1929 BTA LEXIS 2304">*2304 1. The fair market value of the surface rights in land owned by certain of the petitioners was reduced in 1920, due to the fact that the land became impregnated with oil and salt water from oil wells drilled thereon and was thereby rendered permanently less fitted for cultivation. Held that said shrinkage in value is not an allowable deduction from gross income.
2. The amount of sales of cotton made by certain of the petitioners in 1920, determined.
3. A written instrument executed by J. C. Pugh, Sr. and one Eastham on August 1, 1919, held to be a contract of sale which immediately vested in Eastham title to the property described therein, and Pugh was not entitled to any deduction in 1920 and 1921 for depletion of such mineral rights, although the greater part of the consideration for the sale was payable out of royalties.
4. The petitioners held to beentitled to deduct from gross income for the years 1920 and 1921, amounts as allowances for the depletion of mineral rights conveyed to them by J. C. Pugh, Sr., on July 12, 1920.
17 B.T.A. 429">*429 These proceedings, which were duly consolidated for hearing and decision, are for the redetermination of deficiencies in income taxes 17 B.T.A. 429">*430 which the respondent has asserted for the years 1920 and 1921, as follows:
| 1920 | 1921 | |
| J. C. Pugh, sr | $42,638.62 | $417.35 |
| J. C. Pugh, jr | 655.23 | 792.82 |
| Mrs. J. C. Pugh, sr | 42,638.62 | 1,523.17 |
| Mrs. J. C. Pugh, jr | 655.23 | 792.82 |
| O. L. Pugh | $277.04 | $141.80 |
| Mrs. O. L. Pugh | 277.04 | 184.84 |
| L. G. Pugh | 366.32 | 151.04 |
| Mrs. L. G. Pugh | 366.31 | 151.04 |
FINDINGS OF FACT.
The petitioner, Mrs. J. C. Pugh, Sr., is the widow of J. C. Pugh, Sr., who died April 21, 1921, and she is also the executrix of his last will and testament. The petitioners O. L. Pugh and L. C. Pugh are children of J. C. Pugh, Sr.; Mrs. O. L. Pugh is the wife of O. L. Pugh; and Mrs. L. G. Pugh is the wife of L. G. Pugh. The petitioner, the Exchange Bank & Trust Co. of Shreveport, La., is the administrator of the estate of J. C. Pugh, Jr., son of J. C. Pugh, Sr., who died May 9, 1926. Mrs. J. C. Pugh, Jr., is the widow of J. C. Pugh, Jr. J. C. Pugh, 1929 BTA LEXIS 2304">*2306 Sr., J. C. Pugh, Jr., O. L. Pugh, and L. G. Pugh, and their wives, were during the taxable years involved herein residents of Louisiana, and they reported their income on the community property basis.
During the year 1920, and until April 21, 1921, J. C. Pugh, Sr., and his wife, operated a 1,380-acre cotton plantation owned by J. C. Pugh, Sr., which he had acquired prior to March 1, 1913, and which was known as the "Petrovic Plantation." This plantation had a fair market value on March 1, 1913, of $75 per acre. Between March 1, 1913, and the year 1920, improvements were added at a cost of at least $15,000. In the year 1919 oil was discovered underlying the plantation and a number of wells were brought in in the latter part of 1919 and during the year 1920, the greater part of the development occurring in 1920. The oil and salt water from the wells impregnated the ground and caused a growth of coco grass, Johnson grass and noxious weeds, which made the cultivation of cotton and other crops on the plantation unprofitable and permanently impaired the value of the plantation for agricultural purposes, and reduced the fair market value of the surface rights, as distinguished from1929 BTA LEXIS 2304">*2307 the mineral rights, to the extent of $50,000 in the year 1920.
In the year 1920 Johns. C. Pugh, Sr., and Mrs. Pugh sold a number of bales of cotton from their plantation for $4,320 and reported that amount in their income and profits-tax return for that year.
Oil was discovered on the Petrovic Plantation in 1919 under a lease providing for the payment to J. C. Pugh, Sr., of a one-eighth 17 B.T.A. 429">*431 royalty on all oil and gas taken therefrom. On August 1, 1919, J. C. Pugh, Sr., and one J. M. Eastham entered into the following written contract:
STATE OF LOUISIANA,
PARISH OF CADDO.
