*1519 1. Petitioners were the owners of a fractional interest in the mineral rights of a large acreage of lands situated in the State of Texas. In 1933 the entire tract was leased by the owners, including petitioners, for certain annual payments extending over a period of 20 years, and a one-eighth royalty of all oil and gas to be produced. In the same year petitioners transferred their portion of the right to receive the payments to the other owner of the property for a named consideration payable one-half in 1933 and one-half in 1934. Held, such transfer was a sale of petitioner' right to receive such payments for 20 years from the lessee and that petitioners are taxable in 1933 on only the amount which they received in 1933, since they were on the cash basis and did not receive any promissory note or other property for the remaining one-half due in 1934 but only the contractual obligation of the purchaser to pay such amount in 1934; held, further, that since petitioners sold their right to receive any of the 20-year lease payments and parted with all title thereto, they are not entitled to percentage depletion on the cash received in 1933; held, further, that, such transaction*1520 being a sale, petitioners are entitled to recover tax-free their cost basis in computing gain from the transaction.
2. Petitioner in Docket No. 86178 was the owner of a large tract of land in Texas, which was her separate property. In 1933 she leased it for oil and gas production, and as consideration for the lease received from the lessee an agreement to pay a named amount in two installments, and a one-eighth royalty of oil and gas to be produced. Held, that the amount to be paid in two installments was a bonus in the nature of advanced royalties, notwithstanding the amount was calculated on the basis of certain annual payments for 20 years discounted at their present value, and that petitioner is entitled to receive a percentage depletion deduction on the payment which she received from the lessee in 1933.
3. The husband of petitioner in Docket No. 86178 in his lifetime, and during the marital relation, incurred an obligation as a guarantor on a promissory note for another. In the taxable year there was a default by the principal obligor and petitioner and her deceased husband's estate had to pay the amount due on such obligation of guaranty. The principal obligor*1521 was insolvent. Held, the obligation was a community debt, chargeable against community funds, and petitioner is entitled to deduct as a bad debt one-half of the amount which was paid in settlement of this obligation
4. Petitioner in Docket No. 86178 was the owner of an account receivable against a corporation in which she was one of the principal stockholders. The corporation was still in business during the taxable year and the book value of its assets was greater than its indebtedness, including the debt to petitioner. The assets were also of a greater value than carried on the books. Petitioner made no charge-off on her books in 1933 of any part of this debt. Held, that petitioner is not entitled to deduct a part of such debt in 1933 as a debt which became partially worthless in that year and was charged off.
5. Petitioner, as stated in paragraph 4 above, was the owner of shares of stock in a corporation whose assets were of greater value than carried on its books in the taxable year. Although the corporation had losses for several years, including the taxable year, and had a large deficit, the book value of its capital stock was not entirely impaired. It was*1522 still in business in the taxable year, and at the time of hearings in these proceedings and in 1938 operated at a small profit. Held, the evidence does not warrant a holding that petitioner's stock in the corporation became worthless in 1933.
*278 These proceedings have been consolidated.
Docket No. 86179 involves a deficiency in income tax of $10,732.49 which the Commissioner has determined against Alice G. K. Kleberg, executrix of the estate of Robert J. Kleberg, Sr., deceased, for the year 1933. The deficiency results from the addition by the Commissioner to the income reported on the return filed by the taxpayer of $74,670.75 designated "Amount received from the King Estate for 3/32 interest in lease rentals." The Commissioner allowed petitioner $360.17 deductions not claimed on the income tax return which was filed.
The petition in Docket No. 86179 assigns three errors as follows:
I. The inclusion as taxable income for the year 1933 of the sum of $37,335.38 received during the year 1934 from the oil and gas lease to the Humble Oil*1523 and Refining Company of petitioner's one-half interest in 3/32 mineral interest in the King Ranch lands.
II. The disallowance of the deduction for depletion at the rate of 27 1/2% on all amounts of taxable income for the year 1933 from the oil and gas lease to the Humble Oil and Refining Company. III. The disallowance of the deduction of the value at the time of decedent's death of the mineral interest from which the said sums were received.Docket No. 86178 involves a deficiency in income tax of $21,412.12 which the Commissioner has determined against Alice G. K. Kleberg for the year 1933. The deficiency results from additional income and unallowable deductions which the Commissioner has added to the net income reported on her return as follows:
| 1. Depletion on rentals | $6,780.65 |
| 2. Depletion on amount received from King Estate on 1/2 of 3/32 interest in lease rentals | 10,991.10 |
| 3. Additional lease rentals from King Estate | 34,674.02 |
| 4. Interest adjusted | 204.50 |
| 5. Errors in computation on the return | 6,601.02 |
| Total | $59,251.29 |
*279 The petition assigns six errors as follows:
I. The disallowance of the deduction of depletion at the*1524 rate of 27 1/2%, to-wit the sum of $6,780.65, on the amounts received by petitioner from the Humble Oil and Refining Company, to-wit $24,656.92, upon the oil and gas lease on the 30,439.23 acre tract at Santa Gertrudis.
II. The disallowance of the deduction of depletion at the rate of 27 1/2% on the amount received from the oil and gas lease of the 3/32 mineral interest in the King Ranch lands to the Humble Oil and Refining Company. III. The inclusion as taxable income in the year 1933 of the sum of $34,674.02 received in the year 1934 from the oil and gas lease to the Humble Oil and Refining Company of the 3/32 mineral interest of the King Ranch lands. IV. The disallowance of the deduction of $204.50 as bad debt, being petitioner's one-half of the community loss on had debt as guarantor. V. Failure to allow as a deduction the sum of $24,800, loss on capital stock of the Kleberg Town & Improvement Company. VI. Failure to allow as a deduction the sum of $29,760 as a bad debt, one-half of the open account against the Kleberg Town & Improvement Company.The Commissioner in his answer filed in each proceeding denied that he had committed any of the above alleged*1525 errors.
FINDINGS OF FACT.
Petitioner Alice G. K. Kleberg and Robert J. Kleberg, Sr., lifelong residents of Texas, lived together as man and wife from the date of their marriage in the year 1887 until the death of the husband on October 10, 1932. At the time of their marriage they had only a negligible estate.
