*2768 1. GAIN OR LOSS. - In determining gain or loss on a sale in 1920 of an oil and gas lease and equipment acquired in 1919 the basis, in this instance the cost thereof, should be reduced by the amount of depletion and depreciation sustained. United States v. Ludey,274 U.S. 295">274 U.S. 295.
2. METHODS OF ACCOUNTING. - Where the books of certain partnerships were not kept on either an accrual or cash basis or in accordance with any recognized accounting practice, the determination of the respondent of the net income of the partnerships under section 212(b) of the 1918 Act was proper and will not be disturbed in the absence of evidence showing that the basis and manner used by the respondent does not clearly reflect the income.
3. NET INCOME OF PARTNERSHIP DETERMINED. - A partnership in 1919 sold oil leases and equipment for cash, notes worth par, and a stated consideration to be paid out of four-fifths of seven-eights of oil produced. The stated consideration had no fair market value at date of sale. The seller agreed to further develop and operate the property for the purchaser, such costs to be paid only out of one-fifth of seven-eights of oil produced. The partners*2769 at no time believed that the property sold would produce sufficient oil to pay the "stated consideration" or the costs of developing and operating. Respondent determined profit from sale on "Return of Capital" basis, but included the notes in computation for 1920 and refused to allow as a return of capital the excess developing and operating costs. Held, the notes should be included in computation for 1919 and excess costs allowed as a return of capital for the year in which paid.
4. SALE OR GIFT. - A certain transaction held to be a sale, thereby entitling the petitioners to a deduction for the loss resulting from the sale.
*935 In these proceedings, which have been consolidated for hearing and decision, the petitioners seek a redetermination of their income-tax liabilities for the calendar year 1920, for which year the respondent has determined deficiencies as follows:
| Ella Pipes Cline | $21,362.68 |
| W. D. Cline | 17,384.02 |
The errors alleged in the petitions are as follows:
(1) The respondent*2770 erred in determining the profit from the sale of an interest in the Margay Oil lease and equipment by reducing the cost thereof by depreciation and depletion sustained.
(2) The respondent erred in determining the petitioners' distributive share of the income of the partnership of Whitener & Shinholt.
(3) The respondent erred in determining the petitioners' distributive share of the income of the partnership of H. B. Shinholt & Co.
(4) The respondent erred in determining the petitioners' distributive share of the income of the partnership of Norton & Cline.
(5) The respondent erred in disallowing a loss resulting from the sale of petitioners' interest in the partnership of Simack Oil & Gas Co.
FINDINGS OF FACT.
The petitioners are husband and wife and resident citizens of Wichita Falls, Tex.
*936 In 1919 W. D. Cline purchased an interest in an oil and gas lease in the northwest extension to the Burkburnett field at a cost of $75,000. He subsequently expended a total of $88,147.44 for physical equipment in connection with the lease, all of which was a capital expenditure. Cline sold his interest in the lease, together with the equipment thereon, in 1920, *2771 to the Margay Oil Corporation for $107,383.84. The depletion sustained and allowed as deductions from gross income by the respondent on the lease up to the date of sale was $30,098.87, and the depreciation sustained and allowed upon the physical equipment up to the date of sale was $34,682.91. The respondent has determined a profit on the sale of the lease and equipment of $9,018.18, as follows:
| Total selling price | $107,383.84 | ||
| Deduct: | |||
| Cost of lease | $75,000.00 | ||
| Cost of physical equipment | 88,147.44 | ||
| Total cost | 163,147.44 | ||
| Less: | |||
| Depletion sustained | $30,098.87 | ||
| Depreciation sustained | 34,682.91 | ||
| 64,781.78 | |||
| Cost less depletion and depreciation | 98,365.66 | ||
| Profit | 9,018.18 |
During the latter part of March, 1919, a partnership was organized under the name of Whitener & Shinholt, with W. B. Whitener, H. B. Shinholt, and Cline as equal partners. On August 31, 1920, Whitener sold his interest in the partnership to Shinholt and Cline for $27,866.21, and the business was continued as a new partnership under the name of H. B. Shinholt & Co., with Shinholt and Cline as equal partners. The purchase price was paid to Whitener by check, out of*2772 the funds of H. B. Shinholt & Co., on September 6, 1920. The business of both partnerships was that of drilling oil wells on a contract basis.
