*234 Decisions will be entered for the respondent.
Taxpayer Gordon Oil Company assigned two producing oil and gas leases and certain tangible property connected therewith. At the time of the assignment Gordon's leasehold costs had been fully depleted, and the tangible property had an adjusted basis of $ 332,518.10. Gordon received $ 250,000 from the assignees at the time of the assignment, and excepted from the assignment an oil payment in the face amount of $ 3,600,000. It claimed a deduction to the extent that the adjusted basis of the tangible property exceeded the cash payment of $ 250,000. Held, in the absence of evidence that a portion of the remaining consideration was not properly allocable to the tangible property, the taxpayer failed to carry its burden of proving that the tangible property was sold for only $ 250,000, and the deduction must therefore be disallowed.
*1110 Respondent determined deficiencies in the income and excess profits taxes of Gordon Oil Company for the taxable period January 1 to August 31, 1951, in*235 the total amount of $ 46,256.88. He determined further that Mortimer A. Kline is the transferee of the assets of that company, and is liable for the deficiencies. At issue is whether Gordon incurred a deductible loss on the assignment of certain tangible property.
FINDINGS OF FACT.
Some of the facts have been stipulated and are incorporated herein by this reference.
Mortimer A. Kline, hereinafter called Kline, is an individual residing in Los Angeles, California. He filed his income tax return for the taxable year ended December 31, 1951, with the collector of internal revenue at Los Angeles, California.
Gordon Oil Company, hereinafter called Gordon, was incorporated under the laws of the State of California on January 20, 1949. It was incorporated for the purpose of acquiring, exploring, developing, and producing oil and gas properties, and throughout the period of its existence conducted that business. Gordon filed its income and excess profits tax returns for the taxable period January 1 to August 31, 1951, with the collector of internal revenue at Los Angeles, California.
*1111 Gordon, on March 22, 1949, acquired 2 undeveloped oil and gas leases in Placerita Field, Los*236 Angeles County, California. Gordon drilled and equipped 29 producing wells on the leaseholds.
During the period from March to May 1951 Kline purchased all of Gordon's outstanding stock for a total consideration of $ 3,962,432.54. Kline purchased the stock for his own account. The purchases were financed by a loan from a bank in Dallas, Texas. All of the stock in Gordon purchased by Kline was pledged as collateral for the loan.
Kline, after acquiring all of the outstanding stock of Gordon, became a director and the president of the company.
After Kline had acquired control of Gordon, Gordon, as a principal, by proper and appropriate corporate action, executed under date of May 7, 1951, an agreement with Tevis F. Morrow (hereinafter called Morrow) and A. H. Meadows (hereinafter called Meadows). Upon the execution of this agreement there was paid to Gordon $ 250,000 in cash.
The agreement provided, in part, as follows:
For a valuable consideration, cash in hand paid unto Assignor [Gordon] by Assignee [Morrow and Meadows, jointly], the receipt of which is hereby acknowledged, and in consideration of the strict and punctual performance by Assignee, its representatives and assigns, *237 of the covenants herein provided to be kept and performed by Assignee, its representatives and assigns, and, subject to the exception and reservation hereinafter stated, Assignor does hereby grant, bargain, sell, convey, assign, transfer, set over and deliver unto Assignee all interests in lands wherever situated and all easements, permits, licenses, servitudes and rights of every character which are useful or appropriate in exploring for, developing, operating, treating, storing, or transporting oil, gas or other minerals, on the date hereof owned or controlled by Assignor, * * * together with all improvements and all the interests of Assignor in all personal property situated upon or used in connection with mining operations on said lands, and all other tangible personal property or interests therein now owned by Assignor, and all other properties and interests in properties of whatsoever kind or character, except accounts receivable and moneys on hand or on deposit, now owned by Assignor.
