*2307 Where A sold to B all the oil produced from his interest in an oil lease during the period December 2, 1921, to October 2, 1922, for the sum of $625,000, of which the amount of $225,000 was payable at all events and the remainder was limited to an amount equal to the sale price of one-half the oil produced from such interest during said period, with an option in B to purchase said interest in the lease for the sum of $25,000, plus an amount equal to the difference between the sum of $625,000 and what had been paid for oil, said latter amount to be paid out of oil, and where it was uncertain, under the then known facts, whether B would exercise his option, held that the contract was a sale of oil and not a sale of the interest in the lease until the option was exercised; held, further, that A is entitled to deduction for depletion during such period; and held, further, that the exercise of the option by B did not, for income-tax purposes, relate back to the date of the contract.
*368 These proceedings were by*2308 order duly entered and consolidated for hearing and decision and involve the redetermination of the following deficiencies in income tax:
| 1921 | 1922 | |
| Arthur J. Coyle | $344.63 | $3,183.04 |
| Thomas W. Cragg | 732.97 | |
| Benjamin H. Orr | 2,068.78 | |
| John G. Winant | 141,580.28 |
*369 The errors alleged are (1) that respondent has determined that a certain contract between petitioners and the Wichita Petroleum Co. evidenced a sale with the result that petitioners are not entitled to depletion, whereas petitioners claim that said contract was not a contract of sale and that no sale resulted until October 1, 1922, and that petitioners are entitled to a deduction for depletion, and, (2) in the alternative, that respondent erred in not taxing petitioners' income from such alleged sale under section 211(b) of the Revenue Act of 1921.
FINDINGS OF FACT.
Each of the petitioners is a resident of Concord, N.H. In 1921 petitioners acquired, as partners, an oil lease on the property hereinafter described, subject to two overriding royalties of one-eighth each. Upon exploration by drilling, petitioners discovered a well which came in on October 31, 1921, with an initial*2309 flow of 16,000 barrels a day. The temperature of the well at the time it came in was and continued to be about 120 degrees, a temperature which indicated nearness to salt water, which was then thought to be an indication that such water might flood the wells. This well was drilled in what is known as Woodbine sand and on a minor fault of the Balcones fault, which prior to this time had not produced oil. The Woodbine sand was primarily a fresh water sand, and it was then impossible accurately to prognosticate what might be expected from this field.
Petitioners Coyle, Cragg, and Orr discussed the situation with John R. McLane, attorney in fact for petitioner Winant and also legal advisor of petitioners. They took into consideration three possibilities - (1) to continue to operate the property; (2) to make an outright sale thereof, or (3) to enter into an operating contract with some larger company with larger facilities. McLane advised the elimination of the proposition for immediate sale, for the reason that by such immediate sale they would at once lose their deductions for depletion allowances. Petitioners were then in strong financial condition and under no pressure to adopt*2310 any one particular course.
After conferring with the representatives of several large oil companies, petitioners began negotiations with representatives of the Wichita Petroleum Co. The representatives of the latter company *370 were anxious to make an immediate outright purchase of petitioners' interest in the aforesaid oil lease, but were informed by McLane that petitioners had decided not to make an immediate sale but were willing to discuss an operating agreement coupled with an option of purchase. The result of these negotiations was the following contract:
THIS AGREEMENT made and entered into this 2nd day of December, 1921, by and between JOHN G. WINANT of Princeton, New Jersey, by his attorney in fact John R. McLane, and ARTHUR J. COYLE of Mexia, Texas, parties of the first part, and WICHITA PETROLEUM COMPANY, a corporation organized under the laws of the State of Delaware, party of the second part.
WITNESSETH:
That WHEREAS, the parties of the first part are the owners of an oil and gas lease on a certain tract of land situated on the Elija Carter property so called, about three miles southwest of Mexia, Limestone County, Texas, known as the Coyle Lease, containing*2311 sixteen acres of land, subject to a one-eighth royalty interest therein and to an additional over-riding one-eighth royalty interest in favor of a previous owner of said lease, said tract of land being the same sixteen acres described in that certain contract between E. L. Smith Oil Company, and A. J. Coyle, dated August 9, 1921, and filed for record on August 15, 1921, and recorded in Volume 116, Page 436, Deed Records, Limestone County, Texas.