No books as such had been kept by the old partnership during its existence. The partnership did, however, preserve certain records consisting of (1) bank check stubs, (2) invoices from vendors, (3) time sheets which were reports of the men's work and wages due them, and (4) bank statements. Some time between August 31, 1920, and January 1, 1921, an accountant was employed by the new partnership to write up a set of books for the old partnership from the preserved records. The same books were then used as the books of the new partnership.
The books as written up for the old partnership showed that from the time of its organization in March, 1919, to December 31, 1919, it *937 received as compensation from the States Oil Corporation the amount of $48,539.25 and as a refund of interest overpaid to the City National Bank of Wichita Falls, $77.60. The books also showed that during this period the old partnership and borrowed $12,000, and expended $62,907.26, of which $25,203.65 was expended for the following:
| Automobiles | $2,432.50 |
| Tools and equipment | 20,167.94 |
| Camps | 2,603.21 |
| Total | 25,203.65 |
*2773 There were accrued on the books at the close of 1919 the following liabilities, which remained unpaid as of December 31, 1919:
| Atlas Supply Co | $20.32 |
| Jarecki Manufacturing Co | 5.19 |
| Oil Well Supply Co | 372.40 |
| Bridgeport Machine Co | 1.44 |
| Total | 399.35 |
From January 1, 1920, to August 31, 1920, inclusive, the partnership of Whitener & Shinholt received compensation from the States Oil Corporation in the amount of $93,412, and certain miscellaneous receipts totaling $118.76, and capital contributions in the amount of $7,500. There was also accrued on the books of Whitener & Shinholt, as of August 31, 1920, an amount of $36,268, being the amount due on finished and partly finished work for the States Oil Corporation. There were no expenses accrued as of August 31, 1920, but the new partnership of H. B. Shinholt & Co. later paid certain items amounting to $413.48, which were recorded on the books as "paid for August account."
The books of Whitener & Shinholt and H. B. Shinholt & Co. were neither kept on an accrual basis nor on a cash receipts and disbursements basis, as those terms are used as descriptive of an accounting practice, nor according to any recognized*2774 accounting practice.
The respondent determined the income of the partnership of Whitener & Shinholt and H. B. Shinholt & Co., for the period here in question according to the accrual method, and on this basis determined that Cline's one-third interest in the income of Whitener & Shinholt, for the period January 1, to August 31, 1920, was $18,839.39, and that on his one-half interest in H. B. Shinholt & Co., for the period September 1, to December 31, 1920, he sustained a loss of $277.65.
The partnership of Norton & Cline was organized in the early part of 1919, for the purpose of acquiring two oil and gas leases in block 84, Red River Valley Lands Subdivision in Wichita County, Texas, comprising 22.1 acres in one tract and 5 acres in the other. The leases were purchased in 1919 for $271,000 and were taken in the *938 name of W. E. Norton. W. D. Cline owned a one-fifth interest in the partnership.
On June 25, 1919, during the course of drilling and developing the property, an option contract was made and entered into by and between W. E. Norton, acting for the partnership, and Ed D. Steger, trustee, wherein, for the consideration of $100,000 then paid, Steger was given*2775 an option, from the date of the contract until the expiration of five days from and after the completion of the first five wells then being drilled by the partnership, to purchase the leases, together with the equipment thereon, for a total consideration of $2,250,000, payable as follows:
| Cash | $300,000 |
| 60-day note | 100,000 |
| 90-day note | 100,000 |
| First seven-eighths of seven-eighths of all oil produced | 1,750,000 |
| Total | 2,250,000 |
The contract further provided that, in case Steger elected to exercise the option, the $100,000 paid on June 25, 1919, was to apply against the cash payment of $300,000, and that if the option was not exercised the said $100,000 was to remain the property of Norton. Steger immediately organized the Veritas Oil Corporation.
