1930 BTA LEXIS 2214">*2214 1. Legal expenses incurred in establishing or defending title to real estate or minerals thereunder are capital expenditures and are not deductible as ordinary and necessary business expenses.
2. An amount paid pursuant to court judgment to reimburse a trespasser for cost of drilling 10 oil wells on the petitioners' lands, of which 7 were dry wells and 3 were producers, held to be a capital expenditure representing the cost to the petitioner of additional assets.
20 B.T.A. 35">*35 These are proceedings for the redetermination of deficiencies in income tax determined by the respondent as follows:
| Docket | |||
| No. | Petitioner | Year | Deficiency |
| 38813 | George W. Wetherbee | 1923 | $ 949.69 |
| 1924 | 738.24 | ||
| 38814 | Mrs. George W. Wetherbee | 1923 | 949.69 |
| 1924 | 687.74 | ||
| 38815 | Abel Bliss | 1923 | 3,802.65 |
| 1924 | 38.23 | ||
| 38238 | Mrs. Abel Bliss | 1923 | 3,802.65 |
| 1924 | 38.23. |
20 B.T.A. 35">*36 The issue is whether payments made by the petitioners in the taxable year 1923 and 1924 as the result of certain liigation are allowable deductions from1930 BTA LEXIS 2214">*2215 gross income. The proceedings were consolidated for hearing and decision.
FINDINGS OF FACT.
The material facts were stipulated by the parties substantially as follows:
The petitioners, Abel Bliss and George W. Wetherbee, were members of the partnership of Bliss & Wetherbee during the tax years involved, and one-half of each partner's income was reported for taxation by his wife under the community property laws of the State of Louisiana.
About the year 1910 Bliss and Wetherbee acquired approximately 11,000 acres of land in Louisiana. In the year 1921 these petitioners entered into lease agreements with the Humble Oil Co., Gulf Refining Co. of Louisiana, and the Standard Oil Co. of Louisiana, whereby those companies acquired the exclusive right to drill and explore for oil and gas on certain lands of the petitioners, as set forth in the agreements.
In consideration of the lease of said lands, Bliss and Wetherbee received bonuses in the year 1923 of $190,000 from the Humble Oil Co., $70,000 from the Gulf Refining Co., and $112,000 from the Standard Oil Co. In addition to the bonuses received, the partnership was to receive a royalty on all oil and gas.
In their respective1930 BTA LEXIS 2214">*2216 returns for the year 1923, the petitioner reported the said bonuses as gains, but computed the tax at the rate of 12 1/2 per cent under the capital gain provisions of the Revenue Act of 1921. In the notice of deficiency, the bonuses were treated as ordinary income.
One R. O. Roy claimed to hold oil and gas leases on the lands owned by the petitioners, and during the year 1921 entered upon said lands and drilled 10 wells thereon, of which 7 were dry wells and 3 were producers. Subsequent to the drilling of said 10 wells the petitioners instituted court proceedings to eject Roy from their lands, and were successful in doing so in the year 1923. The trial 20 B.T.A. 35">*37 court rendered judgment for the petitioners, decreeing that the lands in question were held by them free from any claim whatever of the defendants, but gave judgment in reconvention for the defendants in the sum of $28,315.39 expended by them in developing said property for oil and gas. An appeal was taken to the Supreme Court of Louisiana, which on June 4, 1923, affirmed the judgment of the lower court. See 1930 BTA LEXIS 2214">*2217 ; .
The petitioners paid Roy said sum of $28,315.39 in 1923, the amount representing drilling costs of Railroad Lands Co. wells as follows:
| No. 1 | 6,667.97 |
| No. 2 | 1,457.40 |
| No. 3 | 1,484.94 |
| No. 4 | 2,481.07 |
| No. 5 | 1,518.62 |
| No. 6 | 1,453.80 |
| No. 7 | $ 4,364.46 |
| No. 8 | 2,518.90 |
| No. 9 | 2,952.46 |
| No. 10 | 3,415.77 |
| Total | 28,315.39 |
Wells Nos. 1 to 7, inclusive, proved to be dry wells, and Nos. 8, 9, and 10 were producers. Nos. 9 and 10 were sold to the Humble Oil Co. for $7,764.83, and No. 8 was retained by the petitioners. The equipment on well No. 8 was appraised at $500.
Other expenses incurred and paid in 1923 by the petitioners in connection with this litigation were $22,071.50 for attorney fees and $73.75 for court costs. The petitioners also paid their attorneys in 1924 additional fees of $10,250 for services in connection with said litigation.