NOW THEREFORE, the parties hereto, in consideration of the mutual promises, covenants and conditions herein set forth, agree as follows:
1. That the party of the second part shall, from and after the date of the execution of this agreement, for a period of ten months ending October 1, 1922, undertake the operation of said lease for and on behalf of said parties of the first part, and shall pay all of the expenses of such operation, and shall drill at its own expense all new or additional wells that may be necessary to be drilled for the successful operation of the property in accordance with the terms and requirements of prior leases, and shall pay all of the State taxes that may be assessed against such production during the said period.
*2312 2. In operating said lease said party of the second part shall be entitled to use without cost or expense all of the machinery, tools, equipment, supplies and other personal property now on said lease or adjacent thereto and intended to be used in connection therewith, but all additional equipment shall be furnished by said party of the second part at its own expense.
3. Said parties of the first part hereby sell to the party of the second part, and the said party of the second part hereby purchases subject to the royalty interests aforesaid all oil produced or that may be produced on said lease for the period commencing at midnight December 1-2, 1921, and ending at midnight October 1-2, 1922, whether said oil be produced from the well now existing on said premises or other wells that may be drilled during said period, all said oil to be retained by the party of the second part as produced, and said party of the second part agrees to pay for all such production without regard to the quality thereof, the sum of Six hundred and twenty-five thousand dollars ($625,000) in payments as follows:
Twenty-five thousand dollars ($25,000) upon the execution of this agreement, and the*2313 balance in ten (10) equal payments of Sixty thousand dollars ($60,000) each, payable monthly on the 5th day of each month, beginning January 5, 1922, provided, however, that payments in cash in excess of $225,000 shall be limited to an amount equal to the proceeds of the sale of *371 one-half of the oil production of said property during said period subject to the royalty interests aforesaid, which sales shall not be for less than the market price therefor in that locality. The title to the oil so produced shall vest in the party of the second part immediately upon the production thereof from said lease. The second party may cease to operate said lease by reason of the failure of the property to produce oil sufficient to pay the operating expenses out of the one-half of the oil production thereof, in which event the property shall revert to said parties of the first part.
4. Said parties of the first part hereby give and grant unto said party of the second part an option to purchase said lease subject to the royalty interests aforesaid to become effective at the expiration of the period ending October 1, 1922, together with the equipment and other personal property above*2314 mentioned, the consideration of such purchase to be Twenty-five thousand dollars ($25,000), provided, however, that if at the expiration of the period ending October 1, 1922, the full amount of $625,000 has not been paid by reason of the operation of the proviso in paragraph 3 hereof, there shall be paid in addition to the sum of $25,000 a further amount equal to the difference between $625,000 and the amount already paid, this latter payment to be made out of one-half the proceeds of the sale of the oil produced and saved on said property subject to the royalty interests aforesaid until payment in full has been made.
Coincidently with the execution of this agreement said parties of the first part shall make, execute and acknowledge in due form of law an assignment and transfer of the lease above described subject to the royalty interests aforesaid, together with all equipment and other personal property above mentioned, and shall deposit said assignment with the Equitable Trust Company of New York in escrow with instructions to the effect that if said party of the second part shall, on or before the 1st day of October, 1922, deposit with said escrow holder a written notice stating*2315 in substance that said party of the second part or its successors or assigns has accepted the above option and agreed to purchase said lease on the terms above set forth, said assignment and transfer will be delivered to the said party of the second part, or its successors or assigns, on October 1, 1922, upon payment to the said escrow holder for the benefit of said parties of the first part the sum of $25,000 in cash.
6. Said party of the second part shall have ten (10) days after receiving a complete abstract of title to said lease within which to examine and approve the title of said parties of the first part, or their interest in said lease, and to the equipment, supplies and other personal property thereon or intended to be used in connection therewith, and said parties of the first part shall deliver such abstract to said party of the second part within ten (10) days from this date. If said title shall be found defective and such defects shall not be cured by said parties of the first part within ten (10) days after notice of such defects, this agreement of shall thereby become of no force or effect, and said first payment on account of oil produced shall be returned to*2316 said party of the the second part and said assignment from the escrow holder to said parties of the first part.