The fifth well was completed on or about August 17, 1919. On August 22, 1919, an agreement was entered into by and between W. E. Norton and W. D. Cline, as parties of the first part, and the Veritas Oil Corporation, as party of the second part, which recited that the first parties for and in consideration of $2,250,000 -
HAVE SOLD, TRANSFERRED, CONVEYED AND ASSIGNED, and by these presents do SELL, TRANSFER, CONVEY*2776 AND ASSIGN unto the said Veritas Oil Corporation all and singular all of the oil and gas lease and leasehold estate, right, title and interest owned by party of the first part in and to -
the two tracts of 22.1 acres and five acres, respectively, of block 84 of the Red River Valley Lands Subdivision which had been acquired by Norton in the early part of 1919. The consideration was to be paid as follows:
| Cash | $300,000 |
| 60-day note | 100,000 |
| 90-day note | 100,000 |
| First four-fifths of seven-eighths of all the oil produced | 1,750,000 |
| 2,250,000 |
The notes were executed by the Veritas Oil Corporation as principal and personally endorsed by Ed D. Steger, John W. Russell, E. H. Jones, H. E. Jones, C. L. Bradford, and W. K. McLain and further secured by a vendor's lien and deed of trust lien on the property executed by the second party to L. R. Buchanan, trustee for *939 the first party. The notes bore interest at 8 per cent and carried the usual provision for attorney's fees at 10 per cent if sued on for collection. They were worth their face value when received.
The $300,000 cash consideration was liquidated by the payment of $200,000 cash on or about the*2777 date of the August agreement and a credit for the $100,000 option money paid under the June contract.
The 60-day note was paid at maturity during 1919, and the 90-day note was paid in installments during the first half of 1920.
The contract of August 22 further recited that the parties of the first part had paid the actual and necessary costs and expenses of drilling, completing and equipping the first five wells; and provided that the second party should pay all of the actual and necessary costs and expenses in the drilling, completing and equipping of all other wells on the two tracts, together with all the costs and expenses of operating; that all such costs and expenses to be paid by second party should be paid out of the remaining one-fifth of seven-eighths of all the oil produced; that said remaining one-fifth of seven-eighths should be run to the pipe line to the credit of first party until all of the expenses chargeable to second party should be fully paid, and that all of the oil produced and saved from the premises from and after June 26, 1919, should become the property of the second party subject to all of the foregoing provisions. The agreement further provided*2778 as follows:
It is distinctly agreed and understood that said property and the development and operation thereof shall be under the joint management and control of the parties hereto, but in no event shall party of the first part be personally or otherwise liable for any of the obligations incurred in the control and management of said property or its development or operation, all such expenses to be paid by party of the second part, and party of the second part shall save party of the first part harmless from any and all such obligations and in addition thereto from all liabilities by reason of accidents or injuries to employees or others; it being distinctly agreed and understood that all of the costs and expenses of development and operation of said lease heretofore or hereafter incurred save and except as to the completion of said first five wells, shall be paid by party of the second part out of one-fifth (1/5) of seven-eighths (7/8) of the oil produced and saved from said premises, the same as above provided to be run to the credit of party of the first part.
* * *
But it is expressly agreed and stipulated that the vendor's lien is retained against the above described property, *2779 premises, and improvements until the above described notes and all interest thereon are fully paid according to their face and tenor, effect and reading, and until the One Million Seven Hundred Fifty Thousand ($1,750,000.00) Dollars, balance of the consideration, shall be fully paid as hereinabove provided, and until all of the costs and expenses in the drilling, development and operation of said property heretofore or hereafter incurred as above provided shall be fully paid, and until all sums shall be paid by party of the second part as hereinabove provided when this conveyance and assignment shall become absolute.
*940 By the early part of 1920 the partnership had completed the drilling of two wells on the 5-acre tract and 8 wells on the 22.1-acre tract. The wells were approximately 1,600 feet deep.