Before me, the undersigned authority, personally came and appeared J. C. Pugh, husband of Carrie Gahagan, a resident of Caddo Parish, Louisiana, who declared that he has this day sold to J. M. Eastham, a resident of Caddo Parish, Louisiana, one-half (1/2) of his one-eighth (1/8) royalty on the following described property, situated in Red River Parish, Louisiana, to-wit:
All of Section 12, except that part thereof situated in the Northwest quarter (NW 1/4), lying West and North of Shingle Bayou, the Northeast quarter (NE 1/4) of Section 13, and the North half (N 1/2) of the Northwest quarter (NW1929 BTA LEXIS 2304">*2308 1/4) of Section 13, all in Township 12, Range 11, and all of that part of the Southwest quarter (SW 1/4) of Section 6, and all of Section 7, situated west of Cypress Bayou, and all that part of the Southwest quarter (SW 1/4) of Section 18 situated South and West of Cypress Bayou, all in Township 12, Range 10, and being all of the property owned by the said J. C. Pugh in Red River Parish, except the part acquired from C. H. Polly situated East of Cypress Bayou; the property embraced in this sale being known as the "Petrovick Plantation" and containing Thirteen Hundred (1300) acres, more or less.
This sale and transfer is made for the price and sum of Two Hundred and Fifty Thousand ($250,000) Dollars; Fifty Thousand ($50,000) Dollars of which is paid in cash, and the balance of Two Hundred Thousand ($200,000) Dollars to be paid out of the one-half royalty herein conveyed to the said Eastham, the said J. C. Pugh to receive the entire royalty of one-eighth (1/8) until the said unpaid balance of Two Hundred Thousand ($200,000) Dollars has been paid out of the said one-half (1/2) belonging to the said Eastham, and thereafter the said one-half (1/2) shall be paid to the said J. M. Eastham1929 BTA LEXIS 2304">*2309 or his assigns.
It is further agreed and understood that the said J. M. Eastham in no way binds or obligates himself personally to pay the said balance of Two Hundred Thousand ($200,000) dollars, and if one-half (1/2) of the royalty from the said property is not sufficient to pay said sum, then the vendor in no way looks to the said J. M. Eastham personally for the payment thereof.
This sale to be operative from the first day of August, 1919, and all oil in tanks now on hand shall go exclusively to the said J. C. Pugh.
Thus done and passed on this the first day of August, 1919.
J. C. PUGH J. M. EASTHAMAttest:
W. W. FLOURNOY A. G. NUSSERJNO. D. WILKINSON, Notary Public.
Endorsed:
No. 3368. J. C. Pugh to J. M. Eastham. Sale of Royalty. Filed for record at 2 p.m. o'clock, August 6, 1919. Drew Davis, Dy. Clerk and Ex-officio Recorder.
Recorded in Book 29, page 208 of Red River Parish Record, on this 7th day of August, 1919.
17 B.T.A. 429">*432 A reasonable allowance to J. C. Pugh, Sr., and his wife for the depletion of their interest in the mineral rights in the Petrovic Plantation is $126,561.54 for 1920 and $17,331.54 for 1921.
On July 12, 1920, J. 1929 BTA LEXIS 2304">*2310 C. Pugh, Sr., his wife, Mrs. J. C. Pugh, Sr., and his children, J. C. Pugh, Jr., O. L. Pugh, L. G. Pugh, and Carama Pugh, executed a written instrument which is in the words and figures following, to wit:
STATE OF LOUISIANA
PARISH OF CADDO
Before me, the undersigned authority, personally came and appeared J. C. Pugh, a resident of Caddo Parish, Louisiana, who stated and declared to me, Notary, that he has this day given, donated, transferred and delivered, and does by these presents give, grant, donate, and deliver unto his sons, J. C. Pugh, Jr., O. L. Pugh, J. C. Pugh, and to his daughter, Carama Pugh, and to his wife, Mrs. J. C. Pugh, nee Gahagan, of same residence, here present and accepting this donation, all of the following described property, situated in the Parish of Red River, said state, to wit:
An undivided one-sixteenth (1/16) interest in and to all of the mineral and mineral rights in and under and appertaining to the following described property:
All of Section Twelve (12), except that part of Northwest Quarter (NW 1/4) lying west and north of Shingle Bayou; Northeast quarter (NE 1/4) and North half (N 1/2) of Northwest quarter (NW 1/4), Section Thirteen (13), 1929 BTA LEXIS 2304">*2311 Township Twelve (12) North, Range Eleven (11) West; all that part of the North half (N 1/2) of Section Eighteen (18) lying south and west of Cypress Bayou; also that part of the Southwest quarter (SW 1/4) of Section Six (6) lying West of Honey Bayou and that part of Section Seven (7) lying West and North of Honey Bayou, and that part of said Section Seven (7) lying North of Shingle Bayou, and that part of Section Seven (7) lying West of Cypress Bayou, all in Township 12 North, Range 10 West, Red River Parish, La.
TO HAVE AND TO HOLD said described property unto said donees, their heirs and legal representatives forever.
This donation is made for and in consideration of the love and affection which the donor has for the donees.