Robert J. Kleberg, during the period from 1885 to the time of his death, was engaged in the management of the cattle ranching properties and other business of his mother-in-law, Henrietta M. King. On March 1, 1919, Mrs. King executed an instrument by which she gave to Kleberg power of attorney to lease the oil and other mineral rights in her lands situated in southwestern Texas and at the same time granted and sold to Kleberg in consideration of services rendered three thirty-seconds of the oil and other minerals in the lands designated. The remaining twenty-nine thirty-seconds of the mineral rights were granted to Kleberg as trustee for a period of 50 years, for the benefit of such persons as the grantor should thereafter designate. Mrs. King died on March 31, 1925, leaving her estate in trust for a period of 10 years.
On his death on October 10, 1932, Robert*1526 J. Kleberg, Sr., left his entire estate to his wife, Alice G. K. Kleberg, who was also named his independent executrix. The estate is still in process of administration.
Facts with Reference to Oil and Gas Leases.
On September 26, 1933, the Henrietta M. King estate owned approximately 971,711.43 acres of land, in which it owned twenty-nine thirty-seconds *280 of the minerals and in which the community estate of Robert J. Kleberg, Sr., and his surviving wife Alice G. K. Kleberg owned, one-half each, the remaining three thirty-seconds. Mrs. Kleberg also owned as her own separate estate 30,439.23 acres conveyed to her by deed of gift from her mother.
On September 26, 1933, the independent executors and trustees of the estate of Henrietta M. King, deceased, Alice G. K. Kleberg, individually and as independent executrix of the estate of Robert J. Kleberg, Sr., deceased, and advisory executors of the estate of Robert J. Kleberg, Sr., deceased, executed a deed of trust in favor of N. K. Robb as trustee, covering 980,890.73 acres of the King estate lands, to secure the payment of a note in the face amount of $500,000 and a note in the face amount of $3,000,000, both executed*1527 September 26, 1933.
The $500,000 note on its face provides for payment on or before five years after date, with interest thereon from date until maturity at the rate of 5 percent per annum and at the rate of 8 percent per annum after maturity until paid.
The $3,000,000 note on its face carries interest after maturity at the rate of 8 percent per annum, with the following provisions:
The principal of this note is payable in installments of One Hundred Fifty Thousand Dollars ($150,000.00) at the expiration of each year beginning ten years after this date, and the balance on or before twenty years after this date. The makers have the privilege of making partial payments before maturity, such partial payments to be applied upon the earliest maturities then unpaid.
Upon all payments made before twenty years after this date, either those made voluntarily or in compliance with the above maturities, the payee shall pay to the makers at Kingsville, Texas, interest at the rate of five percent per annum, payable semi-annually as it accrues upon each of such payments from the date thereof until the end of twenty years after this date.
On the same date, September 26, 1933, the following*1528 leases of oil and mineral rights in the lands designated were executed to the Humble Oil & Refining Co., sometimes hereinafter referred to as Humble, by the owners or trustees listed:
| Term of lease | Acreage covered | Royalties reserved | Owners |
| 20 years | 971,711.43 | 1/8 of oil and gas; $1 per ton on sulphur. | Estate of Henrietta M. King, estate of Robert J. Kleberg, Sr., and Alice G. K. Kleberg. |
| 20 years | 30,439.23 | do | Alice G. K. Kleberg. |
The lands covered by these leases were a part of the King ranch and the surrounding territory. The period of the leases was not to be affected by the production of oil except that the lessee was to retain areas in which oil was being produced at the expiration of the term. The sole consideration for the leases, with the exception of nominal amounts paid on their execution, was the royalties reserved *281 to the lessors and the annual payments agreed upon. The annual payments agreed upon for the lease of the 971,711.43 acres was $127,824.60, payable over a period of 20 years. The payment agreed upon for the lease of the 30,439.23-acre tract was $49,313.83, payable to Alice G. K. Kleberg in two installments, $24,656.92*1529 in 1933 and an equal amount in 1934. The leases themselves did not refer to these payments that were to be made.
Two agreements in addition to the leases were entered into on September 26, 1933, between Humble on the one hand and the lessors of the lands heretofore described on the other. The first, after reciting the execution of the lease covering the 971,711.43 acres of the King estate lands, provided for an "annual rental for the twenty (20) year period of said lease" of $127,824.60, payable annually. It was then recited that the King estate had on that date borrowed $2,723,645.52 from Humble, executing therefor the 20-year promissory note, heretofore referred to, in the face amount of $3,000,000. It was agreed that the debtor should pay no interest on the principal borrowed of $2,723,645.52 except that the annual rental should be withheld each year by Humble and applied on interest due at the rate of 5 percent. The deficiency in interest resulting therefrom, it was calculated, would amount to $276,354.48 at the end of 20 years, the difference between the principal borrowed and the face amount of the note. The agreement provided in addition that during the first 10 years*1530 of the lease the lessee might retain any royalties due to lessors on oil or gas produced, applying them on the interest due on their indebtedness. During the second 10 years such royalties, up to $127,824.60 annually, were to be retained by Humble as its own property.
The second agreement recited first the lease made by petitioner Alice G. K. Kleberg of 30,439.23 acres and two additional leases not here involved made by Alice G. K. Kleberg and the trustees of the estate of Henrietta M. King. It provided among other things that all royalties on oil and gas due to Alice G. K. Kleberg as lessor under the 30,439.23-acre lease described should be applied by Humble successively on the $500,000 and $3,000,000 debts of the trustees of the King estate, petitioner being given in return that portion of the debt which is thereby satisfied. During the second 10 years the lessee was given the right to withhold as its own property royalties due from oil and gas under the leases equal to $22,175.40 per year.