* * * *
Assignor hereby excepts from this conveyance and does hereby reserve unto itself, its successors, representatives and assigns, as a limited overriding royalty interest or production payment*238 free of all development, operation, production and other costs and expenses of any kind whatsoever, subject to the limitation hereinafter set forth, an undivided eighty-five per cent (85%) (hereinafter sometimes referred to as the "reserved share,") of "Assignor's interest," as hereinafter defined, in all of the oil, gas, casinghead gasoline and other hydrocarbons and other minerals in, under and upon, or that may be produced and saved from the lands described in Exhibit 1. 1
(1) As used in the foregoing exception and reservation, the expression "Assignor's interest" means the working interest share of all the oil, gas, casinghead *1112 gasoline and other hydrocarbons and other minerals of any kind whatsoever in, under or upon or that may be produced and saved from the lands * * * which, immediately prior to the execution and delivery of this conveyance, was vested in Assignor and which, from and after the effective date hereof, but for the foregoing exception and reservation, would accrue or belong to Assignee, its representatives and assigns, by virtue of this conveyance.
* * * *
(3) The foregoing exception and reservation shall be effective as of the effective date of this*239 conveyance.
(4) The foregoing exception and reservation shall remain in full force and effect until such time as Assignor, its successors, representatives and assigns, shall have received out of the net proceeds of the sale of the "reserved share" of the oil, gas casinghead gasoline and other hydrocarbons and other minerals of any kind whatsoever the full net sum of Three Million Six Hundred Thousand Dollars ($ 3,600,000), in cash; plus
(a) an amount equal to the aggregate of all severance and gross production taxes and all other taxes and assessments of any kind whatsoever levied upon or assessed against or measured by the production accruing to the "reserved share" and all ad valorem taxes and all other taxes and assessments of any kind whatsoever levied upon or assessed against the property interests hereby excepted and reserved, to the extent, but only to the extent, that any of such taxes or assessments are paid by Assignor; plus
(b) an additional amount equal to interest from May 1, 1951, on the unliquidated balance of the aggregate of said sum and amount at the rate of five per cent (5%) per annum computed monthly on the basis of a 360-day year, 30-day month, on the first*240 day of each month, beginning June 1, 1951.
The net proceeds of the sale of the "reserved share" of the oil, gas, casinghead gasoline and other hydrocarbons and other minerals of any kind whatsoever, shall be applied each month by Assignor, its successors, representatives and assigns, first, to the amount equal to interest as specified in subparagraph (4) (b) above; then to the amount equal to the aggregate of all taxes and assessments that are paid by Assignor as specified in subparagraph (4) (a) above; and then to the sum first specified in this paragraph (4).
(5) It is further understood that upon the aggregate sum and amounts above provided for being paid to and received by Assignor, its successors, representatives and assigns, all rights, titles, and interests hereby reserved unto Assignor shall terminate and thereupon the fractional interest hereby reserved shall be vested in Assignee, its representatives and assigns, free and clear of the exception and reservation herein made, and to evidence the fact, Assignor, its successors, representatives and assigns, will at any time and from time to time execute and deliver on request all necessary and appropriate acquittances.
(6) It*241 is understood that Assignee shall never personally be liable for payment of the above described production payment and that Assignor and its successors, representatives and assigns, shall look exclusively to the oil, gas and other minerals reserved herein for the payment thereof, and that Assignor, its successors, representatives and assigns, shall have no lien whatsoever for the payment of said production payment, provided that nothing in this paragraph contained shall impair the obligation of Assignee under subparagraphs (g), (h) and (i) of Paragraph 10 hereof to account to Assignor, its successors, representatives and assigns, for funds which come into the hands of Assignee and which are attributable to the "reserved share".
(7) The above reservation and exception shall in no sense extend to any lease equipment or other personal property which is included in this sale, all *1113 of which equipment and personal property is being sold to Assignee without reservation.
