Opinion
Docket No. 36059.
1953-06-30
THOMAS W. BLAKE, JR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
William O. Taylor, Esq., Cecil N. Cook, Esq., and Frank J. Knapp, Esq., for the petitioner. F. S. Gettle, Esq., for the respondent.
1. GROSS INCOME— COMPENSATION FOR SERVICES OTHER THAN CASH— YEAR TAXABLE.—A client conveyed an interest in real property in 1937 to an attorney for services rendered and for services to be rendered; a cloud on the title to the property was removed in 1944. Held, the reasonable value of the property not includible in gross income in 1944.
2. SEPARATE INCOME FROM SEPARATE PROPERTY— COMMUNITY PROPERTY— YEAR TAXABLE.— Held, under state law payment received from the sale of oil and gas from the separate property of petitioner was his separate income; held, further, that for the petitioner, on a cash basis, the income is reportable in the year received.
3. DEPLETION.— Held, that petitioner had an economic interest in oil and gas producing property and that he was entitled to a depletion deduction.
4. DEPRECIATION.— Petitioner failed to show an economic loss in certain equipment. Held, petitioner not entitled to a depreciable deduction. William O. Taylor, Esq., Cecil N. Cook, Esq., and Frank J. Knapp, Esq., for the petitioner. F. S. Gettle, Esq., for the respondent.
Respondent determined deficiencies in income tax as follows:
+--------------------+ ¦Year ¦Deficiency ¦ +------+-------------¦ ¦1944 ¦$87,084.26 ¦ +------+-------------¦ ¦1945 ¦441.46 ¦ +------+-------------¦ ¦1946 ¦312.74 ¦ +------+-------------¦ ¦1947 ¦285.19 ¦ +--------------------+
The following issues are presented:
1. When did petitioner receive compensation for legal services performed for Clara May Downey, was it in 1937, as alleged by petitioner, or in 1944, as determined by respondent?
2. If petitioner received the compensation in 1944, is only one-half of it taxable to him under the community property laws of Texas?
3. Is the sum of $85,719.38, received as the result of sale of oil and gas, community income?
4. If the sum of $85,719.38 is community income, what part is includible in petitioner's gross income in 1944?
5. Is petitioner entitled to a depletion deduction for 1944?
6. Is petitioner entitled to a deduction for depreciation on oil well equipment for the years 1944, 1945, 1946, and 1947?
Other adjustments in the deficiency notice are not contested by the petitioner.
FINDINGS OF FACT.
Some of the facts are stipulated and are so found.
Petitioner, Thomas W. Blake Jr., was a resident of Houston, Texas, and his income tax returns were filed with the collector of internal revenue for the first district of Texas. Petitioner was unmarried prior to September 12, 1942, and on that date he was married to Harriette Truman and has continued to be married to her at all times material to this proceeding.
Petitioner received his law degree in February 1934, and thereafter he engaged in the general practice of law in Houston, specializing in oil and gas matters.
Before February 8, 1929, Clara May Downey acquired by inheritance an undivided one-half interest in a tract of land comprising approximately 76 acres. On or about February 8, 1929, Clara May Downey, who was then a married woman, and her mother executed a deed (hereinafter called the 1929 deed), which purported to convey the 76-acre tract to her mother's niece, Grace Keller. On or about April 28, 1934, Grace Keller and her husband executed and delivered a lease to the Humble Oil & Refining Company (hereinafter referred to as Humble), which purported to convey the oil, gas, and other minerals in and under the 76-acre tract to Humble.
While representing a Texas client in 1937, petitioner went to Florida in an effort to buy certain land from Clara May Downey. She then employed petitioner to investigate and examine other titles which she held. After investigating the title to the 76-acre tract and its subsequent conveyance, petitioner informed Clara May Downey that if the facts attendant upon her execution of the 1929 deed were as represented by her, then in his opinion the 1929 deed was void as to her and did not divest her of title to an undivided one-half interest in the property. Further, it was his opinion that she then had legal title to such interest and that the Keller-Humble lease conveyed only an undivided one-half interest in the property (interest of Clara May Downey's mother).
Petitioner and Clara May Downey discussed the problem of what fee should be paid for the work already completed and for the future work contemplated. The results of this discussion are set forth below:
SEPTEMBER 27, 1937.
Mr. THOMAS W. BLAKE, JR.
