*2252 On January 18, 1921, D. E. Armstrong deeded the oil and mineral rights on his farm, on which the original discovery well in the State of Arkansas was brought in on January 10, 1921, to his son-in-law in trust to sell or otherwise dispose of and to distribute the proceeds to himself and children. On the same date the trustee entered into an oil and gas lease with the Pure Oil Co. upon a part of the demised property, for which he received a bonus of $96,000 for entering into the lease. Under the terms of the lease the lessee was obligated to pay a royalty equal to a one-eighth part of all oil produced. The trustee distributed to the beneficiaries annually the net proceeds from all moneys received. Held, that the petitioners, beneficiaries of the trust, are entitled to deduct from gross income received reasonable amounts for depletion.
*1102 These proceedings have been consolidated for hearing and opinion. The case of J. K. Mahony and W. C. Miles, executors of the estate of D. E. Armstrong, Docket No. 30285, and that of Cary A. Lumpkin, Docket*2253 No. 31838, involve deficiencies in income tax for the calendar years 1923 and 1924; all the other cases, bearing two docket numbers each, involve deficiencies in income tax for the calendar years 1921, 1923, and 1924. The issues are:
(1) Whether the petitioners derived any income in 1921 in respect of a bonus payment of $96,000 by the Pure Oil Co., of Ohio, which acquired a lease upon a portion of the property deeded to J. K. Mahony, trustee, the proceeds of which were distributed to them in 1921; and
(2) Whether the petitioners are entitled to deduct from amounts distributed to them in 1921, 1923, and 1924 reasonable amounts for depletion of their interests in the property.
FINDINGS OF FACT.
1. On January 10, 1921, a large oil well known as "Busey No. 1" was discovered on the farm and premises of D. E. Armstrong near El Dorado, Ark. This was the original discovery well in the State of Arkansas.
2. On January 18, 1921, D. E. Armstrong and Carrie S. Armstrong, his wife, executed a deed which provided in part -
* * * for and in consideration of the sum of ONE DOLLAR to us cash in hand paid by J. K. Mahony, trustee, and the love and affection which we bear to the beneficiaries*2254 under this trust, hereinafter named, do hereby grant, bargain, sell and convey unto the said J. K. Mahony, trustee, of El Dorado, Arkansas, and unto his successors and assigns forever, all of the royalty in oil, gas and other minerals, and all oil, gas and other minerals owned by us under and upon the following described lands, situated in the County of Union, State of Arkansas, * * *
owned by them and known as the Armstrong farm, consisting of 504.62 acres.
*1103 The habendum clause of the deed provided in part:
The trusteeship of the said J. K. Mahony, Trustee herein, is specifically defined, and the interests of the beneficiaries under this trust, are fixed as follows, to-wit:
The beneficiaries under this trust, and their respective interests are: D. E. Armstrong, 5/16; W. B. Armstrong, 1/16; Mary Alphin, 2/16; Carey Lumpkin, 2/16; Roberta Mahony, 2/16; Dorothy Miles, 2/16; and Priscilla Armstrong, 2/16, said interests of said beneficiaries being in the proceeds of the sale or other disposition by the said J. K. Mahony, Trustee, of all oil, gas and mineral royalties, or interest therein, and all oil, gas and mineral rights, or interest therein, of every kind*2255 whatsoever, owned by us and under all of the above described lands, the said J. K. Mahony, Trustee, being wholly and entirely responsible to each of the beneficiaries herein, without bond, for their respective interests as hereinbefore defined and set out, the said J. K. Mahony, Trustee, to have absolute discretion as to the time, manner and amounts of distribution of the proceeds arising from the trust reposed in him, accounting to each of said beneficiaries in proportion to their respective interests as hereinbefore set out granting unto the said trustee the right to collect, receive and disburse under his trusteeship herein any and all moneys arising from the payment of rentals and royalties, or from other sources, under any oil and gas mining lease or leases heretofore made to any person or persons covering any of the above described lands, by said grantors.