(8) As a further consideration for this assignment Assignee for itself, its representatives and assigns, covenants and agrees with Assignor, its successors, representatives and assigns, until such time as the aggregate*242 sum and amounts above provided for have been fully paid to and received by Assignor, its successors, representatives and assigns, in a good and workmanlike manner, to develop and operate or cause to be so developed and operated, the oil and gas properties described in Exhibit 1, and to produce oil and gas from the respective wells located on the lands described in Exhibit 1, so long as oil, gas or other hydrocarbons can be produced therefrom in paying quantities, and to comply with all the terms and provisions, both express and implied, of the oil, gas and mineral lease described in Exhibit 1, subject to the proviso stated in the next succeeding sentence hereof. If Assignee elects to abandon or release any specific portion or portions of the properties described in Exhibit 1 from the operation of such oil, gas and mineral lease, in accordance with the provisions contained in such lease, and thereby be relieved from further obligation as to the property which Assignee desires to abandon or release, Assignee prior to such abandonment or relinquishment shall give to Assignor, its successors, representatives and assigns, thirty (30) days' written notice of such intention, and upon written*243 request of Assignor, its successors, representatives and assigns, or any of them, within said period of thirty (30) days, Assignee, its representatives and assigns, shall execute to Assignor, its successors, representatives and assigns, or such of them as may make said written request, or to the nominee of such of them as may make said written request, a reassignment of the interest in the portion of said lease which Assignee desires to abandon or release, by recordable instrument, in which event Assignee shall be relieved from further obligation with reference to the portion so reassigned, but thereby the amount of the aforesaid production payment and the fraction of the production from the remaining lands described in Exhibit 1 out of which it is dischargeable shall not be reduced, affected or impaired. In the event Assignor, its successors, representatives and assigns, do not desire a reassignment of said interest, then Assignor, its successors, representatives and assigns, shall join in the execution of a recordable release of said portion of said property in accordance with the provisions of said lease, but thereby the amount of the aforesaid production payment and the fraction*244 of the production from the remaining lands described in Exhibit 1 out of which it is dischargeable shall not be reduced, affected or impaired.
* * * *
(10) As a further consideration for this assignment, Assignee for itself, its representatives and assigns, covenants and agrees with Assignor, its successors, representatives and assigns, until such time as the aggregate sum and amounts above provided for have been fully paid, to
(a) Deliver at its own expense in quadruplicate to Assignor, its successors, representatives and assigns, on or before November 15 in each year, beginning with the year 1951, a report prepared by a mutually acceptable geologist, setting forth as of the preceding October 1, an estimate of reserves of recoverable oil, gas and other minerals properly allocable to the interests described in Exhibit 1, the future income to be derived from the sale of such recoverable reserves at prices existing as of October 1 of each year (future income to be set forth by years for a six (6) year period and for future years thereafter as a single period); and such other geological and scientific data as Assignor, its successors, representatives and assigns, shall reasonably request;
*245 *1114 (b) Obtain from time to time and at any time, on request of Assignor, its successors, representatives, and assigns, from persons approved in writing by them, any and all geological, engineering and other scientific data and reports regarding the properties described in Exhibit 1 deemed necessary or appropriate by Assignor, its successors, representatives and assigns, and to deliver the same unto Assignor, its successors, representatives and assigns;
(c) Deliver in quadruplicate to Assignor, its successors, representatives and assigns, on or before the last day of each month, beginning with the month of June, 1951, a production report in a form approved by Assignor, its successors, representatives and assigns, setting forth the results of operations of the properties described in Exhibit 1 during the preceding calendar month;
(d) Keep true and correct books and records showing the production of all oil, gas, casinghead gasoline and other hydrocarbons and other minerals of any kind whatsoever from the lands described in Exhibit 1 and all necessary information with respect to such production, to show and determine the "reserved share" of such production;
(e) Permit Assignor, *246 its successors, representatives and assigns, and the accredited agents and nominees of any of them, at all times to go upon, examine, inspect and remain on all lands described in Exhibit 1, and to examine, audit and make excerpts from any and all books and records of Assignee, its representatives and assigns, regarding the lands and properties described in said exhibit and the production from said lands;