Attorney at Law
Second National Bank Bldg.
Houston, Texas.
DEAR MR. BLAKE:
Re: Grace Keller 76.52 acre tract * * * .
I, Clara May Downey, do hereby appoint Thomas W. Blake, Jr., an attorney at law in Houston, Texas, as my agent and attorney for me to recover all my right, title and interest in the tract of land described in the caption hereof, and do hereby fully authorize said attorney to recover said interest for me, and to file suit for the recovery of such interest if he deems such action advisable and to settle, compromise, and enforce my claims and title therein. It is understood and agreed that no settlement or compromise will be undertaken until Mr. Blake has consulted with me in advance and we have mutually agreed upon such settlement or compromise, or upon any other action to be taken therein. In consideration for the services heretofore performed and to be performed by Mr. Blake as my said attorney, I hereby bargain, sell and convey into Mr. Blake an undivided one-fourth (1/4th) part of all my right, title and interest in said tract of land, and in all the settlements, benefits and proceeds arising therefrom, it being understood that this one-fourth (1/4th) interest shall be the only fee to be paid for the services rendered herein. Mr. Blake as attorney, agrees to handle this matter promptly and efficiently and to file suit if we consider such action necessary and to handle all matters relative to the settlement of this title and the preparation of any instruments, trust agreements, or papers of any nature that may be drawn in connection therewith.
This letter is signed by Clara May Downey and Thomas W. Blake, Jr., as her attorney in agreement thereto.
Very truly yours,
(Sgd.) Clara May Downey CLARA MAY DOWNEY (Sgd.) Those. W. Blake, Jr. THOMAS W. BLAKE, JR.
This instrument will be referred to as the 1937 agreement. It was delivered to petitioner by Clara May Downey, but it was not acknowledged, nor was it recorded. Clara May Downey was not a married woman on September 27, 1937.
Neither Grace Keller nor Humble would willingly remove the cloud on Clara May Downey's title. In October 1937 petitioner filed suit in a district court in Texas in which Clara May Downey was named plaintiff and Grace Keller and Humble were named defendants. The nature of the suit was trespass to try title, a statutory form of action for determining title to land situated in Texas. The relief sought by Clara May Downey was the adjudication of ownership, as between her and the defendants, as of an undivided one-half interest in the 76-acre tract.
Petitioner did not want the 1937 agreement recorded because he was Clara May Downey's attorney. If the instrument were recorded, petitioner thought Humble would interplead him in the suit. He felt that his participation as a litigant and attorney would adversely affect Clara May Downey's case before a jury. At no time did Humble join the petitioner in any suit brought by Clara May Downey against Grace Keller and Humble.
Petitioner conducted this trial for Clara May Downey and a judgment in her favor was entered by the trial court on February 12, 1940. The court ‘ordered, adjudged and decreed that the plaintiff, Clara May Downey, is the owner of and shall and does hereby recover of the defendants Grace Keller and husband, Herman T. Keller, Jr., and Humble Oil & Refining Company, a corporation, the title in fee simple and possession of the lands and premises, ‘ known as the 76-acre tract. The court also found that the 1929 deed did not take effect and was void.
The Court of Civil Appeals and the Supreme Court of Texas affirmed the trial court's decision. The mandate of the Supreme Court of Texas was filed December 14, 1944.
At the time the suit was filed the 76-acre tract had some prospective value for oil production, but it was not proven oil land. There were producing wells approximately 6,700 feet west of the tract and a dry hole 6,500 feet southwest of the tract. However, in the early part of 1939, oil development in the area indicated the tract might be productive. On February 29, (sic) 1939, while the litigation was still in process, Clara May Downey and Humble entered into an agreement (hereinafter referred to as the operation agreement) for the development of the tract; petitioner signed this agreement as attorney for the plaintiff, Clara May Downey. This agreement in part is as follows:
In the event Plaintiff shall recover against Humble in said lawsuit title to an undivided interest in the land above described free and clear of the leasehold rights owned by Humble in and to said land and only in such event, Plaintiff, her heirs or assigns, shall be entitled to a similar undivided interest in and to any well or wells drilled by Humble hereunder and in and to all oil and gas theretofore and thereafter produced therefrom, subject to Humble's right of reimbursement out of seven-eighths (7/8ths) of such oil and gas as hereinabove provided. Humble shall continue to operate such well or wells drilled by it hereunder and shall have the right to reimburse itself out of the proceeds obtained at the well or wells from said seven-eighths (7/8ths) of the oil and gas produced and saved from said wells, the actual cost and expense of producing, saving and handling such oil and gas produced therefrom.
