1932 BTA LEXIS 1231">*1231 1. In his allowance of depletion on oil and gas producing property of petitioner the respondent designated a stated amount as allowed on cost and the remainder on discovery value, the amounts allowed on cost for some of the years being based on cost to petitioner's assignor instead of fair market value at the time of acquisition. Where allowances were made on discovery value, the basis included such cost. In a recomputation made to ascertain the amount previously allowed for depletion on cost the respondent used the original allowance in cases where depletion sustained on the correct basis was in excess thereof, and in cases where the original allowance for both cost and discovery value was in excess of the amount which should have been allowed on cost, the amount originally allowed on cost was increased to the amount allowable. Held that the respondent's recomputation reflects the amount previously allowed on cost within the meaning of section 202(b) of the Revenue Act of 1924.
2. The petitioner having elected to treat certain items as expense deductions under the option granted by the regulations, such costs may not be capitalized to increase the cost basis in computing1932 BTA LEXIS 1231">*1232 gain on a sale of the assets in a later year.
26 B.T.A. 868">*868 Proceeding for the redetermination of a deficiency of $174,790.35 in income tax for 1924. The issues are the proper allowance of depletion as a deduction from cost in computing gain realized on the sale of certain oil and gas property and whether the cost basic should be increased by alleged capital expenditures which the petitioner claimed and respondent allowed in prior years as operating expenses. The facts were stipulated. From the stipulation, which is incorporated herein by reference, we make the following findings of fact.
FINDINGS OF FACT.
The petitioner is the sole surviving trustee of McCaskey and Wentz, Trustees of Oklahoma Oil Property.
On April 14, 1917, the Southwestern Oil Company, an Oklahoma corporation, assigned to the predecessors of petitioner, in trust, certain oil and gas leases and other property located in Kay and Noble Counties, Oklahoma, which had cost1932 BTA LEXIS 1231">*1233 the assignor $41,717.02, and at the time of assignment had a fair market value of $1,785,333.35. 26 B.T.A. 868">*869 Thereafter the trust acquired leasehold properties at a cost of $28,184.88.
The trust operated the properties until their sale on July 28, 1924, to the Wentz Oil Corporation, a Delaware corporation, for $4,429,688.75.
In returns filed for each of the years 1917 to 1924, inclusive, the trust claimed certain amounts as depletion. For those years the respondent allowed depletion on the properties amounting to $7,131,016.55. Of this amount, $252,175.02 was designated as having been allowed on cost and the remainder on discovery value.
For 1917 to 1922, inclusive, the cost basis used for the property acquired on April 14, 1917, was cost to the Southwestern Oil Company. For 1923 and 1924 the basis used for such property was fair market value on the date of its acquisition by the trust. The respondent used cost to the trust in computing depletion on the property it acquired after April 14, 1917. In cases where depletion was allowed on discovery value, the value included such costs or fair market value as the case may be. No allowances were made in 1917 for discovery1932 BTA LEXIS 1231">*1234 value.
In his computation of the gain realized in 1924 from the sale of the property, the respondent used as the petitioner's cost basis, the fair market value on April 14, 1917, of the property it acquired on that date, plus the cost of property acquired thereafter, a total of $1,813,518.23. (It was so stipulated, but the statement attached to his deficiency letter shows that respondent used an amount $3,000 in excess thereof.) He reduced the cost basis by $1,532,102.31 for depletion theretofore allowed. The computation was based on the fair market value at April 14, 1917, of property acquired on that date, and the cost to the trust on property acquired thereafter.
The respondent now concedes that the cost basis should be reduced by the sum of $1,077,797.67 for depletion allowed prior to the sale, in accordance with a recomputation made by him in February, 1932. Under this computation, where the depletion sustained on the correct cost basis is in excess of the original allowance, the original figure is retained. In cases where the depletion allowed exceeded what should have been allowed on cost, the amount originally allowed on cost is increased to the correct sum.
1932 BTA LEXIS 1231">*1235 In the years 1917 to 1924, inclusive, the trust expended sums aggregating $2,157,430.09 for labor, wages, fuel, hauling, repairs, etc., in connection with the drilling of oil and gas wells on the leases sold by it and the development of the leases for the purpose of producing oil or gas, including like expenditures for dry holes and leases abandoned prior to the sale. The amounts expended each year were claimed as deductions in the returns filed by the petitioner and were 26 B.T.A. 868">*870 allowed by the respondent as development expenses under the option granted by the Treasury Department in
The issue relating to the deductions just referred to was raised for the first time in February, 1932.
The years 1917 to 1923, inclusive, have been finally closed and the respondent is now, and was prior to February, 1932, forever barred by statute from reopening those years.
OPINION.
ARUNDELL: Section 202(b) of the Revenue Act of 1924 provides, in part, that in computing the amount of gain realized or loss sustained from the sale of property "proper adjustment shall be made for * * * depletion, 1932 BTA LEXIS 1231">*1236 previously allowed with respect to such property."
