944 | 60.78 | 83.27 | 22.90 |
| 1945 | 14.21 | 19.47 | |
| Total | 9,781.97 | $ 12,909.10 | $ 3,006.47 |
*514 Petitioner sold the Cambron lease in 1945 for $ 111.74. In adjusting its basis to compute*168 its loss, petitioner took depreciation of $ 3,548.76 and a percentage depletion of $ 3,006.47, the amounts allowed in its income tax returns in prior years, which gave it a loss of $ 11,278.78. The respondent determined that cost depletion exceeded the percentage depletion taken by petitioner, and accordingly deducted $ 12,910.19 from the unadjusted basis of the lease as representing allowable depletion on the property for prior years, thus reducing the total loss to $ 1,375.06.
Sale of Nonproducing Royalties.
In the years 1946, 1947, and 1948, petitioner purportedly sold certain nonproducing royalty interests designated as royalties Nos. 86, 120, 98, 256, and 242.
Petitioner purchased royalty No. 86 in 1928 for $ 2,586.50. During the period October to December 1928, Phillips Petroleum Company drilled a dry hole to 4,476 feet on the extreme southeast corner of this property and completed a second dry hole in January 1929, to 3,284 feet on the extreme southwest corner. In 1942 Continental Oil Company drilled a dry hole to 4,421 feet about 300 yards north of the property; a "small show" of oil was found at 4,161 feet. In June and July of 1946, Deep Rock Oil Corporation drilled*169 a dry hole in the northeast corner of the property to 3,332 feet. In 1946 petitioner purportedly sold 1 royalty No. 86 for $ 1, reporting a loss of $ 2,585.50 on its return for that year with respect to that property. From August 1950 to January 1951, Olson Drilling Company completed three producing oil wells on the northwest portion of the property to 3,701, 4,103, and 4,062 feet, respectively.
*170 Petitioner purchased royalty No. 120 in October 1928, for $ 2,588.75. In 1930 a dry hole was drilled a mile to the east of this royalty to 3,320 feet, with a "show" of oil at 2,879 feet. In 1939 three dry holes were drilled on property adjacent to royalty No. 120, one a mile to the northeast to 3,083 feet, a second a mile to the northwest to 4,320 feet and a third a quarter of a mile to the northeast to 4,403 feet, with a "slight trace of oil" at 4,215 to 4,285 feet. The only attempt at drilling on the royalty itself was made in 1943, when a dry hole was drilled on the northwest corner to 4,345 feet. Petitioner purportedly sold *515 royalty No. 120 in 1946 for $ 1, reporting a loss on its return for that year of $ 2,587.75 with respect to that property.
Petitioner purchased royalty No. 98 in October 1928 for $ 1,571.50. A dry hole was drilled to 4,035 feet on the northwest corner of this property by T. B. Slick in December 1928. In May 1929, a second dry hole was drilled on the northeast corner to 4,323 feet. Petitioner purportedly sold royalty No. 98 in 1947 for $ 20, reporting a loss with respect to that property on its return for that year in the amount of $ 1,551.50.
*171 Petitioner purchased royalty No. 256 in August 1929, for $ 2,296. Four dry holes were drilled on property adjacent to this royalty between 1938 and 1947. The first was drilled just north of the property in September 1938, to 4,516 feet; a second dry hole was drilled to the south of the property in August 1941, to 4,416 feet; a third was drilled to the east of the property in November 1941, to 4,448 feet, and the fourth was drilled one-half mile to the south of the property in April 1947, to 4,526 feet. No drilling was ever done on royalty No. 256. Petitioner purportedly sold this royalty in 1947 for $ 28, reporting a loss on its return for that year of $ 2,268 with respect to that property.
Petitioner purchased royalty No. 242 in June 1929, for $ 13,122.75. A producing oil well was drilled to 3,939 feet just off the southwest corner of this royalty in January 1930; the only other evidence with respect to this well is that it was subsequently abandoned. A dry hole was drilled to 4,292 feet on the southwest corner of the property in February 1935. In October 1937, another dry hole was drilled north of the middle of the eastern edge of the property to 4,296 feet. In addition *172 to its royalty interest petitioner also had a one-eighth working interest in this property. Wade James, president of petitioner, was present when the drilling was completed in October 1937. It was his judgment at that time that the well was showing enough oil to allow production, but the owner of the remainder of the working interest was in Europe and had left instructions with his foreman that unless "it blew in," to plug the hole and stop it, which the foreman did. Petitioner took percentage depletion on this property on its return for 1936 in the amount of $ 2.95. It purportedly sold the property in 1948 for $ 1, reporting a loss with respect to that property of $ 13,118.80 on its return for that year.
