1929 BTA LEXIS 2645">*2645 The determination of respondent that notes received had a fair market value equal to their face value approved, where the petitioners fail to prove a different fair market value.
16 B.T.A. 109">*109 These proceedings, consolidated for hearing and decision, result from the determination of the respondent of deficiencies in income tax for the calendar year 1920 against W. Oscar Williams in the amount of $2,691.81, and in the case of Georgia Williams in the amount of $3,706.25. Both petitioners assign the same error, e.e., the failure of respondent to include as income for the year 1920 the fair market value of notes given in exchange for property instead of including in income the face value of the notes received.
16 B.T.A. 109">*110 FINDINGS OF FACT.
Petitioners are individuals residing at Perico, Tex. On November 25, 1919, petitioners and approximately 30 associates sold various oil leases and oil lands owned by them to C. N. Haskel of New York City for the sum of $3,200,000. The contract of sale provided that a Delaware corporation, as well as the Hobbs Oil Co., a Texas1929 BTA LEXIS 2645">*2646 common law trust, should be organized, the latter company to have title, operate and manage the oil leases and oil properties in question. Petitioners and the others were to receive in cash or its equivalent, payments from Haskell as follows:
$750,000 on December 15, 1919.
$750,000 on January 15, 1920.
$750,000 on February 15, 1920.
$750,000 on March 15, 1920.
$200,000 on April 15, 1920.
After the aforesaid contract of sale was entered into it developed that the property sold to Haskell was not as valuable as either party had considered it to be, due to the fact that oil production from the property suffered a marked decline.
On December 11, 1919, the parties entered into a supplemental contract whereby it was provided that a test should be made of the oil production from the properties which had formed the basis for the contract of November 25, 1919, and if the test showed a less average production over a period of 15 1/2 days than had obtained on November 25, 1919, the purchase price of the property would be ratably decreased. The test showed such a marked decline in oil production that the sellers felt it should not serve as a basis upon which the supplemental1929 BTA LEXIS 2645">*2647 sales price should be determined. Accordingly, in the early part of 1920, petitioners and associates determined what they felt, on the basis of the lessened oil production, Haskell should be required to pay. Both parties agreed upon a changed purchase price in the amount of $2,100,000.
By June, 1920, Haskell had paid $1,200,000 of the last mentioned sum, but was in arrears on payments then due. The oil production had still further decreased.
Petitioners and associates caused their agents to go to New York and endeavor to secure from Haskell the past due payments. The latter desired the sellers to retake the property which he had purchased. As a result of negotiations it was agreed on June 20, 1920, that the Hobbs Oil Co. should give to the vendors of the property seven promissory notes totaling $900,000 in full payment for the balance due. The notes bore interest and were secured by a deed of trust on all the property owned by the Hobbs Oil Co., which included 16 B.T.A. 109">*111 the property sold by petitioners and associates to Haskell. The notes, their due dates and dates of payment, were as follows:
| Note No. | Date due | Date paid | Face amount |
| 1 | July 20, 1920 | July 26, 1920 | $100,000 |
| 2 | August 20, 1920 | October 4, 1920 | 100,000 |
| 3 | September 20, 1920 | October 4, 1920 | 100,000 |
| 4 | October 20, 1920 | October 20, 1920 | 200,000 |
| 5 | November 20, 1920 | $150,000 was paid Nov. 20, 1920, and | 200,000 |
| remaining $ 50,000 paid Jan. 28, 1921. | |||
| 6 | December 20, 1920 | January 28, 1921 | 100,000 |
| 7 | December 20, 1920 | 3/4 of face amount paid in 1924 | 100,000 |
1929 BTA LEXIS 2645">*2648 The notes so given were negotiable, excepting note No. 7, which was nonnegotiable pending the outcome of a suit, known as The State of Oklahomav. The State of Texas, then pending in the United States Supreme Court, which questioned the title to certain oil lands located in or contiguous to the Red River. Note No. 7 was not valued by the respondent and does not enter into the controversy covered by these proceedings. It was compromised in the year 1924, when three-fourths of its face value was paid.
Stock had been issued and sold by the companies having title to the oil property and petitioners did not desire to take back the property which they had sold, for fear the parties who had bought the stock on the strength of such property might come back on them for the value of their stock. The Hobbs Oil Co. was a subsidiary of a Delaware corporation and it was thought advisable to hold the company intact.
The notes were also accepted, having as collateral a deed of trust, so that if the makers of the notes defaulted in payment the vendors could at least have returned to them their property. Oil was being extracted from the property at June 20, 1920, at the rate of 2701929 BTA LEXIS 2645">*2649 barrels per day and at December 31, 1920, was producing substantially the same amount. Oil-producing property was selling in the Wichita Falls territory, where the property in question was situated, at a price at $600 per barrel daily production. The remaining oil leases owned by the Hobbs Oil Co. were of a speculative value, most of them having been prospected for oil, dry holes having resulted. Banks in the Wichita Falls territory did not usually lend in excess of one-half of the purchase price prevailing for oil producing leases on a daily production basis.
Promissory notes received by the vendors were never offered for sale nor was an effort made to sell them.
In returning the transaction for income-tax purposes, the petitioners contended that the six negotiable notes should be valued at the fair market value at the date of receipt, and the respondent determined 16 B.T.A. 109">*112 that the six promissory notes were worth their face value at date of receipt for income-tax purposes. The interest of petitioners on December 31, 1920, in the unpaid notes on that date in the face amounts of $150,000 was $15,977.32.
OPINION.
MILLIKEN: We are concerned with the fair market value1929 BTA LEXIS 2645">*2650 of the six promissory notes given on June 20, 1920, in the face amounts of $800,000. There is no disagreement between the parties as to the extent of the gain once the fair market value of the notes is determined. Petitioners raise no question as to the amount of the gain or the taxability thereof as concerns the $650,000 actually paid and received by them in the year 1920. They complain that the amount of the notes remaining unpaid in the sum of $150,000 should not be valued at their face value at the date of receipt for tax purposes.