7. Until approval of said title the cash payment of $25,000 on account of oil production shall be held in separate escrow by the said Bank with instructions to deliver said sum to said parties of the first part, or either of them, upon final approval of said title, otherwise to said party of the second part as above set forth.
IN WITNESS WHEREOF, the said parties have hereunto set their hands and seals the day and year first above written.
*372 The above contract was recorded in the office of the County Clerk of Limestone County, Texas. Simultaneously with the execution of the above contract, the assignment of lease provided for in the contract was deposited with the Equitable Trust Co. in New York and operation of the property was turned over to the Wichita Petroleum Co. Other than the above contract, there was no agreement, either oral or in writing, between petitioners and the Wichita Petroleum Co. In making their income-tax returns for the year 1921. petitioners submitted with their return certain information on Form "O" and attached to that form*2317 a copy of the above contract and a short account of its history.
Upon execution of the above contract, the Wichita Petroleum Co. paid petitioners the sum of $25,000 cash payment recited therein. The said company on January 5, 1922, paid the further sum of $60,000; on February 5, 1922, the further sum of $60,000, and on March 5, 1922, the further sum of $60,000; the total cash payments to said date amounting to the sum of $205,000. At this point a dispute arose as to the construction of the contract and petitioners sued the Wichita Petroleum Co. for the April installment of $60,000. Another suit was brought for the May installment of $60,000. In June, 1922, a supplementary agreement was entered into covering further payments. The total amount paid to petitioners by the Wichita Petroleum Co. prior to October 1, 1922, was the sum of $297,305.14. The total sales of three-fourths of the oil produced from the lease for the period December 2, 1921, to October 1, 1922, amounted to the sum of $449,876.02. At that time petitioners had in litigation a claim for an additional amount of approximately $150,000. On October 1, 1922, the Wichita Petroleum Co. exercised its option and took*2318 up the assignment of the lease from the Equitable Trust Co., making at that time a payment in cash of $25,000. Said company continued to make payments out of oil runs thereafter up to March, 1924, when the litigation and all further obligations were compromised by the lump sum payment of about $194,000. The total payments made by the Wichita Petroleum Co. to petitioners for all purposes amounted in the end to the sum of $635,000. The Wichita Petroleum Co. took over the operation of the lease on December 2, 1921. The production of oil from the leased property for the period December 2 to December 31, 1921, inclusive, was 184,257.64 barrels, to which petitioners and the Wichita Petroleum Co. together were entitled to three-fourths. For the remaining nine months the production was 378,835.50 barrels.
During the period December 2, 1921, to October 1, 1922, petitioner Coyle, who was an experienced oil man, remained on the property at the sole expense of petitioners, assisting the Wichita Petroleum *373 Co. in the operation of the lease for the purpose of checking the amount of oil produced, and especially for the purpose of seeing that the property was not improperly drilled*2319 so as to admit salt water into the wells and thus destroy the value of the lease. Petitioners paid local real property taxes on the leasehold for the year 1922 in the approximate amount of $5,290. It has been stipulated by the parties that the proper depletion allowable, if depletion is allowable at all, is 49.45 cents per barrel.
OPINION.
MILLIKEN: The contract between petitioners and the Wichita Petroleum Co. was construed in Wichita Petroleum Co. v. Winant,295 Fed. 67, and it was there held that the only period of time referred to in the contract was the period "commencing at midnight December 1-2, 1921, and ending at midnight October 1-2, 1922," with the result that petitioners were entitled to be paid, in addition to the total cash payments aggregating $225,000, an amount equal to one-half of the proceeds of all oil produced from the three-fourths interest in the lease, that being petitioners' interest which was subject to two overriding royalties of one-eighth each. Giving to the contract the construction placed thereon by petitioners, it appears that they sold to the Wichita Petroleum Co. hereafter referred to as the Wichita Company, all the oil*2320 produced from their three-fourths interest during the "period" for the sum of $25,000 cash and other cash payments, amounting in all to $225,000, plus an amount equal to the proceeds of one-half the oil produced during said "period" with an option on the part of the Wichita Company to purchase their interest in the lease for the sum of $25,000 plus the difference, if any, between the sum of $625,000 and the amount already paid for the oil; the said difference to be paid out of one-half of the proceeds of oil produced from the said three-fourths interest.