Respondent disallowed the losses reported by petitioner on these five nonproducing royalties on the ground that they had become worthless prior to the year petitioner purportedly sold them.
Sale of Once-Producing Royalties.
In the years 1946, 1947, and 1948, petitioner purportedly sold certain royalty interests which had had producing wells on them during the *516 time petitioner held them, but which, with one exception, had been abandoned prior to their purported sale. *173 These oil royalty interests were designated as royalties Nos. 1, 2, 24, 171, 192, 254, and 10.
Royalty No. 1 was purchased by petitioner in December 1927, for $ 2,371.60. Three producing wells were drilled on the eastern three-eighths of this royalty from January 1926 to January 1928. The first well went to a depth of 3,410 feet, the second to 3,396 feet, and the third to 3,294 feet. These wells had some production in each of the years 1927 to 1933, inclusive, but have since been abandoned. Petitioner took percentage depletion from 1927 through 1931 in the total amount of $ 285.27. Petitioner purportedly sold this royalty interest in 1946 for $ 1, reporting a loss on its return for that year with respect to this property of $ 2,085.33.
Petitioner purchased royalty No. 2 in December 1927, for $ 8,738.10. There were four producing oil wells drilled on the property to depths of 4,532, 4,300, 4,295, and 4,320 feet, respectively, and there was some production from these wells during 1927 and 1928, but they have since been abandoned. Petitioner took percentage depletion in those 2 years in the total amount of $ 3,786.14. It purportedly sold this royalty in 1946 for $ 1, reporting*174 a loss on its return for that year with respect to that royalty of $ 4,950.96.
Royalty No. 24 was purchased by petitioner in 1928, for $ 5,131.60. There were six producing oil wells on the property and one dry hole, all of which had been drilled to depths of slightly more than 4,000 feet. Of the six wells, some had been abandoned prior to the time petitioner purchased the royalty in 1928, the others were subsequently abandoned. The property had some oil production for each of the years 1928 to 1940, inclusive. Petitioner took percentage depletion for the years 1928 to 1931, inclusive, of $ 951.32. It purportedly sold royalty No. 24 in 1947 for $ 10, reporting a loss on its return for that year with respect to that property of $ 4,170.28.
Royalty No. 171 was purchased by petitioner in December 1928, for $ 1,902.85. At the time of sale there was a dry hole to 4,363 feet on the northwest corner of the property which had been drilled in 1927 In January 1929, a dry hole to 4,342 feet was drilled off the northeast corner of the royalty with a "show of oil" at 4,330 feet. Another dry hole to 4,232 feet was drilled on the southwest corner of the property in August 1929. A producing*175 well was drilled in the southwest corner of the property to a depth of 4,216 feet. Some oil was produced from this well in 1929 and 1930, and percentage depletion was taken by petitioner in those years in the amount of $ 48.27. Petitioner purportedly sold royalty No. 171 in 1947 for $ 20, reporting a loss on its return with respect to that property of $ 1,834.58.
Petitioner purchased royalty No. 192 in December 1928, for $ 14,761.35. One well was completed on this royalty on December 29, 1928, *517 to 4,205 feet, from which some production was obtained in 1928 and 1929. A dry hole was drilled to 4,467 feet to the south of the property in February 1929. Petitioner took percentage depletion on this property for 1928 and 1929 in the total amount of $ 115.54. In 1947 it purportedly sold this royalty for $ 40, reporting a loss on its return for that year with respect thereto of $ 14,605.81.