(3) On January 25, 1921, D. E. Armstrong and Carrie S. Armstrong, his wife, made and acknowledged a certain declaration of trust with respect to the aforesaid property conveyed by them to J. K. Mahony, trustee, wherein the duties of the trustee are set forth in detail. This declaration of trust provides in part as follows:
*2256 WHEREAS, We, David E. Armstrong and Carrie S. Armstrong, on the 19th day of January, 1921, executed to J. K. Mahony, Trustee, a trust deed, conveying to him, in trust, the royalty and the oil, gas and minerals on certain lands situated in Union County, Arkansas, and more particularly described in said instrument; and,
WHEREAS, Said Trustee, at said time, and as a part of the trust imposed on him by the grantors in said trust deed, understood by the beneficiaries under said trust, was charged with the performance of other duties respecting the administration of said trust; and
WHEREAS, For personal reasons it was desired by ourselves and the parties beneficiary under said trust that said terms and conditions, evidenced by this instrument, be not spread upon the public record of Union County, Arkansas, but that same be preserved as a part and parcel of the terms and conditions of said original declaration of trust in J. K. Mahony, Trustee, now of record;
THEREFORE, BE IT KNOWN: That we, David E. Armstrong and Carrie S. Armstrong, do hereby declare, as evidencing the further conditions imposed on J. K. Mahony, Trustee, by said recorded Trust Deed, which, for the reasons aforesaid, *2257 were omitted therefrom, as follows, to-wit:
1. Said Trust shall remain in force during our life time, and for ten years thereafter, and shall be further continued from year to year, unless a majority in interest of the beneficiaries thereunder shall, after the expiration of said ten year period, request of the Trustee a discontinuance of the trusteeship, in which event said trusteeship shall terminate, and all funds or property in the hands of said Trustee shall be divided in kind among the beneficiaries, in proportion *1104 to their respective interests. Conditioned, however, as in the following paragraph (2).
2. In the event of the death, resignation or inability, for any reason, of J. K. Mahony to act as trustee under this Trust, at any time during the time in the last paragraph referred to, then the same shall terminate, and the funds held by the said J. K. Mahony as trustee shall be paid to the beneficiaries hereunder, in kind and amount in proportion to their respective beneficial interests hereunder. Provided, however, that in the event of the death, resignation, or inability of the said J. K. Mahony to act as trustee herein, at any time, then, and in that event, *2258 a majority in interests of the beneficiaries herein shall have the right to select another trustee who, when selected, shall be charged with the performance of all duties, and clothed with all the powers and discretions by this declaration of trust conferred upon J. K. Mahony, Trustee; and such trustee may be required to enter into bond for the faithful discharge of all duties, and accounting for all trust funds coming into his hands.
On the same day, J. K. Mahony accepted the trust and declared that he would account to the beneficiaries named therein and make disbursements of all funds received at least annually.
4. J. K. Mahony has disbursed and distributed at least annually all the funds coming into his hands as trustee to the said beneficiaries in proportion to their respective interests.
5. On January 18, 1921, J. K. Mahony, as trustee under the deed aforesaid, made and entered into a certain oil and gas lease with the Pure Oil Co., of Ohio, upon a part (32 acres more or less), of the aforesaid property to him conveyed in trust for which he received the sum of $96,000.
This oil and gas lease provided in part as follows:
THIS AGREEMENT, Made and entered into on*2259 this the 18th day of January, 1921, by and between J. K. Mahony, Trustee, of El Dorado, Arkansas, hereinafter called lessor (whether one or more), and The Pure Oil Company, a corporation, hereinafter called lessee.
WITNESSETH, That the said lessor for and in consideration of One Thousand DOLLARS, cash in hand the receipt of which is hereby acknowledged, and of the convenants and agreements hereinafter contained on the part of the lessee to be paid, kept and performed, has granted, demised, leased and let, and by these presents does grant, demise, lease and let unto said lessee, for the sole and only purpose of mining and operating for oil and gas, and laying of pipe lines, and of building tanks, power stations and structures thereon to produce, save and take care of said products, and all that certain tract of land situate in the County of Union, State of Arkansas, described as follows, to-wit: SE 1/4 of S.E. 1/4 of Sec. 30, TWP 17 South Range 15W, less 8 acres off the West side of said tract, said tract of 8 acres having a uniform width across the said forty acres, and containing thirty-two acres, more or less.
It is agreed that this*2260 lease shall remain in force for a term of five years from this date, and as long thereafter as oil or gas, or either of them, is produced from said land by the lessee.
In consideration of the premises the said lessee covenants and agrees:
First. To deliver to the credit of lessor, free of cost in the pipe line to which he may connect its wells, the equal one-eighth part of all oil produced and saved from said leased premises.
*1105 Second. To pay the lessor $300.00 Dollars each year in advance, for the gas from each well where gas only is found, while the same is being used off the premises, and lessor to have gas free of cost from any such well for all stove and all inside lights in the principal dwelling house on said land during the same time by making his own connection with the well at his own risk and expense.
Third. To pay lessor for gas produced from any oil well used off the premises at the rate of one-eighth of net proceeds, for the time during which said gas shall be used.
6. The price received by J. K. Mahony, trustee, for the oil and gas lease aforesaid from the Pure Oil Co. did not exceed the value which the interest leased had when it*2261 was acquired by said J. K. Mahony as trustee, the acquisition and leasing thereof having transpired on the same date.