On September 26, 1933, Humble addressed a letter to the estate of Henrietta M. King, deceased, which was accepted and agreed to by the independent executors and trustees of the estate*1531 of Henrietta M. King, deceased, Alice G. K. Kleberg, individually and as independent executrix of the estate of Robert J. Kleberg, Sr., deceased, *282 and the advisory executors of the estate of Robert J. Kleberg, Sr., deceased. The letter reads in part:
Of even date with this letter we have secured from the Estate of Mrs. Henrietta M. King, deceased, and from the Estate of Robert J. Kleberg, Sr., deceased, and from Mrs. Alice G. K. Kleberg individually, an oil and gas mineral lease covering 971,711.43 acres of land in southwest Texas, being most of what is known as the King Ranch; another lease executed by Robert J. Kleberg Jr., individually, and as trustee, covering some 131,005.59 acres of land in Brooks, Kenedy and Hidalgo Counties, Texas, and another lease executed by Mrs. Alice G. K. Kleberg covering approximately 30,439.23 acres of land in Kleberg County, Texas and Jim Wells County, Texas, to which leases reference is here made for all purposes.
It is our understanding that no exploratory work is to be required under said leases during the first five (5) years from this date; but during the 20-year primary term of said leases Humble Oil & Refining Company is to*1532 explore the leased area as adequately as it can by its geophysical and geologic technique. It is further understood that no exploratory work by drilling is required of Humble Oil & Refining Company except to drill such offset wells as may be implied from the terms of the leases.
* * *
* * * It is here agreed that at any time while said leases are in force, should substantially all the land covered thereby be brought or consolidated into one ownership, then, and in such event: (a) All said leases shall be consolidated and shall be treated as one lase in developing and operating the properties covered thereby without reference to the boundary lines that may separate the several tracts included in the several leases; (b) Also, the provisions contained in the said two agreements in reference to the retention of certain portions of the royalties by the Humble Oil & Refining Company as its own property during the second ten year period thereof, to-wit: one hundred twenty seven thousand eight hundred twenty four and 60/100 dollars ($127,824.60) in said agreement with said Estate, and twenty two thousand one hundred seventy five and 40/100 dollars ($22,175.40) in said agreement with*1533 Alice G. K. Kleberg and Robt. J. Kleberg, Jr., individually and as Trustee, shall also be treated as consolidated, so that the amount which it is entitled to retain shall be the total of said two sums, to-wit: one hundred fifty thousand dollars ($150,000) per year, and the retention may be made out of the proceeds of any royalties derived from any of said lands instead of the lands included in any particular lease.
* * *
On September 26, 1933, the independent executors and trustees of the estate of Henrietta M. King, deceased, addressed a letter to Alice G. K. Kleberg, executrix of the estate of Robert J. Kleberg, Sr., deceased. The letter reads in part:
The annual rental provided for in the oil, gas and mineral lease of this date, executed by the Executors and Trustees of the Estate of Henrietta M. King joined by yourself, as Executrix of the Estate of Robert J. Kleberg, Sr., deceased, as provided in the supplemental agreement with the Humble Oil and Refining Company, amounts to $127,824.60 per year, which will be credited to the King Estate upon its interest, or paid to it as therein provided annually during the twenty year period of the lease.
The three-thirty-second*1534 (3/32) portion, which would be payable to Robert J. Kleberg, Sr's. estate out of the said annual rental, is $11,983.55 per annum. *283 This annual twenty year rental discounted to its present value at the rate of five percent per annum amounts to $149,341.51.
We agree to pay you as Executrix one-half of that sum now, and one-half thereof January 2nd, 1934, and said sums shall constitute full settlement with the Estate of Robert J. Kleberg, Sr. for his portion of all the rentals that are to be credited or paid under said lease during the said twenty year period, so that the King Estate will have no further accounting to make for such rentals to the Robert J. Kleberg, Sr. Estate as they are paid or credited from year to year in the future under said lease. This shall not affect in any manner the Robert J. Kleberg, Sr. Estate's rights in the royalties under said lease.
This offer was accepted and Alice G. K. Kleberg, as executrix of the estate of her deceased husband, received the first installment of $74,670.75, on October 4, 1933. This arrangement of accepting the payment in two installments was made because the King estate was financially unable to pay more than one-half*1535 the sum agreed on during the taxable year. The second installment of $74,670.75, plus interest of $2,352.09, was paid on June 19, 1934. In her income tax return for 1933 Alice G. K. Kleberg reported one-half of the $74,670.75 received in that year as her share of that sum. The estate of Robert J. Kleberg, Sr., reported no part of that amount in its 1933 return. The Commissioner has determined that each should report for 1933 one-half of the entire amount payable in both years.
On September 27, 1933, Robert J. Kleberg, Jr., addressed a letter to "Wallace E. Pratt, vice president, Humble Oil & Refining Company," setting forth the following amounts to be remitted by his company:
1. $500,000.00 loan to the Estate of Henrietta M. King.
i(a) $2,723,645.50 loan to the Estate of Henrietta M. King.
2. $227,040.65 consideration for paid up lease from Robert J. Kleberg, Jr., individually and as Trustee.
3. $49,313.83 consideration for paid up lease from Alice G. K. Kleberg.
Total $3,500,000.00.
In reference to items 2 and 3, one-half of each is to be paid now and the other one-half of each on or about January 2, 1934.
The $227,040.65 consideration paid by Humble*1536 for the lease from Robert J. Kleberg, Jr., is not involved in this proceeding. Robert J. Kleberg, Jr., is a son of Alice G. K. Kleberg and her deceased husband, Robert J. Kleberg, Sr.
On October 2, 1933, Humble paid to the National City Bank of New York, for the account of the San Antonio National Bank, for the account of the San Antonio Loan & Trust Co., for the account of the King estate, $3,223,645.52; and on the same date and in the same manner paid for the account of Alice G. K. Kleberg the sum of $24,656.92.
Except for the tract of land comprising 30,439.23 acres heretofore referred to and her interest in the Kleberg Town & Improvement *284 Co., both belonging to Mrs. Kleberg, all of the property owned by Robert J. Kleberg, Sr., and his wife at the time of his death on October 10, 1932, was community property. The fair market value of the three thirty-seconds mineral interest in the King estate lands belonging to that community on that date was $200,000. In the estate tax return filed for Robert J. Kleberg, Sr., one-half of this property was included at $100,000. In making this valuation of $200,000, $150,000 was attributed to the interest which had been disposed*1537 of to the Humble Oil & Refining Co., and $50,000 was attributed to the royalty interest reserved by the owners. The Commissioner accepted for estate tax purposes the valuation of $200,000 for the three thirty-seconds mineral interest at the time of decedent's death.