Petitioner purchased royalty No. 254 in August 1929, for $ 1,121.42. There were two producing oil wells on this property. The date of drilling and the production therefrom of one of these wells are not disclosed by the record; the other was completed in May 1933, and was drilled to a depth*176 of 3,260 feet. There was some production on this property during the years 1933 to 1936, inclusive, and rentals of $ 5 each were collected in September 1930, and March 1931. This property was leased to the Little River Oil Development Company, terminating in December 1937, and to H. P. Gentner, terminating in April 1946. Petitioner took $ 50.08 in percentage depletion on this property (the years in which this depletion was taken are not disclosed by the record). It purportedly sold the property in 1948 for $ 2, reporting a loss on its return for that year with respect to that property of $ 1,069.34.
Royalty No. 10 was purchased by petitioner in January 1928, for $ 12,759.10. A lessee drilled a producing oil well on this property shortly after the purchase by petitioner of its royalty interest, which was still producing when petitioner sold the property in 1948. The record does not disclose the date the well was drilled or the depth to which it was drilled. Percentage depletion was taken for each of the years 1928 to 1937, inclusive; 1946 to 1948, inclusive; and some of the years between 1937 and 1946, in the total amount of $ 196.04. Petitioner purportedly sold this property*177 in 1948 for $ 10, reporting a loss on its return with respect to this royalty of $ 12,553.06. This royalty is the only interest which petitioner had which was still producing at the time of its purported sale. Petitioner's share of production and income from the well on this royalty, as set forth in petitioner's books, was as follows:
| Year | Barrels | Amount |
| 1928 | 150.46 | $ 60.94 |
| 1929 | 226.36 | 146.27 |
| 1930 | 113.47 | 64.22 |
| 1931 | 12.21 | 4.90 |
| 1932 | 93.98 | 45.59 |
| 1933 | 92.50 | 36.23 |
| 1934 | 91.27 | 66.97 |
| 1935 | 88.22 | 64.99 |
| 1936 | 59.00 | 49.61 |
| 1937 | 37.91 | 33.40 |
| 1938 | 39.60 | 34.38 |
| 1939 | 32.09 | 24.29 |
| 1940 | 31.10 | $ 23.42 |
| 1941 | 29.10 | 21.83 |
| 1942 | 3.88 | 3.51 |
| 1943 | 8.88 | 4.55 |
| 1944 | 4.50 | 4.14 |
| 1945 | 4.08 | 3.66 |
| 1946 | 3.64 | 3.99 |
| 1947 | 3.63 | 6.32 |
| 1948 | 4.16 | 9.77 |
| Total | 1,130.04 | $ 712.98 |
*518 OPINION.
Petitioner claimed a loss in 1944 on a royalty interest which it was alleged became worthless in that year due to the expiration of petitioner's right to redeem the property under Oklahoma law. The royalty was purchased by petitioner in 1929. In 1930 it was offered for sale at a public auction and was purchased by Grace Gilbreath, who took the property and paid the taxes thereon until*178 1942, at which time she caused to be served upon all interested parties a "Notice of Application for Tax Deed," pursuant to title 68, section 451, of the Oklahoma Statutes, which provides that a purchaser of real estate at a tax sale may, if no person redeems such lands within 2 years, get a deed for the land, or so much of it as remains unredeemed. The statute provides, however, that before any holder of a certificate of purchase issued at a tax sale shall be entitled to a deed, he shall serve upon the owners a notice, signed by himself, which shall recite the sale of the lands, specify the date of the sale, and notify such person that unless redemption is made within 60 days after service of such notice, a tax deed will be demanded and will issue as provided by law. Until the expiration of the said 60 days, redemption may be made by any person authorized by law to redeem.
It is petitioner's contention that under Oklahoma law the right to redeem its royalty interest did not expire until 1944, and that it, therefore, took the loss in the right year. Respondent, on the other hand, argues that while the general rule regarding losses suffered on a tax sale is that the loss is deductible*179 in the year in which the period of redemption expires, Derby Realty Corporation, 35 B. T. A. 335, there is an exception to the general rule, that the loss does not and should not have to wait until the expiration of the right of redemption, where the facts indicate that the property was worthless prior thereto, and cites Commissioner v. Peterman, 118 F. 2d 973, affirming a Memorandum Opinion of this Court, decided November 27, 1939.