Respondent insists that petitioners were endeavoring to evade income tax and that this was the purpose they had in view when the contract was drawn. We see no fraud in the case. Petitioners submitted with their income-tax returns a copy of the contract, together with a short statement of its history. Respondent was given full notice of what had occurred and in computing the deficiency evidently relied upon the contract, a copy of which was furnished him by petitioners. The real question, then, is whether by reason of the contract petitioners should or should not be given the benefit of deductions by reason of depletion, and*2321 this turns on the effect and character of the contract. The issue is whether petitioners fall inside or outside the line prescribed by the revenue act. See Bullen v. Wisconsin,240 U.S. 625">240 U.S. 625.
*374 In order to get a clear view of the whole situation, we will first view it as of the date the contract was made and then look at what actually resulted. The testimony given at the hearing discloses that the representatives of the Wichita Company were anxious to purchase outright but does not disclose the terms of their offer. Those terms appear in the opinion in Wichita Petroleum Co. v. Winant, supra.There it appears that the offer was to purchase the lease for the sum of $650,000, of which the sum of $250,000 was to be paid in installments by March 5, 1922, and the remainder out of the proceeds of the sale of oil. The contract we have before us was to the effect that the sum of $225,000 was to be paid in cash and in addition for the period December 1-2, 1921, to October 1-2, 1922, petitioners were to receive an amount equal to one-half of the sale price of the oil, and the Wichita Company was given an option to purchase the petitioners' *2322 interest in the lease for the sum of $25,000, plus the difference between $625,000 and what had been paid by the latter date. In both cases the ultimate amount to be paid was the same. The difference consists in the terms contained in the proposed contract and those contained in the final agreement. A pertinent fact that confronted petitioners at the time the contract was entered into was that theirs was the first oil produced from Woodbine sand. Their well came in at a temperature of about 120 degrees, which indicated a proximity of salt water and that the well might soon cease to produce oil in paying quantities. It appears that the life of the oil production was at this time quite problematic. The whole matter had the aspect of speculation. The purpose of petitioners was to preserve to themselves the right to a deduction for depletion. For this purpose they were willing to reduce the amount to be paid in cash to the extent of $25,000, making that sum the amount to be paid if the option were exercised. They waived the absolute right to receive an amount equal to one-half the proceeds of the oil during the life of the lease, making the latter right dependent upon the amount*2323 of oil produced before October 2, 1922, and also dependent upon whether the Wichita Company exercised its option. On this point the attorney, who drew the contract and who was also attorney in fact for petitioner Winant, having stated that there was considerable doubt at the time the contract was executed as to what would be the situation on October 1, 1922, testified as follows on cross examination:
Q. By that do you mean you were in some doubt as to whether you were going to get all of your money under the contract by reason of the wells petering out?
A. Yes. We figured we were taking considerable chance based on what was known of the Mexia field at the time this contract was made, that is, against an outright sale in getting our full consideration at the time of the contract, as *375 against a deferred sale until some time quite in the future, and we were taking a very real risk, but it was one that was worth taking.
Next, looking backward, we find these fears verified to a certain extent. Instead of the three-fourths interest in the lease producing oil to the extent that one-half thereof would be equal to the amount of $400,000, the total sales of oil from that*2324 interest produced only $449,876.02, of which petitioners were entitled to an amount equal to one-half. The result was that on October 1, 1922, petitioners had received and were entitled to receive cash payments amounting to $225,000, and to receive from oil the amount of $224,938.01, or a total of $449,938.01. In fact, by reason of litigation petitioners received prior to October 1, 1922, only the amount of $297,305.14. To put it another way, the Wichita Company received $61.99 less for oil sold than it paid or owed to petitioners for the oil purchased, and in addition paid all expenses of operation and state production taxes. The result of this was that before the Wichita Company could exercise its option, it would be compelled to pay petitioners the sum of $25,000 and agree that out of the oil produced, subject to prior royalties, it would pay to them the further sum of $175,061.99. The final outcome was that the Wichita Company executed this option and instead of paying petitioners the total sum of $650,000, they actually paid them the sum of $635,000. The fact that petitioners, by taking the course they did, might have achieved the same result which would have resulted from*2325 the contract offered by the Wichita Company is not conclusive that taxes have been evaded rather than avoided. See United States v. Isham17 Wall. 496">17 Wall. 496, where the court pointed out that one could avoid a stamp tax on checks for $20 or more by issuing several checks for less than that amount. The true question is whether the contract, taken as a whole, was a contract of sale of the lease or was a contract of sale of oil coupled with a bona fide option to purchase the lease.