The parties are in agreement that allowances made on discovery value play no part in the computation. Their disagreement has to do with the amount previously allowed on cost. The petitioner contends that because in the audit of his returns for 1917 to 1924, inclusive, the respondent designated sums aggregating $252,175.02 as allowed on cost, he should be held to that figure in adjusting the cost basis for computing profit made on the sale, even though such allowances, so far as they applied to the assets acquired on April 14, 1917, were computed on an erroneous basis. The respondent, on the other hand, insists that he is entitled to reduce the basis by $1,077,797.67 for allowances previously made on cost. Which of the two figures is correct, is the only point in controversy under the issue.
The Revenue Act of 1917 contained no provision for the allowance of depletion on the basis of discovery value.
The amount of $7,703.32 allowed on cost is retained in the recomputation of the respondent, even though the amount of depletion sustained on cost was $291,552.72. For this reason there can be no difference of opinion as to1932 BTA LEXIS 1231">*1237 the proper adjustment to be made for depletion allowed for 1917.
In auditing the returns for 1917 to 1924, inclusive, the respondent allowed $7,131,016.55 for depletion. Of this amount he designated $252,175.02, the amount contended for by petitioner, as "allowed on cost" and the remainder as "allowed on discovery appreciation." This figure, except in so far as it applies to 1923 and 1924, when the correct bases were used, was computed on the basis of the cost to the Southwestern Oil Company of the property acquired on April 14, 1917, instead of fair market value at the time of acquisition by the trust. In 1927, when the respondent determined the deficiency, he increased the amount previously allowed on cost from $252,175.02 to 26 B.T.A. 868">*871 $1,532,102.31 to compensate for his error in using cost to the assignor instead of fair market value on April 14, 1917, as the basis for the leases acquired from the Southwestern Oil Company. He now concedes this to be wrong and proposes to use the sum of $1,077,797.67 as a reduction of the base, in accordance with a recomputation made in February, 1932. A few examples will be sufficient to illustrate the method he employed in arriving at1932 BTA LEXIS 1231">*1238 the amount. In 1918 the respondent allowed $56,411.45 as depletion on the West Simmons lease, $258.23 being designated as allowed on cost and the remainder on discovery appreciation. Although the sum of $68,802.89 was allowable on cost, in his recomputation he limited the figure to the amount of $56,411.45, the sum actually allowed in his audit of the 1918 return. For the same year he allowed depletion amounting to $323,377.02 on the J. Welsh lease. Of this sum $449.64 was designated as allowed on cost. The depletion sustained on the proper basis (fair market value on April 14, 1917) was $75,464.81; hence he uses this figure as the depletion previously allowed on cost. In that year the West Herman lease had no discovery value and sustained depletion of $11,987.67 based on its fair market value at April 14, 1917. Having allowed but $336.25 for depletion on cost, the respondent did not increase the sum. The same rules were followed for all of the leases in all years in which the incorrect cost basis was used for the assets acquired from the Southwestern Oil Company.
The petitioner has presented an elaborate brief in which he reasons that the respondent must be held to what1932 BTA LEXIS 1231">*1239 at the time the latter designated as depletion on cost. We quite agree that the statute limits depletion to be considered in computing gain or loss to what was actually allowed. But if the taxpayer gets a deduction for depletion in fact - and that is what he got here - the amount of the depletion in fact allowed must be taken into consideration in determining the gain or loss, regardless of respondent's designation of what he did. Beginning with the Revenue Act of 1918, the law permitted depletion to be taken, in specified circumstances, on the basis of the value of the property at the time of discovery or within thirty days thereafter, instead of on cost. It was only when discovery value was greater than cost that it formed a basis for depletion and consequently in allowing depletion on discovery value the taxpayer received a deduction which was not only ample to restore his capital, but something additional. The statute did not provide for two kinds of depletion in the same circumstances, but the one - discovery value - took the place of the other. It is only when property is disposed of as in the instant case that it becomes necessary to "break down" the computation1932 BTA LEXIS 1231">*1240 as made by the respondent. As the petitioner in this case is not being charged with a single dollar of depletion that in fact was not allowed to him in the several years during which he operated the 26 B.T.A. 868">*872 property, we are of the opinion he has no just complaint against the respondent's action.
Under this method of computing the depletion previously allowed on cost the respondent gets no advantage of errors made due to the use of an improper basis, but in the final analysis is merely making corrections for improper designations without in any instance actually increasing the sum allowed on cost. In those cases where the present amount exceeds the sum designated as allowed on cost, the increased sum was, in fact, allowed, it having been included in the allowance made on discovery appreciation, as the parties have stipulated.
We think the respondent's recomputation reflects the amount previously allowed for depletion, and hold the proper adjustment under section 202(b) of the governing statute for depletion to be $1,077,797.67, as proposed by the respondent.
Under the remaining issue we are asked to increase the cost basis by $2,157,430.09, less an amount for exhaustion1932 BTA LEXIS 1231">*1241 and depletion, and the cost of any dry holes and producing wells on leases abandoned, which were charged off in the the year drilled, for certain items claimed by the petitioner and allowed by the respondent in and prior to 1924 as development expenses under the option granted by
There should be deducted from the gain realized on the sale the sum of $100,794.14, as a net loss from business operations, in accordance with paragraph 20 of the stipulations.
Decision will be entered under Rule 50.