The following table shows the gross production of the two tracts in question under the above mentioned June and August agreements, seven-eighths of such production, the selling price of the seven-eighths of the production, and the amount of the selling price actually collected in each of the periods:
| Periods | Gross production | Seven-eighths | Selling | Amount |
| in barrels | production | price | collected | |
| July to December, 1919 | 114,676.52 | 100,341.95 | $227,726.41 | $78,097.97 |
| Year 1920 | 149,009.48 | 130,383.46 | 458,739.22 | 592,475.50 |
| Year 1921 | 93,015.58 | 81,388.65 | 159,107.46 | 172,158.07 |
| Year 1922 | 31,755.67 | 27,786.24 | 61,088.99 | 63,930.54 |
| Total | 388,457.25 | 339,900.30 | 906,662.08 | 906,662.08 |
*2780 During 1919 the partnership of Norton & Cline paid operating expenses of $118,325.48 and development costs in connection with the two tracts in question of $267,425.41, of which $141,168.11 was the cost of the first five wells and $126,257.30 the cost of wells subsequent thereto. During 1920 it paid operating expenses of $126,317.66. A commission upon the sale of the property of $20,000 was paid in 1919 and $16,551.20 in 1920. Its office expenses in 1920 amounted to $2,678.37.
The partners of Norton & Cline at no time believed that one-fifth of seven-eighths of the oil produced from the two tracts would pay the operating and development costs provided for in the above mentioned agreements of June and August, nor did they believe that four-fifths of seven-eighths of the oil produced would ever pay the remaining consideration of $1,750,000, but considered that the purchaser in the August agreement was in effect merely making a "donation" to them of the cash and notes in the amount of $500,000. The actual cost of operating the property amounted to more than one-fifth of seven-eighths of the oil produced, but no attempt was ever made to collect this difference from the Veritas*2781 Oil Corporation or anyone else.
Shortly after the agreement of August 22, 1919, the Veritas Oil Corporation transferred its interest in the two tracts to the Gay-Tex Oil Corporation. Some time after 1920 the partnership of Norton & Cline, for $1,000, purchased from the trustee in bankruptcy all of the interest of the Gay-Tex Oil Corporation in the two tracts in question and received from him a quit-claim deed therefor, and in December, 1922, resold the property to the Magnolia Petroleum Co. for a consideration of $70,000.
*941 The respondent determined that the net income of the partnership of Norton & Cline for the year 1920 amounted to $579,059.60, and that Cline's one-fifth distributive share therein amounted to $115,811.92. This amount was arrived at as follows:
| Cash and notes received by the partnership | ||
| in 1919 | $300,000.00 | |
| Part purchase oil installments from | ||
| four-fifths of seven-eighths of production | ||
| for 1919 | 62,478.37 | |
| 362,478.37 | ||
| Cost of lease | $271,000.00 | |
| Commissions paid | 36,551.20 | |
| Development costs first five wells | 141,168.11 | |
| 448,719.31 | ||
| Balance of original cost to be returned in | ||
| 1920 | 86,240.94 | |
| Additional cash received in 1920 | $200,000.00 | |
| Part purchase oil installments in 1920 | 473,980.41 | |
| 673,980.41 | ||
| Less balance of original cost as above | 86,240.94 | |
| Profit from sale in 1920 | 587,739.47 | |
| Less total amount of other deductions | ||
| allowed to the partnership | 8,679.87 | |
| Net distributive income from the partnership | 579,059.60 | |
| Cline's one-fifth interest in partnership | 115,811.92 |
*2782 On or about January 15, 1920, W. D. Cline, by oral agreement, purchased a one-fifth interest in a partnership known as the Simack Oil & Gas Co. for a cash consideration of $25,960. On September 17, 1920, an assessment of $40,000 was made against the partners and Cline paid his share of the assessment in cash amounting to $8,000.