A loss is deductible in the year sustained and the question of when a loss is sustained is a factual one, and the burden of proof is on the petitioner. The failure to redeem may be cogent evidence of both a loss to the taxpayer of his interest in property and the time of such loss, but it is only such evidence when it is likewise demonstrated that the property had value prior to the year in which the expiration of the redemption right occurred. Petitioner argues that its action in spending time and money in a suit against Gilbreath in trying to preserve its title "seems the strongest practical proof that the royalty had value." The difficulty with this argument is that the facts upon which*180 it relies are not disclosed by the record. There is no evidence as to when the purported lawsuit was instituted, when it was settled, or even its purpose; *519 nor has any showing been made that any payment was made for legal services in respect of this royalty interest in 1944, as claimed. The only evidence other than James' testimony to the single fact that there was a lawsuit is the letter from Arrington & Miller, attorneys in Shawnee, Oklahoma, to petitioner's counsel, wherein they refer to a case captioned Gilbreath v. Pouder, et al. This letter was dated April 11, 1944, and bears an undated note beneath the body of the letter written by James, to the effect that the case was disposed of by letting judgment go to Gilbreath and that petitioner was to get a deed for its royalty interest on payment of its pro rata share of past taxes. However, another note on that letter indicates that James was of the opinion that the property was not worth petitioner's part of the taxes because it was "condemned by dry holes." The only evidence of a dry hole being drilled on or near the property was in 1930, but James testified that that hole did not render the property worthless. We*181 thus have no evidence of when the dry holes were drilled which "condemned" the property for oil production. It appears that the property was worthless at the time the redemption right expired, and we lack sufficient information to determine when it lost its value. It may have been in 1944, when petitioner claimed the deduction, or it may have been an earlier year. Such being the state of the record, we must sustain respondent's determination on this issue.
With respect to the Horsting litigation, it is petitioner's contention that the nature of the suit against the Horstings was essentially a suit for an accounting by one joint adventurer against another, which, it argues, is the "classical type of litigation giving rise to a deductible legal expense. Kornhauser v. United States, 276 U.S. 145">276 U.S. 145." Respondent, on the other hand, contends that the settlement of the lawsuit established petitioner's interest in the Jim Wells properties to its satisfaction, which indicates that this was the principal objective in instituting the lawsuit, and that the petitioner was correct in its original treatment of the expenses as a capital expenditure on its books. *182 Respondent does not contend that so much of the legal expenses as may have been incurred for an accounting are not deductible, nor does petitioner contend that so much of the legal expenses as may have been incurred to defend or perfect title to its property are deductible. The question for decision is accordingly one of fact.
It is rather obvious from the settlement agreement entered into by the parties that the legal expenses incurred in relation to this litigation and settlement are not one or the other of either an accounting or defense of title, but that such fees included payment for services, part of which resulted from petitioner's claim for an accounting and part of which resulted from petitioner's defense of title to its property. Petitioner has made no allocation of the legal expenses. Inasmuch *520 as it is clear that part of the legal expenses was incurred with respect to the accounting, although the amount thereof has not been shown, we have found as a fact, bearing heavily upon petitioner "whose inexactitude is of his own making," that the deductible legal expenses incurred were $ 1,179.33. Cohan v. Commissioner, 39 F. 2d 540.*183
Petitioner sold the property known as the Cambron lease in 1945 for $ 111.74, the unadjusted basis of which was $ 17,945.75. In arriving at its adjusted basis to compute its loss, petitioner deducted from its basis, determined under section 113 (a) of the Internal Revenue Code of 1939, the amount which it had reported as depreciation and depletion for prior years. The respondent does not contest the depreciation allowance of $ 3,548.76 used by petitioner in adjusting its basis, but contends that petitioner should have used cost depletion rather than percentage depletion during the years that the lease was producing; that such cost depletion which was "allowable" was $ 12,910.90, as distinguished from the percentage depletion "allowed" of $ 3,006.47; and that under section 113 (b) of the Code, 2 petitioner's basis is thereby reduced and its loss is $ 1,375.06, rather than the $ 11,390.52 claimed by petitioner.
*184 Section 113 (b), supra, provides that in determining the gain or loss from the sale or other disposition of property, the basis determined under section 113 (a) shall be adjusted for depletion, to the extent of the amount "allowed" as deductions in computing net income, but shall not be less than the amount "allowable."