Counsel for petitioners strenuously contends that we should value the notes as of the date of receipt, i.e., June 20, 1920, unaffected by events transpiring subsequent thereto and within the year 1920.
When property is exchanged for other property, the property received in exchange shall, for the purpose of determining gain or loss, be treated as the equivalent of cash to the extent of its fair market value, if any. See section 202 of the Revenue Act of 1918. In this case petitioners received promissory notes and it is their fair market value that determines the extent of the gain realized. We think that gain should be ascertained as of the1929 BTA LEXIS 2645">*2651 date of the receipt of the notes. We think it could not be successfully contended that, if A purchased a building in the year 1920 for $1,000 and them immediately exchanged it for stock in a corporation having a fair market value at the date of the exchange of the $1,000, he has realized a taxable gain by reason of the exchange, and this is true even though during the remainder of the year 1920 and on December 31, 1920, the stock which he received may have increased in value so as to have a fair market value of $5,000, and, conversely, if the stock during the same period and at the end of the year had suffered a reduction in fair market value of $500, that he has suffered a deductible loss for taxation purposes. To attempt to fix and determine the fair market value of property received in exchange at other than the date of the exchange and receipt would inject into such calculations unrealized depreciation or appreciation. In reaching such a conclusion we do not mean to infer that events happening immediately after the exchange may not in a proper case play an important part incident to a valuation.
We therefore proceed to determine the fair market value of the six notes at June 20, 1920. 1929 BTA LEXIS 2645">*2652 Counsel for petitioners requests us to find a 16 B.T.A. 109">*113 fair market value which will not be in excess of $162,000. This figure is arrived at by taking the prevailing purchase price of oil production obtaining in the Wichita Falls territory of $600 per barrel and multiplying that sum by the daily production on June 20, 1920, of 270 barrels of oil. In contending for a valuation of only $162,000, he also objects to our giving consideration to the fact that prior to December 31, 1920, the sum of $650,000 was paid on the notes, or that on January 28, 1921, the entire face value of the notes had been paid.
The notes in question were the obligations of the Hobbs Oil Co. That company had title to various oil leases and oil lands which the petitioners and others had sold to C. N. Haskell, and it was a subsidiary of a Delaware corporation that also had large holdings in the State of Taxas. The property in question covered thousands of acres of land. We were not informed of the surplus, if any, which the Hobbs Oil Co. may have had on hand at the time the notes were given. The president of the company testified that its stock had been sold to a large number of persons, and one of the1929 BTA LEXIS 2645">*2653 reasons the notes were taken was because they did not want the holders of the stock to come back on them for the value of the stock, it having been sold on the strength of the large holdings here in question. Large sums, for all we know, may have been received by the Hobbs Oil Co. from the sale of its stock, or were reasonably expected to be received when the notes here in question were given. We can not agree that the oil production on the day the notes were given should be the sole and only factor entering into the determination of the fair market value of the notes.
It is a matter of common knowledge that purchasers of stock in an oil company may be perfectly willing to pay an amount for its stock out of all proportion to the immediate value of the asset, i.e., oil leases standing behind the stock. The purchasers may be incorrigible optimists and their optimism may cause the corporation to have in its treasury a sum of money having no reasonable proportion to the value of the assets. It seems unreasonable to us in the light of subsequent events that we should take into account the sole factor of the daily oil production and the price at which it could have been sold on June 20, 1920. 1929 BTA LEXIS 2645">*2654 Within 36 days after the notes were given one of the notes in the amount of $100,000 was paid to the vendors of the property. If the money with which to pay that note was ratably received over the 36-day period, it was received at the rate of $2,777 per day, and by dividing that sum by the daily oil production of 270 barrels, the oil must have sold for a sum in excess of $10 per barrel, even leaving out of consideration the cost of production. Or, if the income was ratably earned over the period June 20 to November 20, during which time $650,000 was paid, it was 16 B.T.A. 109">*114 received at the rate of over $4,248 per day, and by dividing that sum by the daily production of 270 barrels, the oil must have sold for a sum in excess of $15 per barrel, leaving out of consideration the cost of production. We know that such a price for crude oil did not obtain in the year 1920 in the Wichita Falls territory, for, according to the Survey of Mineral Resources of the United States published by the United States Geological Survey in 1921, the highest price at which crude oil was sold in Texas in 1920 was $3.50 per barrel. So we are reasonably certain that the money with which the notes were paid1929 BTA LEXIS 2645">*2655 was not received alone from the sale of the daily oil production. We have used the daily production of oil of 270 barrels because the president of the Hobbs Oil Co. testified the daily production at the close of the year 1920 was approximately the same as at June 20 and we were not advised of discoveries or increased production during the periods involved.
While we do not base our decision alone on the payment of $650,000 made on the notes during the year, we can not close our eyes to it when no explanation whatever is given as to how the money was received with which to make the payments that were made during the year. For all we know the money with which to make the payments that were made may have been in existence or in reasonable contemplation on June 20, 1920. We are satisfied, however, considering the circumstances under which the notes were given, that they may not have been worth their full face value when received by the petitioners. No doubt it might have been necessary to discount their face value in order to arrive at their fair market value. The petitioner asks us to determine the fair market value for all the notes to be $162,000 on June 20, 1920, and, as we1929 BTA LEXIS 2645">*2656 have heretofore explained, we are not satisfied that such sum represents the fair market value of the notes on the day they were given.
The petitioner, not having established the fair market value of the notes, we refuse to disturb the determination of the respondent.
Judgment will be entered for the respondent.