(f) Deliver to the credit of Assignor, its successors, representatives and assigns, into the pipe lines to which the wells may be connected, free of all charges, the "reserved share" of the oil produced and saved from the lands described in Exhibit 1;
(g) Account to Assignor, its successors, representatives and assigns, for the net proceeds of the sale of the "reserved share" of the gas, casinghead gasoline and other hydrocarbons other than oil produced from the lands described in Exhibit 1;
(h) Pay to Assignor, its successors, representatives and assigns, the proceeds of the sale of the "reserved share" of the oil produced and saved from any lands described in Exhibit 1, which on the date hereof is subject to a crude oil sales contract under the terms of which Assignor is not entitled*247 to be paid direct by the purchaser of such production for the "reserved share";
(i) Account to Assignor, its successors, representatives and assigns, for the "reserved share" of all gas produced from any lands described in Exhibit 1, which on the date hereof is subject to a gasoline extraction contract under the terms of which Assignor is not entitled to be paid direct by the purchaser of such production for the "reserved share";
(j) Pay all taxes and assessments of any kind whatsoever levied upon or assessed against or measured by the production by Assignee of oil, gas, casinghead gasoline and other hydrocarbons or other minerals of any kind whatsoever from the lands described in Exhibit 1, and all ad valorem taxes and all other taxes and assessments of any kind whatsoever levied upon or assessed against the lands and properties described in Exhibit 1, which are due and payable after the effective date hereof;
(k) Comply with all laws and regulations pertaining to the exploration and development of the lands described in Exhibit 1 and the conduct of all operations under the oil and gas mining lease described in said exhibit;
(l) Pay all costs and expenses incurred in developing*248 and operating the lands described in Exhibit 1 and not permit any mechanic's, materialmen's, or laborer's liens to attach to said lands or any interest therein or any personal property thereon.
*1115 (11) An event of default will occur upon the happening of any one or more of the following events:
(a) Should Assignee, its representatives or assigns, in any respect fail strictly and promptly to keep and perform or to observe any one or more of the conditions, obligations, covenants, promises and undertakings herein provided to be observed, kept and performed by it, and such failure to observe, keep and perform any one or more of such conditions, obligations, covenants, promises and undertakings continues for thirty (30) days after demand for performance is made in writing on Assignee, its representatives and assigns, or any one or more of them, by Assignor or those successors, representatives and assigns of Assignor at the time holding at least an undivided two-thirds (2/3) of the rights, titles and interests hereby reserved unto Assignor; or
(b) Should there be appointed a receiver of Assignee, its representatives or assigns, or of any of its properties; or
(c) Should Assignee, *249 its representatives or assigns, be adjudicated an involuntary bankrupt, by a court of competent jurisdiction; or
(d) Should Assignee, its representatives or assigns, apply to be adjudicated a bankrupt; or
(e) Should an assignment be made by Assignee, its representatives or assigns, for the benefit of creditors; or
(f) Should Assignee, its representatives or assigns, fail for sixty (60) days after any money judgment against it shall have become final, to pay such judgment.
On the occurrence of any event of default, Assignor or those successors, representatives and assigns of Assignor at the time holding at least an undivided two-thirds (2/3) of the rights, titles and interests hereby reserved unto Assignor, shall thereupon or thereafter have the continuing and absolute right, privilege and option, until the limited overriding royalty interest or production payment herein reserved has been fully paid, liquidated and discharged, to take over, hold, manage, operate and develop all or any part of the interest of Assignee, its representatives and assigns, in the oil, gas and mineral lease and oil and gas mining leasehold estate described in Exhibit 1 and the lands and properties covered*250 thereby, together with the interest of Assignee in all machinery and equipment of every kind and character located on said lands or which may be used or useful in the operation of said oil, gas and mineral lease, and the further right to sell all of the oil, gas and other minerals of every kind whatsoever produced, saved, derived, obtained or accruing alike to the interest of Assignor and the interest of Assignee thereunder. If such right, privilege and option be exercised, Assignor, its successors, representatives and assigns, shall not be liable to Assignee, its representatives and assigns, or to anyone claiming or to claim under them, or any of them, for any action or failure to act except as to any such act or omission which is the result of actual bad faith.