Facts With Reference to the Kleberg Town & Improvement Co.
Shortly after the year 1900 the St. Louis, Brownsville & Mexico Railroad was built through south Texas and through the King ranch.
On January 12, 1903, the Kleberg Town & Improvement Co. was incorporated by Henrietta M. King and Robert J. Kleberg for the purpose of subdividing and selling real property in cities and villages and for the erection of buildings thereon. The amount of its capital stock was $500,000, divided into 5,000 shares of $100 par value each. Within a short time thereafter Henrietta M. King by three deeds transferred to the corporation some 75,000 acres of land near Kingsville and Raymondsville, Texas, composing a part of the King ranch, in return for which the retire capital stock of the corporation was issued to her. One-half of this stock was presented by Mrs. King as a gift to the railroad company to induce it to build and*1538 operate a railroad through this section of Texas.
The capital stock of the Kleberg Town & Improvement Co. was reduced from $500,000 to $50,000 by amendment to its charter adopted on June 3, 1914. Five hundred shares of new stock with a par value of $100 were issued ratably to the stockholders. This reduction in capital stock was reflected on the books of the company at first by a debit to the capital stock account and a credit to a stock retired account. On December 31, 1914, this amount of $450,000 was transferred to the profit and loss account. This amount was reduced to $325,000 during the period from 1914 to 1918 by the payment of dividends to shareholders in the amount of $125,000. In the latter year, pursuant to instructions of the stockholders, the remaining $325,000 was transferred from profit and loss to accounts payable opened in the name of the stockholders, this sum being divided ratably among them as follows: $162,500 to the St. Louis Trust Co., which held the stock issued to the railroad, $161,200 to Henrietta M. King and $650 each to two individuals who held qualifying shares.
*285 During the year 1918 Henrietta M. King transferred as a gift to her*1539 daughter, Alice G. K. Kleberg, her stock in the Kleberg Town & Improvement Co. and the open account standing in her name on the books of that corporation. This transfer was reflected on the books of the company and payments were made to Alice G. K. Kleberg from time to time, reducing the amount standing in the account to $52,160 by January 1, 1933. Thereafter no additional payments have been made.
The lands owned by the Kleberg Town & Improvement Co., its chief assets, were carried on its books in 1918 at $7.38 per acre. Their fair market value averaged $25 per acre, varying from a low of $12.50 in the case of certain acreage to a high of $37.50 in the instance of others. The value of the land at that time was in some degree dependent on the high prices then received on the sale of cattle and cotton.
On all land sold by the company after 1922 it retained a one-sixteenth interest in all minerals therein and from the production of oil on these lands realized after 1925 a small income. Approximately ten wells have been drilled on the company's lands. However, oil production has been small and some of the wells have been abandoned altogether. In the taxable year only one or*1540 two of the wells were being operated.
The Kleberg Town & Improvement Co. realized its principal income during its entire existence from the sale of lands in and around Kingsville and Raymondsville, Texas. The town of Kingsville was chiefly dependent for its existence on the King ranch and its various interests, and on the Missouri Pacific Railroad, which maintained shops and offices there. There were some productive enterprises in the town, including a cotton mill, a dairy, and a creamery, none of which was owned, however, by the company. It had a waterworks, an electric light system, and paved streets. The College of Arts and Industries, State college, with 700 to 800 students in attendance, was located there.
Beginning with the year 1925 the town of Kingsville suffered reverses, the cotton mill closing in that year. The railroad went into receivership in 1933 and its shops and offices were moved to Houston. The bank operated in Kingsville by the King interests under the name of Robert J. Kleberg & Co. was in that year in an insolvent condition. the King estate in 1933 decided to desist in its efforts to develop the town of Kingsville and confine itself thereafter to*1541 its business of cattle ranching.
In the year 1928 and in all subsequent years down through 1933 the Kleberg Town & Improvement Co. operated at a deficit.
*286 The Kleberg Town & Improvement Co. balance sheet on the dates shown read as follows:
| December 31, 1933 | December 31, 1934 | |
| ASSETS: | ||
| Cash | $6,596.22 | $3,663.23 |
| Notes receivable | 58,100.83 | 53,571.45 |
| Stocks | 4,850.00 | 4,850.00 |
| Land | 29,622.54 | 29,510.34 |
| Buildings | 5,058.01 | 5,058.01 |
| Furniture and fixtures | 698.68 | 698.68 |
| Sidewalks | 1,090.69 | 1,090.69 |
| Street paving | 2,881.74 | 2,881.74 |
| Sewerage system | 12,191.08 | 10,784.83 |
| 121,089.79 | 112,108.97 | |
| LIABILITIES: | ||
| Accounts payable | $117,853.81 | $117,435.97 |
| Common stock | 50,000.00 | 50,000.00 |
| Undivided profits | 1 -46,764.02 | 1 -55,327.00 |
| 121,089.79 | 112,108.97 |
On December 31, 1934, there remained in the possession of the company the following lands which were among those transferred to it in 1903-1906:
| Land | Book value | Assessed value |
| 261.19 acres (location unidentified) | $1,005.66 | $1,935.00 |
| 2,287 city lots in Kingsville and Raymondsville, Texas | 19,777.21 | 57,544.00 |
| 530 city lots in Ricardo, Texas | 2,991.94 | 1,480.00 |
| 19 1/2 lots in Kingsville, including cottages | 10,793.54 |
*1542 The book values at which these various items of realty were carried on the company's books represented only March 1, 1913, value, except that in the case of the item last listed the value shown represents only the amounts remaining unpaid on contracts under which these lands were sold and later reclaimed. No value for the one-sixteenth mineral interest in the land retained by the company was reflected in the balance sheet of the company. The item of accounts payable in the balance sheet above includes the amounts owed to the stockholders on the open accounts described heretofore.