We are not bound by the recitals of the contract nor by the particular terms used in any one paragraph but should construe the paper as a whole. The fact that it purports to sell the oil rather than the lease is not controlling if the contract taken by its four corners discloses a contrary contention. See Heryford v. Davis,102 U.S. 235">102 U.S. 235. Neither are we bound by the fact that the contract purports to vest in the Wichita Company an option, if in fact there was no real room for choice. See In re Sheets Printing & Mfg. Co.,136 Fed. 989; *2326 Corbett v. Riddel,209 Fed. 811; Burroughs Adding Machine Co. v. Bogden, 9 Fed.(2) 54.
If we do not take into consideration the surrounding facts and circumstances and the nature of the property involved, we might at *376 first blush be impressed by the fact that the contract proposed by the Wichita Company and the one actually executed would in the end, if carried out, reach precisely the same result. The exception "if carried out" is the flaw in the statement. The Wichita Company was not obligated to operate the lease beyond midnight of October 1-2, 1922. It would and must have stopped at that date unless it paid the sum of $25,000 and agreed to pay out of oil the difference, if any, between the amount of $625,000 and the amount representing one-half of the oil to be produced during the "period" from the three-fourths interest. Looking at this proposition as of the date of the contract, it would seem that it was by no means certain that the Wichita Company would exercise its option. The oil was being produced under new conditions. Its temperature did not indicate a long life of production. It could not then be said how much*2327 would be paid out of the oil prior to October 1, 1922, nor how much would have to be paid out of oil subsequent to that date. The amount of $25,000, especially when taken in connection with the exhausting nature of the property, was no small amount. It is true that it might be expected that by October 1, 1922, the Wichita Company's investment would be quite large, but it should be remembered in this connection that we are not dealing with lasting property such as land or houses, but with a class of property which is exhausted by every barrel of oil extracted, with the result that the payments to be made under the option might be out of all proportion to the then remaining value of the property. Petitioners were confronted on the one hand with large immediate profits coupled with high taxes and on the other with a chance to lose some of their profits but with the result of lower taxes. Taking into consideration all the facts presented, we are convinced that in adopting the course they did, petitioners took a real bona fide chance to lose some of their gain. As it turned out, the Wichita Company was compelled to agree to pay out of oil production the further sum of approximately*2328 $175,000, in addition to the sum of $25,000 in cash. We think that at the outset it was by no means certain that the Wichita Company would exercise its option and are therefore of opinion that the contract was a contract of sale of oil coupled with a bona fide option to purchase the lease.
The rights of an optionee are thus stated in Thompson on Real Property, vol. 5, sec. 4287(h):
INTEREST OF OPTIONEE. - An option does not pass to the optionee any interest in the land; but a contract of sale does transfer to the vendee an interest in the land; and therefore a person appearing in the character of an optionee possesses nothing except the right to elect to buy, and he has no interest in the land until, by his acceptance of the option, he transforms the option into a contract of sale and changes his character from that of an optionee to that *377 of a vendee. So long as a person stands in the position of an optionee, his rights are those of an optionee, and his rights as a vendee do not come into existence until he occupies the position of a vendee.