In the deficiency letters all of the foregoing expenditures were disalllowed as deductions in determining net income of the partnership for the years 1923 and 1924.
OPINION.
TRAMMELL: The issue raised by the petitioners1930 BTA LEXIS 2214">*2218 in these proceedings is whether they are entitled to deduct as ordinary and necessary business expenses certain expenditures made by them in the taxable years as a result of litigation involving the title of lands in the State of Louisiana.
In 1923, pursuant to final judgment of the Supreme Court of Louisiana, the petitioners paid R. O. Roy the sum of $28,315.39 representing the cost to said Roy of drilling 10 oil wells on the petitioner's lands. In the same year the petitioners paid to their attorneys $22,071.50 for services in connection with the litigation, and $73.75 court costs. In 1924 the petitioners paid to their attorneys additional fees in the amount of $10,250. These amounts were claimed by the petitioners as expense deductions in the partnership 20 B.T.A. 35">*38 returns of income. The respondent disallowed the deductions, holding that the amounts in question constituted capital expenditures.
The petitioners instituted the litigation against Roy for the purpose of establishing their title to the mineral rights in the lands. They were in effect defending their title against the claims asserted by Roy. Expenses incurred in such litigation are capital expenditures, and1930 BTA LEXIS 2214">*2219 are not deductible as ordinary and necessary business expenses. ; ; ; .
Under the principles laid down in the foregoing decisions, the amounts expended by the petitioners herein for attorney's fees and court costs clearly come within the category of capital expenditures. Accordingly, the respondent's determination as to these items is approved.
The respondent has also determined that the item of $28,315.39 was a capital expenditure. This amount was paid by the petitioners pursuant to the court's judgment requiring them to reimburse Roy for the cost of drilling the 10 oil wells on their lands, of which 7 were dry wells and 3 were producers. The petitioners allege that the said amount included machinery to the value of $8,264.83, and contend that the balance of $20,050.56 is deductible as an ordinary and necessary business expense. The petitioners further contend in the alternative that, if the said amount so paid to Roy is not deductible as expense, that portion thereof1930 BTA LEXIS 2214">*2220 which represents the cost of drilling the 7 dry wells is deductible as a loss sustained in 1923.
The Supreme Court of Louisiana appears to have regarded the sum of $28,315.39 as representing the cost of developing the oil field on the petitioner's property, which resulted in the bringing in of three producing oil wells. In its opinion (), the court said:
Plaintiffs complain of the judgment in reconvention for the expenses and expenditures of defendants in developing the oil field upon the property. We are convinced from all the circumstances that a failure to make this allowance would, in effect, permit the plaintiffs to enrich themselves at the expenses of the defendants; that equity, fair dealing, and law require that they should make the reimbursement, especially since they stood by and permitted the defendants to make the outlay and incur the expense for their benefit without protest, or at least without resorting to proper legal remedies until oil had been discovered.
We are constrained to take the same view. The petitioners were required by the court to reimburse Roy for his drilling expenses because of the fact that as a result of the court's1930 BTA LEXIS 2214">*2221 judgment the petitioners would acquire the benefits flowing from the drilling operations which resulted in the three producing oil wells. Otherwise, 20 B.T.A. 35">*39 the petitioners would, to the extent of he development of the oil field, have enriched themselves at the expense of Roy. The drilling operations and the discovery of oil increased the value of the land. On account of the enrichment as the result thereof the petitioners were required to pay not only the cost attributable to the producing wells, but the entire expenditures of the drilling operations of which the petitioners received the benefit. The decree provided that the minerals belonged to the petitioners, but that they should reimburse Roy for these expenditures. In order to reliever or remove any claim, right or interest of Roy, this payment was required. Such payment may therefore be considered as a capital expenditure. There was no segregation of the expenses of the dry holes from the producing wells by the court. The decree made no distinction between the expenditures. The total expenditures for the drilling operations were required to be paid by the petitioners in order to secure to themselves the clear and1930 BTA LEXIS 2214">*2222 unencumbered title to the mineral rights. The cost of drilling the dry holes may not therefore be separated from the cost of the producing wells and considered as expense or as a loss. They were all required to be paid in order to clear the title.
What the rule would be had the petitioners themselves drilled these wells, we need not consider, since a materially different state of facts is presented.
The deficiencies determined by the respondent are approved.
Judgment will be entered for the respondent.