During the year 1934 the accountant who had kept the books of the company and of the petitioners since 1914 informed petitioner Alice G. K. Kleberg of the poor condition of the company and the absence of prospects for improvement. He was instructed to charge off as worthless the stock of Alice G. K. Kleberg and did so on her books for the year 1934. At the same time the open account standing in her name on the company's books was ascertained to be worthless to the extent of one-half its value and charged off her books in the amount of $29,760.
*287 The Kleberg Town & Improvement Co. continued*1543 in existence after the taxable year. Its office expenses, cost of telephones, and salaries of its employees were paid by the King ranch. The company had deficits in the years 1934 through 1937. In 1938 it realized a profit of approximately $2,600. Its stock has never been listed or sold on any stock exchange.
The return of Alice G. K. Kleberg for 1934 contains the following statement:
KLEBERG TOWN & IMPROVEMENT COMPANY
| Line 18 | |
| Deductions | |
| Loss stock Kleberg Town & Improvement Co | $24,800.00 |
| Loss open account Kleberg Town & Improvement Co. 1/2 of $59,520.00 | 29,760.00 |
| Total | 54,560.00 |
* * *
The company has been running at a loss several years. As shown by its income tax report for 1934, its capital became impaired by operating losses during 1934, its returns showing a small net worth January 1, 1934 and showing it to be insolvent December 31, 1934.
The capital stock is therefore charged off as a total loss, and one-half of the open account is charged off as a loss for the year 1934.
The stock of the Kleberg Town & Improvement Co. did not become worthless in 1933. The account of Alice G. K. Kleberg against the Kleberg Town & Improvement Co. *1544 did not become partially worthless to the extent of $29,760 in 1933 and no charge-off of such an amount was made on the books of Alice G. K. Kleberg in 1933.
Both petitioner Alice G. K. Kleberg and the estate of Robert J. Kleberg, deceased, kept their books and reported their income during the taxable year on the cash basis.
Community Bad Debt of $409.
With reference to the item of $204.50 bad debt deduction claimed by petitioner Alice G. K. Kleberg and disallowed by the Commissioner, the parties stipulated at the hearing as follows:
Petitioner alleges that during the year 1933 she and her deceased husband's estate were required to pay out of their community estate the sum of $409.00 upon a note guaranteed by Robert J. Kleberg, Sr., during his life, one-half of which sum, or $204.50 was claimed by each petitioner in his return for 1933 as a deduction.
The Commissioner, in determining the deficiency allowed the estate this full amount of $409.00 as a deduction and disallowed the petitioner the $204.50 claimed by her as a deduction.
Should the Board hold now that this was a community transaction and that petitioner is entitled to $204.50 as a deduction, the Board*1545 should likewise hold *288 that the Commissioner was in error in allowing the estate more than $204.50, and the Board should make the proper adjustment.
OPINION.
BLACK: We shall first discuss and decide those issues which are common to both proceedings. The first of these issues is whether the agreement by petitioners with the representatives of the King estate by which they agreed to transfer their right to receive $11,983.55 per annum for a period of 20 years from Humble for their oil and gas lease of a three thirty-seconds interest in the King ranch for a consideration of $149,341.51, payable in two installments, was a sale of the right to receive such payments, as the Commissioner contends, and whether the entire amount was taxable in 1933 although only one-half of it was received in 1933, as the Commissioner contends, or whether the transaction simply amounted to a step-up plan as to the time of payments, as petitioners contend, and petitioners are only required to return for taxation the actual amounts that they received in 1933. They were both on the cash receipts basis. The facts with reference to this transaction are fully stated in our findings of fact and*1546 need not be here repeated.
It is our opinion that the respondent is correct in his contention that the transaction between petitioners and the representatives of the King estate was a sale, but we do not agree with the respondent that the entire $149,341.51 is taxable to petitioners in 1933.
In , the elements necessary to constitute a sale were discussed. Among other things the court said:
The word "sell" * * * in its ordinary sense means a transfer of property for a fixed price in money or its equivalent. .
Let us examine the agreement between petitioners and the representatives of the King estate. The parties were competent to contract. There was mutual consent. The thing the absolute or general property in which was transferred from petitioners to the King estate was petitioners' right to receive 20 annual rental payments of $11,983.55 each. The price in money paid or promised was $74,670.75 in cash paid upon the execution of the agreement, and a promise to pay $74,670.75 in cash on January 2, 1934. Thus all the elements of a sale are present. *1547 Thereafter, the King estate had the absolute right to receive as its own property from Humble the entire annual rental of $127,824.60 without accounting to petitioners for any of it. Petitioners had transferred to the King estate all of their right to receive any portion of such annual rental for a cash consideration of $149,341.51. In our opinion that transaction between petitioners and *289 the King estate must be regarded as a sale as that word is understood in its ordinary signification.
It, however, does not follow, as respondent contends, that the entire gain is taxable in 1933, the year the sale was made. Section 111(a) of the Revenue Act of 1932 provides that the gain from the sale or other disposition of property shall be the excess of the "amount realized" therefrom over the basis. Section 111(b) provides:
(b) AMOUNT REALIZED. - The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.
What "property" did petitioners receive during 1933 other than the sum of $74,670.75 in money? Obviously, petitioners received nothing more in the year*1548 1933 than the contractual promise of the King estate to pay the remaining one-half of $149,341.51 during 1934. In , after reviewing at considerable length several cases where a part of the consideration for the sales there involved was evidenced only by a contract to pay in a later year, we said:
In none of the foregoing cases was there any evidence introduced directed to the question of the fair market value of the promise to pay, except in the case of Dudley T. Humphrey, supra, discussed above.
In all of the court decisions above discussed the courts took the position that, when evidence was introduced showing that the deferred payments were evidenced only by contract, where no notes, bonds, or other evidences of indebtedness other than the contract were given, such contract had no fair market value, and that the amounts of the deferred payments should be included in income when received. * * *
Applying the principles enunciated in the Titus case and the cases discussed therein to the instant proceedings, it seems clear that only one-half of the total consideration of $149,341.51 was realized by petitioners*1549 in the taxable year 1933, and that the respondent erred in proposing to tax petitioners in 1933 upon the amount that was to be received and which was actually received in 1934.