7. The property interest conveyed by the deed aforesaid by D. E. Armstrong and Carrie S. Armstrong, his wife, to J. K. Mahony, trustee, had no known or demonstrated value as of March 1, 1913, and had no cost basis in the hands of said D. E. Armstrong and Carrie S. Armstrong, his wife.
8. If the beneficiaries named in the aforesaid deed conveying the oil and minerals lying under or upon the lands therein mentioned to J. K. Mahony, trustee, became by said deed the owners of an interest subject to a depletion deduction, that is, if said beneficiaries were the owners under the deed, either in law or in equity, of property subject to depletion under the Revenue Acts of 1921 and 1924, then the amount of depletion allowable as a deduction to the whole group, divisible according to their respective interests in the property, is as follows:
| 1921 | $36,139.67 |
| 1923 | 27,843.19 |
| 1924 | 10,162.14 |
9. The deficiency notices sent by the Commissioner to the petitioners involving determined deficiencies for 1921 show that the Commissioner determined that the*2262 trustee made a sale of a lease in 1921 for $66,000; that from this amount the Commissioner allowed a deduction of $6,600 commission and determined that a balance of $59,400 was distributed to the beneficiaries in that year; that in addition thereto there was distributed to the beneficiaries $25,361.60 representing oil royalties received in 1921. From these amounts the Commissioner has disallowed the deduction of any amount representing an allowance for depletion.
10. In the determination of deficiencies for the years 1923 and 1924, the Commissioner has disallowed the deduction from gross income of any amount representing an allowance for depletion.
*1106 OPINION.
SMITH: 1. The parties have stipulated that if the beneficiaries are entitled to depletion deductions for the tax years involved the amounts deductible for all the petitioners (divisible according to their respective interests in the property) are as follows:
| 1921 | $36,139.67 |
| 1923 | 27,843.19 |
| 1924 | 10,162.14 |
From an inspection of the deed of trust of January 18, 1921, and of the supplemental declaration of trust of January 25, 1921, it is apparent not only that the beneficiaries had an*2263 interest in the income of the trust, but that they had an interest in the corpus in exactly the same proportion. The facts in this case are substantially the same as those which obtained in , wherein the court held that reasonable allowance for depletion should be made in computing beneficiaries' income from royalties on mining properties held in trust, the beneficiaries being held to have a property right and interest in the corpus of the trust. The court observed:
The petitioners have a property right and interest, within the decision of ), as real as that of the lessee referred to in Lynch v. Alworth-Stephens Co. (supra). Their interest in the ore body is as direct as the interest of the lessor, which is contingent upon the fulfillment by the lessee of the obligations under its lease. Included in the current payment of royalties is a sum representing the value of each ton of ore removed. As stated in the Lynch case, allowance is to be made "to every one whose property right and interest therein has been depleted" and it would therefore seem that these*2264 petitioners should be allowed deductions for depletion which their property interest sustained by reason of the mining operation.
The government accedes to the doctrine that in all mining operations there is some depletion. But whose ore is depleted is put into question. If the petitioners have any property interest in the corpus, it is being depleted. Certainly, they, who receive the income, the title owners of the corpus of the trust, the trustees, might have a depletion allowance. These petitioners who have the property right to which we have referred, receive the royalties without deduction. The statutes provide for depletion. The trustees merely pass on the royalties received in the percentages the will requires of them. The terms of the trust require that the entire royalties be paid currently to the beneficiaries. No depletion reserve was to be set aside or retained by the trustees.
We are of the opinion that the petitioners all had a depletable interest in the property conveyed to Mahony and that they are entitled to deduct from their gross incomes their pro rata shares of the depletion allowances stipulated.
*1107 2. The second question for decision*2265 is whether the petitioners derived any income from distributions made to them by Mahony from the $96,000 bonus for entering into the lease with the Pure Oil Co. Counsel for the petitioners sets forth his contention in his brief upon this point as follows:
It has been stipulated that this part of the property when acquired had the same value as it had when disposed of, the acquisition and disposition having transpired on the same date. If then, as we believe, the basis of such property in the hands of the trustee was its value at the date of acquisition, no gain or income resulted from the disposition thereof for the same amount; and the distribution of the proceeds to the beneficiaries of the trust does not, we submit, result in income to them.
The record discloses that Mahony did not sell any part of the property which was deeded to him by D. E. Armstrong and his wife. He simply entered into a lease with the Pure Oil Co. by which it was permitted to take oil and gas from a tract of about 32 acres. The $96,000 in question was received by Mahony as a bonus for entering into the lease. A bonus for entering into a lease represents taxable income. *2266 ; . This contention of the petitioners is denied.
Reviewed by the Board.
Judgment will be entered under Rule 50.