A case in which the facts were very much like those in these proceedings is *2329 Phenix Insurance Co. v. Kerr,129 Fed. 723. The question in that case was whether Kerr was within the meaning of the provisions of a fire insurance policy the sole and unconditional owner of a grain elevator which had been burned. The facts were thus stated by the court:
* * * The evidence was that Kerr bought, paid $6,000 for, and took the title to the elevator. Thereupon he made a written agreement with Rundberg & McCann to the effect that they should have the possession and use of the property for a monthly rental of $100 and for the payment of the premium on the insurance; that they should be at liberty to pay more than $100 per month if they saw fit; that, if they failed to pay as much as that amount for two successive months, the contract should cease, and Kerr should retain the moneys he had received, but that, if they should continue to make the payments until they should aggregate $6,000 and interest at 10 per cent per annum, Kerr would convey the elevator to them. When the loss occurred, Rundberg & McCann were not in default. They had paid about $1,200 under this contract, and they were in the possession of the property. * * *
After stating that*2330 under a contract of sale and purchase the vendee is the one who suffers loss, the court proceeds:
* * * But if the owner gives to another the option to purchase a piece of property, and the latter does not irrevocably accept the offer and definitely agree to make the purchase, the loss of its injury or destruction falls upon the owner of the property, and not upon the owner of the option, because the latter is not bound to take or pay for the property, and he cannot be compelled to do so. And, while the owner of the option may accept it, and compel the owner of the property to comply with its terms, until the owner of the option does so he has no interest in the property. He has nothing but a mere right to acquire an interest, and this is neither the ownership nor any interest in the property which impinges upon its unconditional ownership by him who gave the option. Richardson v. Hardwick,106 U.S. 252">106 U.S. 252, 254, 27 L. Ed. 145">27 L.Ed. 145, 146, 1 Sup.Ct.Rep. 213; Gustin v. Union School District,94 Mich. 502">94 Mich. 502, 34 Am. St. Rep. 361">34 Am.St.Rep. 361, 54 N.W. 156">54 N.W. 156. The result is that the owner of property who has given an irrevocable option to purchase it to one who has not agreed*2331 to accept the option or to buy or to pay for the property still has the unconditional ownership of it within the proper interpretation of the clause upon that subject in policies of insurance, and the may maintain an action upon a policy for injury to it by fire. The plaintiff was in that situation. He was the owner of the elevator. He had given an option to purchase it to Rundberg & McCann. They had paid $1,200 for that option, and in partial acceptance of it, so that it had become irrevocable. But they had not agreed to complete their acceptance, or to buy the property, and they were not bound to take or to pay for it. They had no interest in it, but a mere right to acquire an interest which they were at liberty to enforce or to abandon. The interest of the plaintiff was the sole and unconditional ownership, and his action upon the policy was well brought.
From the above, we conclude that if the Wichita Company had not exercised its option there can be no question that the title to the lease *378 would have remained in petitioners, with the consequent right to deduction for depletion. What effect then does the fact that the option was exercised have upon the question*2332 involved?
At this point, respondent contends that when the Wichita Company exercised its option it was to "be considered as the owner ab initio," and in support of this contention cites Kerr v. Day,14 Pa.St. 112; Peoples Street Ry. Co. v. Spencer,156 Pa.St. 85; 27 Atl. 113; Bauer v. Hill,267 Pa. 559">267 Pa. 559; 110 Atl. 346; Crossman v. Insurance Co.,198 Mich. 304">198 Mich. 304; 164 N.W. 428">164 N.W. 428; Crowly v. Byrne,71 Wash. 444">71 Wash. 444; 129 Pac. 113. While there is language used in the above cases which, if taken out of its context and apart from the facts and questions involved, could possibly be construed to sustain respondent's contention, nothing can be found in any one of them to the effect that an optionee, upon the exercise of his option, becomes the owner of the property from the date of the option. All that was in fact decided in the Kerr and Crowly cases was that one who purchased with notice of an outstanding option, purchased subject to the option. The Bauer case related to a contract of outright sale - no option was involved. The*2333 Spencer case related to the proceeds of a fire insurance policy. It was there held that an option contract contained in a lease taken in connection with a deed of the same date, was only a method of securing a loan made by the optionor to the optionee. All that was decided in the Crossman case was that one who acquired for a valuable consideration an option on property had an insurable interest in the property. The Day and other Pennsylvania cases are largely based on the English case of Lawes v. Bennett, 1 Cox.Ch.Cas. 167, and other English cases following that case. In the Lawes case it was held that where one had given an option on real estate and after his death the optionee exercised the option, the realty was converted into personalty and the proceeds went to the next of kin and not to their heir at law. This case, though followed, has not received the unqualified approval of the English bench. See Note 57, L.R.A., pp. 651, 652, and Smith v. Lowenstein,56 Ohio State 