We have examined the cases cited by the respondent in his brief in support of his contention that the entire consideration was taxable in 1933, but we do not regard these cases as being in point.
Petitioners next contend that they are entitled to a percentage depletion allowance upon the $74,670.75 which they received from the King estate during 1933 as a result of the transactions just above discussed. They contend that the payment to them of $74,670.75 in 1933 represents a cash advanced royalty payment and as such is depletable. It seems to us that this contention can not be sustained for the reason that petitioners did not retain their right to receive three thirty-seconds of the annual rental of $127,824.60 to be paid by Humble. As has already been held in this opinion, they sold that right to the King estate for a consideration of $149,341.51 payable *290 in two installments. The reason given by the respondent in his statement attached to the deficiency notice in Docket No. 86178 for denying*1550 depletion as to this item is that "it is held by the Bureau that the transaction represented a sale of future lease rentals, or right to receive future lease rentals and the amount received was, therefore, not subject to depletion." We think this determination by the respondent is correct and is a valid reason for denying petitioners a deduction for depletion on the $74,670.75 which they received from the King estate during the taxable year 1933. Cf. ; ; ; ; ; and . In the Anderson case the Supreme Court, among other things, said:
The sole owner and operator of oil properties clearly has a capital investment in the oil in place, if anyone has, and so is taxable on the gross proceeds of production and is granted a deduction from gross income as compensation for the consumption of his capital. See Burnet*1551 v. Harmel, supra, at 107-108; . By an outright sale of his interest for cash, such an owner converts the form of his capital investment, severs his connection with the production of oil and gas and the income derived from production, and thus renders inapplicable to his situation the reasons for the depletion allowance.* * * [Italics supplied.]
See also .
When petitioners transferred to the King estate their right to receive the annual payments from Humble for the lease of their three thirty-seconds interest in the King ranch lands, the King estate became entitled to receive whatever depletion, if any, was allowable as to this interest. Two separate and distinct taxpayers are not entitled to receive depletion deductions as to the same oil interest . On this issue we sustain respondent.
We will next discuss issue 3, raised in Docket No. 86179. This issue was raised by petitioner in the alternative, and in substance is that if the Board sustains the Commissioner in his disallowance of percentage*1552 depletion deductions as respects the payments received from the three thirty-seconds interest, then the Commissioner erred in not allowing the petitioner in Docket No. 86179 a recovery of cost basis in determining gain from the disposal of such interest to the King estate.
Since this opinion holds that the transaction between petitioners and the King estate was a sale of petitioners' right to three thirty-seconds of the annual rental of $127,824.60 to be paid by Humble for a period of 20 years, it follows that the amount of gain or loss from this sale must be determined in accordance with sections 111 and 113 *291 of the Revenue Act of 1932. As far as the present issue is concerned, the material provisions of these sections are as follows:
SEC. 111. DETERMINATION OF AMOUNT OF GAIN OR LOSS.
(a) COMPUTATION OF GAIN OR LOSS. - Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113(b), and the loss shall be the excess of such basis over the amount realized.
SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
(a) *1553 BASIS (UNADJUSTED) OF PROPERTY. - The basis of property shall be the cost of such property; except that -
* * *
(5) PROPERTY TRANSMITTED AT DEATH. - * * * If the property was acquired by the decedent's estate from the decedent, the basis in the hands of the estate shall be the fair market value of the property at the time of the death of the decedent. * * *
Petitioner Alice G. K. Kleberg in Docket No. 86178 concedes she has no cost basis to be applied against her one-half of the amount realized in determining the amount of her gain or loss from the sale. Therefore, the remainder of the discussion under this issue will apply only to the petitioner in Docket No. 86179, namely, Alice G. K. Kleberg, executrix of the estate of Robert J. Kleberg, Sr., deceased.
Does the estate of Robert J. Kleberg, Sr., have a basis to be applied against its one-half of the amount realized in determining the amount of its gain or loss from the sale?
Our findings of fact show that decedent Robert Kleberg's one-half interest in three thirty-seconds of the mineral rights in the King ranch property was valued for estate tax purposes at $100,000. The estate tax return was made approximately a year*1554 after Kleberg's death and shortly after the Humble lease had been executed.
If the Kleberg estate had sold its entire interest in all the oil, gas, and other minerals in the King ranch, there could be no question but in computing the gain or loss on the sale it would be entitled to a basis of $100,000 under section 113(a)(5) of the Revenue Act of 1932. But it did not do this. It merely sold its right to receive one-half of three thirty-seconds of the annual rental of $127,824.60 to be paid by Humble. Should any part of the basis of $100,000 be allocated to that sale? We think that unquestionably such an allocation must be made, if it is possible to make it, because the Kleberg estate sold part of its mineral rights in the three thirty-seconds interest and it retained part of this interest. Cf. .
The evidence shows that the value of $100,000 was arrived at by attributing $75,000 to the right of the Kleberg estate to receive the *292 annual rental from the Humble lease and $25,000 to the right of the Kleberg estate to receive its share of the specific reserved royalties mentioned in paragraph 3 of the lease. No value*1555 was attributed to the retained interest of one-half of three thirty-seconds of all the oil, gas, and other minerals, if any, in the King ranch after the expiration of the lease to Humble made on September 26, 1933. Petitioner, the Kleberg estate, contends that it is entitled to use, as a basis in determining the gain or loss upon the sale in question, $75,000 of the $100,000 basis attributable to the entire mineral interest owned by the Kleberg estate at the time of the sale. We think that under the sections of the statute above cited this contention must be sustained.
The petitioner in Docket No. 86178, Alice G. K. Kleberg, had no cost basis and claims none. Recomputation under Rule 50 should be made in accordance with the above.