The operations of the Simack Oil & Gas Co. had not proved successful and toward the close of the year 1920 it owed approximately $50,000, of which Cline's share would be about $10,000. There was still a possibility, however, that the partnership might be successful. Cline did not feel that he cared to risk any more in the business, and was anxious to dispose of his interest. Some time in December, 1920, he made an oral agreement with one S. L. McDowell, wherein McDowell was to take over Cline's one-fifth interest in the partnership of the Simack Oil & Gas Co. without assuming any part of the existing indebtedness and with the understanding and agreement that if the subsequent operations of the partnership were unsuccessful, McDowell, and not Cline, would be responsible for the loss. If, on the other hand, the subsequent operations were successful, *2783 the debts of the partnership existing at the time the agreement was made were to be paid by McDowell out of his share in the profits. It was the understanding that Cline was not to recover any part of the $33,960 already invested in the partnership by him. The respondent allowed the petitioners for 1920 a loss of $9,547.31, under Block *942 C of the return, as representing Cline's pro rata part of the losses sustained by the parthership on its 1920 operations.
OPINION.
GREEN: We will discuss the issues here involved in the order previously mentioned.
The first issue is whether, in determining gain or loss on a sale in 1920 of an oil and gas lease and equipment acquired in 1919, the basis thereof should be reduced by the amount of depletion and depreciation sustained. The petitioners, in their reply brief, concede that this issue should be decided against them upon the authority of , and we so decide.
The second and third issues relate to the proper determination of Cline's distributive share of the net income of the two partnerships, Whitener & Shinholt and H. B. Shinholt & Co. for the year 1920. Cline contends*2784 that the income of these partnerships should have been computed upon the cash receipts and disbursements basis for the year 1920, instead of the accrual basis as determined by the respondent. We have found as a fact that the books were not kept upon either of those bases, in the commonly accepted meaning of those terms, or in accordance with any recognized accounting practice. Upon such facts, section 212(b) of the Revenue Act of 1918 is applicable, wherein it is provided, inter alia:
The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income.
The burden is upon the petitioners to show that the basis and manner of the respondent's determination does not clearly reflect the income. This we think they have failed to do. The greater portion*2785 of the petitioners' argument is based upon an erroneous premise, namely, that the respondent did determine the income of Whitener & Shinholt for the period ending December 31, 1919 (which period is not before us), upon a cash basis. The revenue agent who examined the partnership's books for this period testified, as petitioners' witness, that in order to determine the income of Whitener & Shinholt for the period ending December 31, 1919, upon a cash basis it would have been necessary for the respondent to eliminate the accounts payable accrued by the partnership as of December 31, 1919. As this was not done it is improper to say that the respondent's determination for that period was upon the cash basis. The respondent used the accrual method in the computation of income for both years. *943 The determination of the respondent on these two issues should not be disturbed. Cf. .
The fourth issue involves the determination of the correct net income for the year 1920 of the partnership of Norton & Cline, in which Cline owned a one-fifth interest. before considering the merits of this issue, we will dispose of the motion to*2786 amend the petition filed by petitioners' counsel on September 18, 1927, and set down for hearing at Washington on October 25, 1927. The petitioners were not represented at the hearing on the motion which, after being opposed by counsel for the respondent, was taken under advisement. As appears from the bottom of page seven of petitioners' reply brief, the motion to amend the petition respecting the Norton & Cline issue was filed by petitioners' counsel "to avoid any misconception of the pleadings." The assignment of error in the original petitions pertaining to the Norton & Cline issue is that, "The taxpayer's distributive share of the profit of the partnership of Norton & Cline was incorrectly determined." Whether we grant or deny the motion will not affect our decision on this assignment of error. The motion merely clarifies an issue already made, and the motion is granted.