If the aforesaid right, privilege and option is exercised, Assignor, its successors, representatives and assigns, shall be entitled to collect the proceeds of the oil, gas and other minerals accruing both to the interest hereby assigned and the interest hereby reserved unto Assignor. It is understood that no duty is hereby imposed on Assignor to exercise such right, privilege and option, but if it is exercised, then for*251 all costs incurred in the preservation, protection, operation and development of said properties, and in the discharge of any obligations appertaining thereto, together with interest at the rate of six per cent (6%) per annum, computed monthly on the first day of each month from the respective dates of outlay on the unliquidated balance of such costs, Assignor, its successors, *1116 representatives and assigns, shall be entitled to reimbursement from the proceeds of production accruing to the interest that by this assignment is vested in Assignee, and for the balance, if any, Assignor shall account to Assignee.
If such right, privilege and option is exercised, it is understood that Assignor, its successors, representatives and assigns, shall have no title or interest of any character in the personal property and equipment on the lands described in Exhibit 1 and in the properties and interests in properties conveyed hereby, and shall have solely the entire use of such personal property and equipment, free of any rental costs or other charges whatsoever, for the purpose of operating said premises, and that all such properties shall at all times remain the property of Assignee. *252 Said right, privilege and option may be exercised at any time and from time to time after occurrence of an event of default by Assignor or those successors, representatives and assigns of Assignor at the time holding at least an undivided two-thirds (2/3) of the rights, titles and interests hereby reserved, communicating a desire to take over possession of said properties to Assignee, its representatives or assigns, or any one or more of them, whereupon Assignee, its representatives and assigns, shall immediately deliver possession of said premises and do all other acts and things necessary or appropriate to be done to make such right, privilege and option effective. It is further understood that said right, privilege and option is a continuing option and that no exercise of such right, privilege and option shall be held to exhaust said right, privilege and option, but the same may be exercised at any time and from time to time until the limited overriding royalty interest or production payment herein reserved shall have been fully liquidated and paid.
*253 The excepted interest reserved by Gordon in the agreement with Morrow and Meadows would be liquidated in full substantially prior to the exhaustion of the economic life of the leases and was not tantamount to an overriding royalty.
At the time of the agreement with Morrow and Meadows, Gordon had fully depleted its leasehold cost in both of the leases, but had on hand tangible assets pertaining to the operation of the leases, with a then adjusted basis of $ 332,518.70. These assets, their respective costs to Gordon, adjustments due to depreciation, and their adjusted basis were as follows, as of the date of the agreement:
| Physical equipment in wells | $ 159,748.52 |
| Buildings | 8,147.12 |
| Machinery and equipment | 5,414.27 |
| Pipelines | 18,909.76 |
| Pumping equipment | 94,745.87 |
| Reservoirs and tanks | 25,725.35 |
| Autos and trucks | 7,200.05 |
| Total | 319,890.94 |
| Less: Reserve for depreciation | 37,429.80 |
| Adjusted basis of fixed assets | 282,461.14 |
| Crude oil inventories -- at book amount | 13,215.15 |
| Materials and supplies -- at book amount | 34,204.04 |
| Electrical service deposits | 2,638.37 |
| Total adjusted basis of properties sold | 332,518.70 |
*1117 Kline, on behalf of Gordon, negotiated*254 the sale of the working interest in the leasehold estates and the sale of all of its other properties except cash and accounts receivable with Morrow and Meadows. Morrow and Meadows never had any connection with Gordon as an officer, stockholder, director, or otherwise.
Following the execution of the agreement with Morrow and Meadows, Gordon was dissolved and all of its assets and property then on hand, including the excepted interest, were distributed in complete liquidation of the company to Kline in cancellation and redemption of all of the outstanding stock of the company.
After Gordon was dissolved and liquidated, Kline, as a principal, sold the excepted interest which he had received in liquidation of Gordon for $ 3,600,000, to a purchaser with whom he never had any prior connection. Following the liquidation of Gordon and the sale of the excepted interest, Kline paid off the indebtedness he had incurred with the Dallas bank in connection with his purchase of all of the outstanding capital stock of Gordon.
Kline was the transferee of the assets of Gordon upon its complete liquidation in August 1951.
Gordon as a result of the transaction with Morrow and Meadows claimed a loss*255 deduction of $ 82,518.70. Respondent disallowed the deduction.
OPINION.