The remaining issues concern only Alice G. K. Kleberg, petitioner in Docket No. 86178. The first of these issues is whether she is entitled to depletion on the amount of $24,656.92 received by her from Humble in 1933 as the result of the lease to Humble of her 30,439.23-acre tract.
In denying depletion as to this item the respondent in a statement attached to the deficiency notice said:
Depletion claimed of $6,780.65 on an amount of $24,656.92*1556 received from the Humble Oil and Refining Company in 1933 has been disallowed since it is held that the amount received represented advanced delay rentals and as such was not subject to depletion.
Paragraph 8 of the agreement executed between petitioner and Humble provided in part:
8. During the second ten year period from date hereof, Humble Oil & Refining Company shall have the right to appropriate unto itself and to retain as its own property, the proceeds of all the royalties on oil, gas and other minerals accruing during each year to Alice G. K. Kleberg and Robt. J. Kleberg, Jr., individually and as Trustee, and/or either of them, from and under said leases to the extent of an aggregate of twenty two thousand one hundred seventy five and 40/100 dollars ($22,175.40) each year; and such deduction shall be made before applying any of the proceeds during such years from such royalties on said notes as hereinbefore provided.
If the proceeds from all of such royalties in any year during said second ten year period should not equal said sum of twenty two thousand one hundred seventy five and 40/100 ($22,175.40) the deficiency between such proceeds and the twenty two thousand*1557 one hundred seventy five and 40/100 ($22,175.40) shall not be carried forward into succeeding years. * * *
It will be noted that the $22,175.40 named above, as the amount which Humble had the right to reimburse itself out of royalties during the second 10-year period of the lease, represents the sum of $3,957.07 and $18,218.33, annual payments to Alice G. K. Kleberg *293 and Robert J. Kleberg, Jr., respectively. In other words, during the second 10-year period of the lease between Alice G. K. Kleberg and Humble, the latter had the right to appropriate unto itself the proceeds from royalties up to the annual rent of $3,957.07 which was payable to her, but if the proceeds from royalties in any one of those years of the second 10-year period failed to equal $3,957.07, the deficiency could not be made up in any succeeding year. In order for the annual rental during the second 10-year period to take the place of royalties to the extent of the entire annual rental of $3,957.07, two things were necessary. First, oil, gas, or other mineral would have to be discovered and produced, and, second, the proceeds from production each year during the second 10-year period would have to*1558 be sufficient to at least equal the annual rental of $3,957.07.
On September 26, 1933, Humble wrote a letter to the King estate in which, among other things, it said:
It is our understanding that no exploratory work is to be required under said leases during the first five (5) years from this date; but during the 20-year primary term of said leases Humble Oil & Refining Company is to explore the leased area as adequately as it can by its geophysical and geologic technique. It is further understood that no exploratory work by drilling is required of Humble Oil & Refining Company except to drill such offset wells as may be implied from the terms of the leases.
Instead of Humble paying Alice G. K. Kleberg an annual amount of $3,957.07 each year for 20 years, this amount was discounted down to a present value of $49,313.83, one-half of which was paid petitioner in 1933 and the other half in 1934.
On the basis of the above facts it is our opinion that the amount received by petitioner in 1933 (one-half of $49,313.83 or $24,656.92) is in the nature of advance royalties, as petitioner contends, rather than advance delayed rentals, as respondent contends, and is, therefore, subject*1559 to depletion. The respondent in his brief contends that the amount received was not subject to depletion upon the grounds that it was rent rather than a bonus or advance royalty. He relies upon ; ; ; and . The Duffy case is not very helpful, as the Supreme Court was not called upon to distinguish between rental on the one hand and royalties on the other. The three other cases cited above and relied upon by the respondent, although holding the amounts there involved to be delayed rentals, do lay down certain principles that govern in the determination of the difference between delayed rentals and royalties.
For example, in the Sneed case the payments which we held to be "delayed rentals" and not a "bonus" in the nature of advance royalties *294 were paid to Sneed as the lessor under the following clause in the lease:
If no well be commenced on said land on or before the 26th day of May, 1927 (one year after its execution) this lease*1560 shall terminate as to both parties unless the lessee on or before that date shall pay or tender to the lessor, * * * the sum of $160 [$1 per acre], which shall operate as a rental and cover the privilege of deferring the commencement of a well for twelve months from said date. In like manner and upon like payment or tender the commencement of a well may be further deferred for like periods of the same number of months successively.
The $4,334 rent payment involved in , we held to be a similar payment to that involved in the Sneed case, supra. In the instant case the situation is different. The payment of $24,656.92 involved was not made by Humble to petitioner as delayed rental. The transaction as we view it was substantially this: Petitioner in consideration of a payment of $49,313.83 payable to her in two installments, plus a reserved oil and gas royalty of one-eighth of the oil and gas to be produced, leased her 30,439-acre tract to Humble for a period of 20 years, and thereafter as to any developed structures for as long as production is had from such structure. Under this state of facts we hold that the $24,656.92 received*1561 by petitioner in 1933 was a bonus in the nature of advance royalties, and that petitioner is entitled to percentage depletion thereon.
Issue 4. - Disallowance of One-half of a Community Bad Debt.
Issue 4 in Docket No. 86178 concerns the Commissioner's disallowance of one-half of $409 which the community estate of petitioner and her deceased husband, Robert J. Kleberg, Sr., had to pay by reason of a guaranty contract which he had entered into during his lifetime. The deficiency notice, in disallowing to petitioner a deduction of one-half of this claimed community bad debt, says:
The amount of $204.50 claimed as interest paid on a note on which Robert J. Kleberg, Sr. was one of two guarantors has been disallowed since the amount actually represented a bad debt, the total of which was deductible by the Estate of Robert J. Kleberg, Sr.
What the parties have stipulated with reference to this issue is shown in the concluding part of our findings of fact.
The Commissioner in his brief, after quoting the stipulation with respect to this issue, says:
Respondent determined that the full amount of $409.00 represented a bad debt, the total of which was deductible by the estate. *1562 Petitioner offered no proof on this point; and the Commissioner's determination should be approved for lack of proof.