As set out in our findings of fact, the respondent has treated the transaction between Norton & Cline and the Veritas Oil Corporation as a sale occurring in 1919. Because that provision of the contract providing for the payment of $1,750,000 out of four-fifths of seven-eighths of all oil produced had no*2787 fair market value, he determined the profit on the "return of capital" theory which, as we said in , "contemplates the receipt by the taxpayer of his entire cost before there can be taxable income." He further held that the excess over the one-fifth of seven-eighths of the oil produced of the development and operating expenses paid by the partnership after the sale was not a proper deduction by the partnership, but should have been set up on its books as an account receivable due from the Veritas Oil Corporation. The petitioners do not take issue with the respondent as to his determination of the year in which the sale was made, or as to his use of the "return of capital" theory in determining the profit, which theory we have applied to similar issues where part of the consideration for the sale had no fair market value. See . But the petitioners do object to the inclusion, as a part of the consideration received in 1920, of the two notes totaling $200,000, which had a fair market value equal to their face when received in 1919 and on which $100,000 was actually*2788 paid during 1919. They further contend that because the partners at no time ever believed that one-fifth of the oil produced from the two tracts would ever pay the development and operating costs provided for in the sale agreement, such excess of the costs over the one-fifth of seven-eighths of the oil should *944 either be considered as a part of the cost of the property sold in determining the profit from the sale, or as "an allowable deduction at the time when it becomes certain that there will never be any excess of receipts over future operating expenses to apply upon the then existing deficit." (Petitioners' brief.) The petitioners' proof discloses two minor errors in the respondent's computation of profit respecting "commissions paid" and "other deductions," facts concerning which we have set out in our findings and which will appear presently in our computation of net income of this partnership for the year in question.
We have found as a fact that the two notes totaling $200,000 had a fair market value equal to their face when received in 1919. The respondent was in error in including them as a part of the consideration received in 1920.
Addressing ourselves*2789 to the excess costs of development and operating expenses made in accordance with the sale agreement over the one-fifth of seven-eighths of the oil produced, we are confronted with the following problem. A partnership was organized in 1919. It purchased a lease on two tracts of land for a cash consideration of $271,000. It proceeded to develop the land for oil and gas. During the course of development, it, through one of its partners, entered into an agreement with one Steger where, in consideration of $100,000 then paid, Steger was given an option to buy, on or before the fifth day after the completion of the fifth well, the lease, the leasehold estate, and all right, title and interest therein owned by the partnership, for a total consideration of $2,250,000, to be paid in cash, notes, and oil produced. Steger organized a corporation and on the fifth day after the completion by the partnership of the fifth well, to wit, August 22, 1919, the partnership sold, transferred, conveyed, and assigned to the corporation "all and singular all of the oil and gas lease and leasehold estate, right, title and interest owned by the parties of the first part" in the two tracts for a total*2790 consideration of $2,250,000, payable as follows:
| Cash | $300,000 |
| 60-day note | 100,000 |
| 90-day note | 100,000 |
| First four-fifths of seven-eighths | |
| of all the oil produced | 1,750,000 |
| 2,250,000 |
The contract of sale then provided (and here is where the difficulty arises) that the property and the development and operation thereof should be under the joint management and control of both parties; that all costs of development and operation of the property made or to be made subsequent to the day after the fifth well was completed were to be paid by the purchaser out of the remaining one-fifth of seven-eighths of the oil produced; and that the *945 seller was to retain a vendor's lien on the property and receive credit from the pipe line runs for the one-fifth of seven-eighths of the oil produced, until all such costs had been paid. But the parties did not act in strict accordance with the agreement. The petitioners at no time believed that there could be produced from the lease sufficient oil to pay the remaining cost of $1,750,000 plus the costs of further development and operation of the property. They considered that they had made a very favorable contract*2791 and that in substance the buyer was virtually making a "donation" to them of the $500,000 paid in cash and notes. The parties interested in the corporation evidently soon became aware of their unfortunate purchase and directed their interests to other enterprises. The partnership, however, continued to operate and develop the property, since under the agreement it was entitled to the full seven-eighths of all the oil produced until it had received in addition to the $500,000 already paid, the full remaining consideration of $1,750,000 plus all operating and development costs paid after the completion of the fifth well, which was completed five days before the sale. The partnership never considered it had any claim against the purchaser or anyone else for any of the development or operating costs paid in connection with the lease in question, nor did it make any such claims against anyone. During 1919 it expended $267,425.41 in development and operation of the property, of which $141,168.11 was paid for the development of the first five wells, and $118,325.48 for operating expenses. During 1920 it paid operating expenses in the amount of $126,317.66. There were also other amounts*2792 paid for commissions and office expenses which appear in the findings of fact.