The computation of depletion by the cost or unit method necessitates three factors, namely, the basis of the property, the estimated total recoverable units in the property, and the number of units recovered during the taxable year. Petitioner and respondent have no dispute in respect of the basis or the number of units recovered during the taxable year; the controversy arises over the estimated total *521 recoverable units in the property. James testified, not in respect to this particular property but with respect to all the various properties petitioner at one time or another acquired, that, on the basis of his examination of such properties when petitioner acquired them, he was of the opinion that petitioner would recover enough oil to make a profit on the whole operation and that the 27 1/2 per cent depletion allowance which petitioner took was as accurate*185 a forecast of the total amount of the depletion needed to restore the capital investments as could have been obtained by any other means. On the basis of this testimony, petitioner, in its brief, argues that since it invested approximately $ 13,000 in the lease, 3 it follows mathematically that there must have been approximately $ 47,000 worth of oil under the ground, and based upon the price of oil in 1937, when such estimate was made, this would equal about 35,000 barrels of oil. The difficulty with this argument is that percentage depletion is limited by section 114 (b) of the 1939 Code 4 to 50 per cent of net income, and inasmuch as petitioner apparently had no net income from the property for several of the years in question, no percentage depletion could be or was taken. Aside from illustrating the fallacy of petitioner's argument as to computing the number of barrels of oil in the ground on the basis of percentage depletion, these facts also make it apparent that for at least those years when petitioner was not able to take percentage depletion, cost depletion, regardless of how small, would have been greater. Furthermore, the record indicates that production from the*186 Cambron lease dropped from 5,299 barrels of oil in 1937 to 2,235 barrels for the year 1938. In 1939 production fell to 792 barrels, for the next 3 years it dropped approximately 200 barrels a year, and in 1945 produced only 14 barrels. Thus, the production record of the "several" wells on that lease gave strong indication that those wells were not going to produce 35,000 barrels of oil, nor does petitioner *522 contend otherwise. In the light of such facts, it is obvious that petitioner's original estimate of the oil potentialities of the lease, if it may be said that there was an estimate, was in error and such fact should have been apparent to it in 1939 or 1940. Petitioner, on brief, states that because James "felt that the wells drilled were entirely inadequate to exhaust the property, he made no reestimate of the oil contents" of the lease. We are unable to find in the record any evidence regarding the Cambron lease which would justify the opinion contained in that statement. The bare statement by James that the several wells did not exhaust the oil contents of the lease, without some elaboration as to what facts led him to that conclusion, is insufficient to meet *187 the burden of proof which the petitioner bears. It does not appear to us from the record as a whole that the units of oil in the ground were ever estimated or considered in adopting percentage depletion, but rather that percentage depletion was used as a matter of policy with petitioner, and without regard to the statutory provision that the allowance shall in no case be less than it would be if computed without reference to percentage depletion. Petitioner has offered no evidence of ever having computed its depletion on the cost or unit basis, but on the contrary, freely admits that when depletion was taken, it took percentage depletion exclusively. It is necessary for a taxpayer, using percentage depletion, to also compute depletion by the unit method, for the allowance for depletion shall not be less than depletion shown by unit computation. Sec. 114 (b), supra, and see Producers Oil Corporation, 43 B. T. A. 9.
*188 Petitioner further argues that respondent has been arbitrary and unreasonable in determining the number of units recoverable from the lease. We do not agree. Respondent in his computation of petitioner's depletion determined that the production from the existing wells completely exhausted the oil under the leased property. In view of the production schedule of the wells and the sale by the petitioner of this lease for $ 111.74, together with the failure of petitioner to offer any countervailing evidence, it is our opinion that respondent's action was reasonable, and his determination is sustained.
During the period 1946, 1947, and 1948, petitioner allegedly sold 12 oil royalties. Five of these royalty properties had never produced oil, six of them had produced at one time but had since stopped, and one was still producing nominal quantities of oil at the time of its purported sale. Five of the royalties were purportedly sold for $ 1, one for $ 2, two for $ 10, two for $ 20, one for $ 28, and one for $ 40. Petitioner paid an aggregate of $ 68,951.52 for the 12 properties.