The stipulation as to the facts involved in this issue is not as clear as it should be. However, at the hearing when the stipulation on this issue was entered into it was done by respondent's counsel *295 stating orally into the record what we have copied in our findings of fact, and after respondent's counsel had thus stated it petitioner's counsel agreed thereto. We think it is only fair to construe the stipulation as an agreement that the facts with reference to this issue were as had been stated by petitioner in her petition and that only an issue of law was being presented to the Board for decision. Otherwise, it seems to us that the stipulation to which we have referred would have no point.
The facts stated in the petition with reference to this issue are as follows:
During the year 1933 petitioner and her deceased husband's estate were required to pay out of their community estate the sum of $409 upon a note guaranteed by said Robert J. Kleberg during his life. Said note was then wholly uncollectible and was uncollectible as a bad debt during*1563 the year 1933. It was a liability of the community estate of petitioner and her deceased husband and was paid out of said estate belonging one-half to each. Commissioner has allowed the same as a bad debt, but has attempted to allow it wholly to the husband's estate as a deduction, whereas it should be deducted one-half from the income of petitioner and one-half from the income of her husband's estate.
The Commissioner makes no point that the debt was not ascertained to be worthless in 1933 nor that it was not properly charged off in that year. The only point that he makes is that the deduction of the entire debt of $409 should be allowed to the estate of Robert J. Kleberg, Sr., as he has determined, and that petitioner Alice G. K. Kleberg has not offered sufficient evidence to overcome the presumptive correctness of this determination. Assuming that the facts are as stated in the petition of Alice G. K. Kleberg, and we do make that assumption because of the reasons just stated, we hold in favor of petitioner on this issue.
In *1564 , a Texas case, it was held that a husband's debt as a surety on a bond was a community debt, even though the debt became fixed by the principal's default after the dissolution of the marriage by death of one of the spouses, the court holding that all such debts by the husband are charges upon the entire community estate. In that case, the court, among other things, said:
A debt or obligation created by the husband during coverture, as this one was, creates a charge upon the community estate, and hence, in general terms, a community debt may be said to be any debt or liability made by the husband during marriage. Ballinger, Community Property, Sect. 117.
Our sustaining petitioner on this issue means that in a recomputation under Rule 50 the petitioner in Docket No. 86179 should only be allowed a deduction of one-half such bad debt instead of being allowed all of it as the Commissioner has done in his determination of the deficiency.
*296 Issues 5 and 6. - Claimed Deductions for Bad Debt and for Worthless Stock.
Petitioner in her income tax return for the year 1934 claimed a deduction of $29,760 as a bad debt, *1565 which she had ascertained to be worthless in that year and had charged off to that extent out of a total indebtedness which she held against the Kleberg Town & Improvement Co. She also claimed a deduction of $24,800 as representing cost of stock she owned in that corporation, which she alleged became worthless in 1934. We do not have the year 1934 before us. Petitioner has now changed her position and claims that she is entitled to these deductions in the year 1933, which we have before us, and she has made appropriate assignments of error to that effect. This change in position she, of course, has the right to make, and if the evidence sustains her claims as to these deductions in 1933 she will be entitled to have them allowed in a computation under Rule 50.
We shall first take up the claimed bad debt deduction. The respondent opposes this claimed deduction on the ground that if a debt exists it was not without value nor charged off during the year 1933.
Even if we assume that $29,760 of petitioner's $59,520 debt became uncollectible in 1933, and we are not deciding that such is the fact, we could not allow petitioner's claim. *1566 The claimed deduction for a bad debt must be disallowed for the adequate reason that the debt was not charged off during the taxable year. On this point the evidence is clear that no entry charging off the debt was made on petitioners' books until the year 1934. In this circumstance the deduction may not be allowed. Sec. 23(j), Revenue Act of 1932; , and cases there cited.
It should be noted that section 23(j) of the Revenue Act of 1932, unlike prior revenue acts, in the case of a partial worthlessness of a debt provides that "The Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction."
The requirement of a charge-off made during the taxable year, since it is found in the taxing statute itself, may not be excused on any showing such as petitioner now contends, that she was in doubt as to the year of worthlessness or that she was uninformed during the taxable year as to the financial condition of the debtor. Petitioner claims a deduction allowed by the statute and must therefore bring herself clearly within the terms of the law. *1567 . This she has not done and accordingly the action of the respondent in disallowing the claimed bad debt deduction is approved.
There remains the question of the worthlessness of the stock held by petitioner in the Kleberg Town & Improvement Co., for which *297 she claims a loss in 1933 in the amount of $24,800. The evidence on this point shows substantially the following situation: The Kleberg Town & Improvement Co. during the years from its founding down through the taxable year had its principal source of income in the sale of its lands. Prior to the year 1928 the gross income or gain realized therefrom was in excess of all expenses, but during the period 1928 through 1933 it was not sufficient to cover taxes and other items of expense. The prospects for the profitable sale of its lands declined during this period, due to generally poor business conditions that prevailed in the towns in which the lands were located. The company's balance sheet at the end of the taxable year shows a deficit in the amount of approximately $46,000, which left only about $4,000 of unimpaired capital. In 1934 the corporation's*1568 losses continued and its balance sheet at the end of 1934 showed that all the capital stock of the corporation had been wiped out and that there was a capital deficit according to the books at the end of that year. It was in that year that the petitioner charged off the investment on her books. It may well be that she is entitled to the deduction in 1934, but we have not that year before us, and we are not passing upon the merits of the deduction in that year. We simply say that we do not think petitioner has sustained her burden of proof to show that the stock became entirely worthless in 1933. Doubtless the value of the stock had shrunk to where it had only a small value in 1933, but that is not enough to entitle her to the deduction which she claims.
Petitioner in her proof on this point is under the necessity to show that the company's stock had no value in 1933. ; ; ; *1569 . This we think has not been shown.
On the basis of all the evidence we can not say petitioner has sustained the burden she must assume to show the error in Commissioner's determination and accordingly the claimed deduction for stock loss in the amount of $24,800 must be disallowed.
Decision will be entered under Rule 50.
Footnotes
1. Deficit. ↩