346; *2334 34 N.E. 159">34 N.E. 159. That such conversion is a purely equitable fiction is shown by the decision of Lord Eldon in Townley v. Bedwell, 14 Ves. 591. There one had executed a lease containing an option to purchase. After his death the lessee exercised his option. The contest was between the heir at law and the next of kin. Lord Eldon followed Lawes v. Bennett, and held that the purchase price went to the next of kin, and referring to that case said: "That case was very much argued and I do not mean to say that a great deal may not be urged against it." On the other hand, and this is the part of the opinion applicable to these proceedings, he decreed that the heir at law was entitled to the rents up to the date of the exercise of the option, thus clearly deciding that no conversion in fact took *379 place until the actual sale. In another English case, Edwards v. West, 6 Ch.Div. 858, the facts were that the landlord covenanted to insure and the tenant had an option to purchase. Before the time of exercising the option, the leased buildings burned and the landlord received the insurance money. The tenant then exercised his*2335 option and claimed the insurance money as part of his purchase on the ground that his option, when exercised, related back to the date of the option. This the court denied, saying:
In the first place, it has been said that by the law of England the exercise of the option causes it to relate back to the time of the creation of the option in such a manner as to render the property for this purpose property of the purchaser as from the date of the contract which gave the option; so that here, although the option was given by contract made in April and not exercised until the 28th of September, yet that when it was so exercised, on the 28th of September, it operated retrospectively, and made the property the property of the purchaser as from the month of April preceding, and consequently made the vendor trustee of the fruits of the property for the purchaser. Now it appears to me that such a conclusion would be highly inconvenient, because it would place a person under the obligations which rest upon a trustee, or make him free from them, by reference to the act which was not performed until a future day; and the retrospective conversion of a person into a trustee of property is a*2336 result eminently inconvenient. * * * According to the view which I conceive to be true, the conversion of property, which means the treating it as belonging to somebody else before it has been actually transferred to that other person, results from a contract which can be specifically enforced; so that, where there is no specific performance of contract possible, there is no conversion. It flows in effect from the principle of equity which considers that done which ought to be done, and which the court can compel to be done, and it extends so far back as those circumstances exist, and no further. In other words, where there is a contract capable of being specifically enforced as from the date of that contract, and neither earlier nor later, the property comprised in the contract is deemed to belong to the purchaser, and the money to be paid is deemed to belong to the vendor, because those two things ought to be done; but here there is no obligation to do them at any earlier date than that of the contract constituted by the exercise of the option. The conversion cannot, according to the principle, relate back to an earlier date than the contract which gives rise to it.
*2337 To the same effect see Caldwell v. Frazier, 65 Kans. 24; 68 Pac. 1076. On this question it is said in Thompson on Real Property, vol. 5, sec. 4287(h):
When, by accepting an option, a person changes his position from that of an optionee to that of a purchaser, the interest in the land created by the contract of sale dates, in most jurisdictions, from the date of the contract of sale, and is not, by force of fiction, deemed to date from the date of the option.
Whatever may be the merits of this fiction when applied to the devolution of estates, it can find little, if any, place in income-tax law. Our various revenue acts make the taxable year, whether calendar or fiscal, the period for which all income must be returned and taxed. Except for the net loss provisions in the various revenue *380 acts, the net income for the taxable year is dependent on what occurred in that year. While it is true income and losses may be accrued by one who keeps his books on that basis, yet such accruals must be based on what actually occurred in the taxable year. If we admit the fiction here asserted by respondent, we will find one returning and properly*2338 returning as rent what he received from a lease and years afterwards we will find the same person compelled to return such rentals as purchase money received. The contract we have before us runs through two taxable years and it would be quite peculiar to hold that petitioners were the owners of the lease during December, 1921, but that they were not owners of the lease from that time on to the time of execution of the option. The contention made by respondent is based entirely upon a fiction. Tax laws deal with realities. Taxes "are not laid upon abstractions." Edwards v. Slocum,287 Fed. 651; affd., 264 U.S. 61">264 U.S. 61. We find no merit in this contention.
We are of opinion that petitioners were the owners of their three-fourths interest in the lease up to midnight October 1-2, 1922, with the result that they are entitled to deductions for depletion up to that date. This disposes of petitioners' alternative contention, that they should be taxed under section 211(b) of the Revenue Act of 1921.
Judgment will be entered under Rule 50.