If the transaction before us were simply the sale of tangible property for $ 250,000, then certainly the seller would have sustained a deductible loss measured by the excess of its adjusted basis ($ 332,518.70) over the sales price. But the difficulty with petitioners' position is that the record fails to support their assumption that the tangible property was sold for $ 250,000, and there is no convincing evidence that the consideration passing to the seller in respect of the tangible property was less than its adjusted basis.
The cash payment of $ 250,000 was part of an integrated transaction involving an assignment of the working interests in two producing oil and gas leases along with all related assets except cash and accounts receivable. The assignment of the working interests, however, was made subject to a reserved production payment in the amount of $ 3,600,000 out of 85 per cent of the oil, gas, or other minerals produced. The reservation also included an amount equal to interest at the annual rate of 5 per cent upon the unliquidated balance and, in addition, all production and ad valorem taxes paid*256 by the assignor. The assignees covenanted to develop and operate the oil and gas properties in a good and workmanlike manner and to produce oil and gas so long as they could be produced in paying quantities, except to the extent that the assignees should abandon or release any *1118 specific portions of the properties by reassignment to the assignor. The instrument of assignment contained comprehensive provisions, including certain visitorial privileges and rights of inspection, calculated to enable the assignor to assure itself of the assignees' compliance with their various covenants. These covenants were plainly of considerable value to the assignor.
Nowhere in the instrument of assignment is there any language indicating either explicitly or by implication that the $ 250,000 cash payment was the sole consideration for the tangible property. A reading of the instrument as a whole persuasively suggests that it represented a "package deal," and we have no way of knowing on the record before us whether a proper allocation of the total consideration running to the assignor in respect of the tangible property includes something more than the $ 250,000 cash payment.
Obviously, *257 the parties could easily have varied the amount of the immediate cash payment with appropriate accompanying changes in the consideration relating to the so-called reserved payment. Or, they might even have eliminated the immediate cash payment entirely while at the same time providing for increased consideration in respect of the other covenants. Could it fairly be said in such circumstances that the tangible property was being sold for nothing? The answer is plainly no. The transaction was a matter of negotiation between the parties, and it was entirely up to them as to whether there would be any immediate cash payment or the amount thereof. And if there was a cash payment, as in the present case, there must be some satisfying proof that it represented the sole consideration for the tangible assets before the assignor can succeed in its claim that it suffered a deductible loss, measured by the excess of the adjusted basis over the cash payment. Otherwise, merely by juggling the cash payment and the so-called retained interest, it would be able to obtain a deduction on account of a loss that it in fact did not sustain. We do not believe that such result was ever intended by*258 the Congress.
Our problem is to determine whether the consideration properly allocable to the tangible property was less than its adjusted basis. Petitioners merely assert, without proof, that the consideration consisted solely of the $ 250,000 cash payment. The burden of proof, however, was upon them, and they have completely failed to carry it. There is no convincing evidence that the tangible assets were worth less than their adjusted basis at the time of sale, or that the seller negotiated a deal whereby the total consideration receivable in respect of such assets was less than their adjusted basis. One who claims a deduction on account of loss must establish his right to it.
The Government's position is supported by administrative practice of at least some 15 years' standing. G. C. M. 23623, 1943 C. B. *1119 313. See also Rev. Rul. 55-35, 1955-1 C. B. 286. Petitioners' reliance upon Choate v. Commissioner, 324 U.S. 1">324 U.S. 1, is misplaced. No issue was raised in that case as to whether a loss was actually sustained; that fact was assumed, and the Supreme Court*259 explicitly noted that no question was "presented concerning the allocation of a portion of the purchase price to the equipment." 324 U.S. at p. 4. Cf. "Theoretical 'Loss' On Equipment Arising From Producing Leasehold Assignment," 4 Oil and Gas Tax Quarterly 1, 9-10. The very heart of the present case is whether a loss was in fact sustained, and on that question petitioners have failed to carry the burden of proof.
In Docket No. 57291 petitioner Kline does not contest his liability as transferee.
Decisions will be entered for the respondent.
Footnotes
1. The properties described in Exhibit 1 were the leaseholds held by Gordon prior to this agreement.↩