Respondent disallowed the losses claimed by petitioner to have resulted from the alleged sale of these properties*189 on the ground that all the nonproducing royalties were worthless prior to such sale and that *523 the properties which had once produced were either fully depleted, having exhausted the oil supply on the property, or in the alternative, were like the nonproducing royalties, worthless prior to sale. It is respondent's contention that the repeated drilling of dry holes on or in the immediate vicinity of the nonproducing royalties, and the exhaustion of oil and the abandonment of the wells on the properties that once produced oil, were events which resulted in the loss of the sale value of the royalties in the ordinary channels of trade, which would have caused a prudent and informed business man to eliminate them from the asset side of his balance sheet. C. C. Harmon, 1 T. C. 40, reversed on another issue 323 U.S. 44">323 U.S. 44. He further argues that the alleged sale by petitioner of these properties for the nominal sums for which it sold them is indicative of the fact that they were worthless and that petitioner was cognizant of such worthlessness.
Petitioner, on the other hand, claims that all of the 12 properties in question *190 had value at the time of sale, and that the explorations made on the various properties did not exhaust the oil in the case of the once-producing royalties or the possibility of oil on the nonproducing royalties. Petitioner makes the claim that it was in liquidation and that it was because of this that it sold the properties at all and particularly it is why it disposed of them for a nominal sum. We think the fact that the alleged sales were spread over a period of 3 years militates against any inference from other evidence of record that the royalties were disposed of under pressure of time so that their full market value could not be realized. There is nothing in the record which indicates that the amounts received were other than token payments accepted for purposes of claiming loss deductions on the various royalties, and no more. The record of each of the royalty interests indicates numerous dry holes on and near the nonproducing properties, and abandoned wells and dry holes on and near properties that had once produced. Petitioner offered as proof that the properties were not worthless prior to sale evidence that some producing wells were drilled on or near some of these*191 properties after they had been disposed of. The question of the value of oil property revolves not merely on whether oil can be obtained from the property, but whether profitable quantities will ever be available. Chaparral Oil Co., 43 B. T. A. 457; C. C. Harmon, supra.There is no evidence that the oil from these wells was available in sufficient quantities to give value to the property, or whether it was merely nominal, as in the case of the wells on these properties for which we do have production records. The fact that the taxpayer, after a clear indication that a property has become worthless, wishes to retain its royalty interest therein in the hope that some income may ultimately be realized from it, does not add value to the property. Assuming, however, that the wells subsequently *524 drilled did lend value to the property, it is well recognized that subsequent events may show reasonable business judgments to be inaccurate, Rhodes v. Commissioner, 100 F.2d 966">100 F. 2d 966; Chaparral Oil Co., supra, but the possibility that such events might occur cannot*192 be used as an excuse for refusing to make reasonable judgments according to everyday business standards on the basis of facts presently known. The showing that the properties in question, as well as adjoining properties, have been under lease subsequent to their purported sale by petitioner is likewise not determinative of the value of the property, in the absence of any showing of the value of such leases. The only direct evidence we have of the value of these properties is the price obtained by petitioner for its royalty interest which, as set forth above, was only nominal.
Petitioner relies heavily upon cases to the effect that oil royalties represent interests running with the land and as such retain a potential value until sold or otherwise disposed of, Roy Nichols, 14 B. T. A. 1347, 17 B. T. A. 580, except where the taxpayer determines the royalties to be worthless prior to sale, in which case such determination should be sustained unless the taxpayer was clearly unreasonable and unfair in arriving at his decision. Rhodes v. Commissioner, supra.Petitioner argues from these cases that inasmuch*193 as it has not determined the royalties to be worthless and the royalties are interests running with the land, the determinative event of petitioner's sustained loss is the sale of the properties. We have held in the Harmon case that oil and gas royalties may become worthless the same as any other class of property "upon the happening of some event which results in the loss of its sale value in the ordinary channels of trade and would cause a prudent and informed business man to eliminate it from the asset side of his balance sheet." The fact that petitioner never determined the royalties to be worthless is immaterial, for the criterion for the deductibility of a loss is not ascertainment but when the loss is sustained. L. S. McLeod, 19 B. T. A. 134; S. G. Armstrong, 24 B. T. A. 321; American Multigraph Co., 10 B. T. A. 406. On the record before us, there is nothing to show that petitioner did not sustain the losses as a result of the properties having become worthless prior to the taxable years, when the purported sales were made. Petitioner admits on brief that it "followed a consistent*194 policy of not writing off royalties as worthless until sold, even though in the first years of its existence such a practice might have resulted in tax savings." It thus appears that petitioner established for itself a standard of conduct for determining losses contrary to that set forth in section 23 (f) of the 1939 Code. The result of such a policy is obvious, for it ignores the reality of the facts pertaining to the value of the royalties.