It is agreed and understood that said property is donated to the said donees in equal division, and that all of said parties hereby appoint J. C. Pugh, Jr., as Trustee, to handle all of the income from said property herin donated, with full power and authority to sign all division and transfer orders, and to do all things necessary or incidental to the administration or sale of said property, including the receiving of moneys, he to have full charge1929 BTA LEXIS 2304">*2312 of the management of same and of the distribution of all of the income from said property between said donees.
The donees, being now present, stated and declared to me, Notary, that they hereby accept the above and foregoing donation according to the terms on which the same is made, and sign hereunto as evidence of their acceptance thereof.
It is further agreed and understood that this donation is to be in force and effective of date August 1, 1920.
17 B.T.A. 429">*433 IN TESTIMONY WHEREOF said parties have hereunto signed their names, in the presence of me, Notary, and the two attesting witnesses, on this the 12th day of July, A.D. 1920.
J. C. PUGHCARRIE GAHAGAN PUGH
L G. PUGH
CARAMA PUGH
J. C. PUGH, JR. O. L. PUGHWITNESSES:
M. TODDHENRY E. RONDEAU.
ABE GOODMAN,
Notary Public in and for Caddo Parish, Louisiana.
Endorsed:
No. 8449. J. C. Pugh to O. L. Pugh, et als.
DONATION. Filed for record at 9 a.m. o'clock, July 14, 1920.Recorded in Book 37, page 619 of Conv. record, Red River Parish, La., on this 14th day of July, 1920, Drew Davis, Clerk and Ex-officio Recorder.
The amounts of allowable depletion of the mineral rights covered by1929 BTA LEXIS 2304">*2313 said written instrument were $24,872.95 for 1920 and $59,202.35 for 1921.
The respondent, upon audit of the returns of income filed by the above named persons for the years 1920 and 1921, determined that J. C. Pugh, Sr., and his wife were not entitled to any deduction from gross income for the year 1920 on account of the damage done to the surface rights of the Petrovic Plantation by oil, salt water, weeds, grass, etc.; that they were not entitled to any allowance in the years 1920 and 1921 for depletion of the interest in mineral rights covered by the contract of August 1, 1919, between J. C. Pugh, Sr., and J. M. Eastham, and that the donees named in the written instrument of July 12, 1920, and their respective husbands and wives, are not entitled to any deductions from their gross incomes for the years 1920 and 1921 as allowances for the depletion of the property conveyed by said instrument. The respondent also increased the income of J. C. Pugh, Sr., and Mrs. J. C. Pugh, sr., for 1920 on account of cotton sold by them in that year from $4,320 to $13,181.30.
OPINION.
MARQUETTE: These proceedings involve the income-tax liability for the years 1920 and 1921 of four men and1929 BTA LEXIS 2304">*2314 their respective wives. Four issues are raised by the pleadings, three of which are found only in the cases of J. C. Pugh, Sr., and Mrs. J. C. Pugh. The other issue is common to all of the cases. It appears to be accepted by the parties that the incomes on which the taxes are based were community incomes and were reported on that basis.
17 B.T.A. 429">*434 The first issue is whether J. C. Pugh, Sr., and his wife are entitled to any deduction from their income for 1920 on account of damage to or a loss of value in the Petrovic Plantation, which damage or loss was due to the fact that the land became impregnated with oil and salt water from oil wells drilled thereon, and covered with a growth of noxious weeds and grasses, thereby rendering it permanently less fitted for cotton and other crops, to the production of which it had theretofore been devoted. It appears to be fairly established by the evidence that the plantation, which had been acquired by J. C. Pugh, Sr., prior to March 1, 1913, had a fair market value of $105,000 on that date. It also has been established that in 1919 oil was discovered underlying the plantation and that in the latter part of 1919 and in the year 1920 oil1929 BTA LEXIS 2304">*2315 wells were drilled, the larger part of the development occurring in 1920. Oil and salt water from these wells impregnated the land and caused the growth of coco grass, Johnson grass, and other noxious grasses and weeds, so that the plantation was rendered permanently less fitted for the production of cotton and other crops which had theretofore been raised thereon, and that the fair market value of the surface rights of the plantation in 1920, as distinguished from the mineral rights, was reduced by at least $50,000. We are, however, unable to find any reason or authority for allowing the deduction claimed. Granting that the usefulness of the plantation for agricultural purposes has been permanently impaired, it does not follow that a deductible loss has been sustained. There was a shrinkage in fair market value, but such shrinkage in value does not give rise to a deductible loss, any more than an increase in such value gives rise to income. Until there has been a sale or other disposition of the property is is impossible to say whether a gain or loss will be sustained. In 1929 BTA LEXIS 2304">*2316 , this theory was expressed as follows: "The income tax laws do not profess to embody perfect economic theory. They ignore some things that either a theorist or a business man would take into account in determining the pecuniary condition of the taxpayer. They do not charge for appreciation of property or allow for a loss from a fall in market value unless realized in money by a sale." In our opinion Pugh and his wife sustained no deductible loss within the meaning of the Revenue Act of 1918.