The parties to this proceeding agree that the profit from the sale in 1919 should be returned in accordance with the "return of capital" method. But the respondent has refused to consider, as a part of the capital to be returned to the partners, any part of the development or operating costs paid by the partnership subsequent to the completion of the fifth well on or about August 17, 1919. No reason for this refusal is given in his deficiency letter, but from the entire record we assume that he considered such costs as being chargeable to the Veritas Oil Corporation and that, if paid by the partnership, they should be treated by it as an account receivable due from the corporation. But the partners, notwithstanding the agreement of August 22, 1919, never asserted a right to reimbursement of the operating and development costs except as they were entitled to the proceeds from one-fifth of seven-eighths of the production, which they knew would never be sufficient. It was necessary to incur such costs before there could be further production. *946 Under such circumstances, we think that the partnership*2793 is entitled to a return of the part of such operating and development costs for each year which was in excess of one-fifth of seven-eighths of the oil produced before the profit, if any, for that year is determined. Such expenditures are comparable to commissions or other expenses paid in connection with a sale and as such should be applied in reduction of the sale price.
The repossession and resale of the property occurred subsequent to 1920, the year here in question, and is, therefore, not involved in these proceedings.
The net income of the partnership of Norton & Cline for the year 1920, determined in accordance with the foregoing, is $348,275.35 and is set forth in schedule form as follows:
| Cash and notes received in 1919 | $500,000.00 | ||
| Part purchase oil installments from 4/5 of 7/8 of production for 1919 | 62,478.37 | ||
| Total consideration received during 1919 | 562,478.37 | ||
| Less return of capital: | |||
| Cost of lease | $271,000.00 | ||
| Development cost of first 5 wells | 141,168.11 | ||
| Commissions paid in 1919 | 20,000.00 | ||
| Development costs subsequent to first 5 wells paid in 1919 | $126,257.30 | ||
| Operating costs subsequent to first 5 wells paid in 1919 | 118,325.48 | ||
| 244,582.78 | |||
| Deduct receipts from 1/5 of 7/8 of production for 1919 | 15,619.60 | ||
| 228,963.18 | |||
| 661,131.29 | |||
| Balance of capital to be returned in 1920 | 98,652.92 | ||
| Part purchase oil installments from 4/5 of 7/8 of production for 1920 | 473,980.41 | ||
| Less return of capital: | |||
| Balance from 1919 above | $98,652.92 | ||
| Commissions paid in 1920 | 16,551.20 | ||
| Operating costs for 1920 | $126,317.66 | ||
| Deduct receipts from 1/5 of 7/8 of production for 1920 | 118,495.09 | ||
| 7,822.57 | |||
| 123,026.69 | |||
| Profit for 1920 | 350,953.72 | ||
| Deductions allowed partnership: Office expense previously referred to as "other deductions" | 2,678.37 | ||
| Net income of partnership for 1920 | 348,275.35 | ||
| Cline's 1/5 distributive share | 69,655.07 |
*2794 *947 The fifth and last issue is whether the petitioners are entitled to a loss of Cline's investment of $33,960 in the one-fifth interest in the partnership of Simack Oil & Gas co. upon his disposition of that interest to McDowell in December, 1920. Cline acquired the interest under an oral agreement and disposed of it in the same manner. The respondent contends that Cline's disposition of the interest in question was a gift rather than a sale, for the reason that no consideration moved from McDowell to Cline. With this we do not agree. One of the essential terms of the agreement between McDowell and Cline was that McDowell would be responsible for one-fifth of the future losses of the partnership if the latter continued to be unsuccessful. In our opinion, the transaction was a sale by Cline of his one-fifth interest in the partnership to McDowell and, since under the terms of the agreement Cline would never recover any part of his investment of $33,960, such investment represented a total loss. the petitioners concede, however, that the amount of $33,960 should be reduced by the amount of $9,547.31 already allowed by the respondent as representing Cline's pro rata*2795 part of the losses sustained by the partnership on its 1920 operations.
Judgment will be entered under Rule 50.