*525 We have carefully studied all the evidence with respect to each of petitioner's properties and, with the exception of royalty No. 10, have concluded, for the reasons set forth above, that the respondent did not err in determining that both the nonproducing and once-producing royalties were worthless prior to the year of their purported sale by petitioner.
Royalty No. 10 had an unadjusted basis to petitioner of $ 12,759.10. There was one well on this property which was evidently drilled in 1928 and which was still producing nominal amounts of oil when it was sold by petitioner in 1948 for $ 10. The evidence shows petitioner's share of oil production from the property for the years 1928 to 1936, inclusive, was 927.47 barrels, or an*195 average of 103.05 barrels per year; for the years 1937 to 1941, inclusive, was 169.80 barrels, or an average of 33.96 barrels per year; and for the years 1942 to 1948, inclusive, was only 32.77 barrels, or an average of 4.68 barrels per year. Percentage depletion was taken on this royalty interest in the aggregate amount of $ 196.04. The respondent determined that cost depletion exceeded percentage depletion taken by petitioner by $ 12,038.57, thus reducing petitioner's loss to $ 514.49. It is respondent's contention that petitioner's basis on the royalty should have been recovered by depletion prior to sale, his argument as to depletion allowed or allowable being the same as that made with respect to the Cambron lease. It is petitioner's position that there was enough oil under the ground to return its investment through percentage depletion.
As in the Cambron lease issue, there is no evidence that petitioner ever estimated the oil reserves with respect to royalty No. 10, but rather, took percentage depletion as a matter of policy. What we have said in regard to this policy in discussing the Cambron lease issue applies equally here. After giving all the facts with respect to*196 this issue full consideration, particularly the fact that in 14 years of production on this property petitioner recovered less than 2 per cent of its investment therein and the fact that notwithstanding its high appraisal of the oil potential of the property, it sold this royalty interest for $ 10, we conclude that the respondent did not err in adjusting the basis for royalty interest No. 10, and his determination with respect thereto is sustained.
Decision will be entered under Rule 50.
Footnotes
1. As to this royalty and each of those which follows, the ledger sheets from petitioner's books were placed in the record, which in each instance, save one, would seem to indicate a closing by sale of the royalty at cost on December 31 of the particular year. It is only by reference to the representations in the returns that we have a breakdown of these closing entries as between the nominal or token sales prices, depletion in cases where oil royalties had been received and the amounts of the losses claimed. Where there had been production, the portions of the cost which had been recovered through depletion represent exactly 27 1/2 per cent of the oil royalties which had been received, as shown by other ledger sheets which are also of record.↩
2. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --
* * * *
(b) Adjusted Basis. -- The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided.
(1) General rule. -- Proper adjustment in respect of the property shall in all cases be made --
* * * *
(B) in respect of any period since February 28, 1913, for exhaustion, wear and tear, obsolescence, amortization, and depletion, to the extent of the amount --
(i) allowed as deductions in computing net income under this chapter or prior income tax laws, and
(ii) resulting (by reason of the deductions so allowed) in a reduction for any taxable year of the taxpayer's taxes under this chapter (other than subchapter E), subchapter E of chapter 2, or prior income, war-profits, or excess-profits tax laws,
but not less than the amount allowable under this chapter or prior income tax laws. * * *↩
3. Cost of equipment was $ 4,747.85, to which depletion was not applicable.↩
4. SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
(a) Basis for Depreciation. -- The basis upon which exhaustion, wear and tear, and obsolescence are 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.
(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.
* * * *
(3) Percentage depletion for oil and gas wells. -- In the case of oil and gas wells the allowance for depletion under section 23 (m) shall be 27 1/2 per centum of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance under section 23 (m) be less than it would be if computed without reference to this paragraph.↩