The evidence herein also shows to our satisfaction that J. C. Pugh, Sr., sold on his own account, in the year 1920, certain cotton for which he received $4,320. The respondent has increased the amount of such sales to $13,181.30. It appears that other cotton was in fact sold by Pugh, but that it was not for his own account but for the accommodation of other persons, and that he was not entitled to the proceeds. Mrs. Pugh testified positively that the cotton sold by J. C. 17 B.T.A. 429">*435 Pugh, Sr., on his own account, brought only $4,320. On this point we sustain the petitioners.
The third question is whether J. C. Pugh, Sr., was entitled1929 BTA LEXIS 2304">*2317 to deduct any amount for depletion of the mineral rights covered by the written instrument executed by him and witnessed on August 1, 1919. The respondent denies that Pugh was entitled to any allowance for depletion of that interest, on the ground that he conveyed the entire interest to Eastham on August 1, 1919. The petitioners contend that Pugh and Eastham intended that the conveyance to Eastham should cover only the interest remaining after Pugh had received $200,000 in royalties and that Pugh was the owner of the mineral rights until they had been depleted to that extent. We do not agree with that contention. In the case of , the same contention was made by the petitioner relative to the effect of a written instrument which, in its essentials, is practically identical with the instrument executed by Pugh and Eastham. In holding adversely to the petitioners, we stated:
The contract between the petitioners and West on one side, and Foster, Looney & Wilkinson on the other, refers to the petitioners and West as "vendors" and to Foster, Looney & Wilkinson as "vendees," which term we adopt for the purpose of this opinion. 1929 BTA LEXIS 2304">*2318 It recites that in consideration of $200,000, to be paid entirely out of the oil produced on the tract of land described in the contract "the said H. C. Walker, Jr., and Elias Goldstein do sell, transfer and convey unto the aforesaid vendees the excess royalties of one twenty-fourth (1/24) of all the oil, gas and other minerals, reserved for them under the aforesaid lease * * *."
Petitioners claim that we should disregard the words used in the contract and look to its substance, and that when so viewed it was not a contract of sale but that under it their rights as lessors were continued until they had received $200,000 out of the oil and that by the contract the petitioners and George West were recognized as the owners of the one-sixteenth royalty interest which was the subject of the contract. These contentions are not borne out by the recitals and the provisions of the contract. It clearly appears that the vendors and vendees were claiming under adverse titles, and that the purpose of the agreement was not to recognize the rights of each other, but to settle the controversy by a compromise of that which had theretofore been contested. The sum of $200,000 was "to be paid entirely1929 BTA LEXIS 2304">*2319 out of the oil produced from the above described tract of land, either by the lessees of the said George West and their assigns, or by the lessees of the said Lillie G. Taylor, and their assigns, and accruing to the credit of the undivided one-sixteenth (1/16) interest that is vested in the said vendees by reason of the purchase above referred to by them from the said Lillie G. Taylor on the one hand, any by reason of their purchase from the said vendors under this contract on the other hand."
It thus appears that the $200,000 was not payable to the petitioners and West out of their interest in the oil, but was payable out of the interest of the vendees, which they had acquired from Lillie G. Taylor, and from the petitioners and West.
17 B.T.A. 429">*436 Putting aside the fact that the contract uses the words "sell, transfer and convey," and the words "vendors" and "vendees," and looking to the substance of the contract alone, the conclusion can not be escaped that the contract was a contract of sale which divested the taxpayers and West of all interest in the property therein referred to, and vested eo instanti the title thereto in the vendees for the consideration of $200,000 payable1929 BTA LEXIS 2304">*2320 out of the royalties the contract for which was assigned to the vendees. Such being the case, the respondent did not err in refusing to allow the petitioner a dedution for depletion.
We are of opinion that the instrument under consideration was a contract of "sale to be operative from the first day of August 1919," and that Pugh was on that day divested of the title to the property described in the instrument and that the respondent did not err in refusing to allow him deductions for depletion thereof in 1920 and 1921.
The last question is whether the several petitioners are entitled to deduct from gross income in the years 1920 and 1921, any amount for the depletion of the mineral rights covered by the donation deed executed by Pugh, Sr., on July 12, 1920. The respondent denies the right of the petitioners to this deduction, on the ground that the property was held in trust, the income to be collected and distributed by a trustee, and that the deductions for depletion should be allowed only to the trust as an entity. The petitioners also proceed on the theory that the property was held in trust for them. We think, however, that the instrument of July 12, 1920, merely created1929 BTA LEXIS 2304">*2321 an agency, and that the petitioners, as the owners of the property, are entitled to allowances for depletion according to their respective interests.
Reviewed by the Board.
Judgment will be entered under Rule 50.