During 1939 Humble drilled three wells on the tract; all produced oil and gas in commercial quantities.
In 1943, while petitioner was in the Army Air Force, it appeared that he might be sent overseas. On June 28, 1943, upon petitioner's request, Clara May Downey executed a ‘Confirmation Deed.‘ This is in part as follows:
WHEREAS, it is the desire of the parties that said conveyance of September 27, 1937, shall be hereby confirmed in this instrument and placed in recordable form, in order that public record may be made of said conveyance and the passage of title;
NOW, THEREFORE, I, CLARA MAY DOWNEY, a feme sole, in consideration of the premises, and for valuable and sufficient considerations from the separate estate of Thomas W. Blake, Jr., hereby acknowledged, and for the purpose of confirming the above referred to conveyance of September 27, 1937, have BARGAINED, GRANTED, SOLD and CONVEYED, and do hereby BARGAIN, GRANT, SELL and CONVEY to the said THOMAS W. BLAKE, JR., as his separate estate, his heirs and assigns, the following described property situated in Harris County, Texas, * * * :
Pending the litigation in said cause which affected the title to the above described property, there has been produced certain oil, gas and other minerals from said property, which have been held by the Humble Oil & Refining Company, or their representatives, in accordance with an agreement entered into between Clara May Downey (thru Thomas W. Blake, Jr.) and the Humble Oil & Refining Company, dated on or about February 10, 1939, pending the appeal in said suit, and it is hereby affirmed and acknowledged that the said Thomas W. Blake, Jr. is the owner, by virtue of said conveyance of September 27, 1937, of an undivided one-fourth (1/4) of the rights, titles and benefits accruing to Clara May Downey under the terms of said agreement, in such manner that Clara May Downey shall own three-fourths (3/4) of the interest accruing thereunder, and said Thomas W. Blake, Jr., shall own one-fourth (1/4) of the interest accruing thereunder, including the interest in the wells, property and equipment situated on said land, and the production, royalties and proceeds from the sale thereof heretofore produced, saved or sold therefrom, as his separate estate.
When the litigation (Downey v. Keller, et al.) was terminated by the Supreme Court of Texas in December 1944, Humble delivered to petitioner its check for $85,719.38. This payment was made in 1944, and it represented the proceeds from oil and gas sales allocable to the petitioner's one-eighth interest, less his one-eighth part of the cost of drilling, developing, and operation of the 76-acre tract. This payment was made pursuant to a regular division order executed in identical counterparts by petitioner and Clara May Downey. This division order showed that petitioner owned one-fourth of one-half of the production and Clara May Downey owned three-fourths of one-half.
A division order is a document in common usage in the oil industry. It is customarily prepared by the prospective purchaser of oil or gas produced from a particular tract of land after appropriate investigation has been made of the title to the tract. Among other things, it purports to show the interested parties in the oil and gas produced from the tract and the amount of their respective interests in the oil and gas, and includes covenants of warranty by such interest holders as to their ownership. Ordinarily, the purchaser of oil or gas from a tract will not make payment therefor until a division order has been executed by each party interested in the oil and gas produced from the tract.
At approximately the same time that Humble paid petitioner it also paid Clara May Downey a sum consonant with her ownership of an undivided three-eighths interest in the tract.
Petitioner and his wife filed separate income tax returns on a community property basis for the taxable year 1944. Petitioner filed his return on the cash receipts and disbursements basis. Each of their returns included an amount of $30,346.91 which was computed as follows:
+-------------------------------------------------------------------------+ ¦Cash payment received from Humble ¦ ¦$85,719.38¦ +--------------------------------------------------------------+----------¦ ¦Add: Cost of depreciable equipment deducted in computing above¦ ¦ +--------------------------------------------------------------+----------¦ ¦figure ¦ ¦3,363.25 ¦ +-----------------------------------------------+--------------+----------¦ ¦ ¦ ¦$89,082.63¦ +-----------------------------------------------+--------------+----------¦ ¦Deduct: (1) Depletion ¦$27,427.86 ¦ ¦ +-----------------------------------------------+--------------+----------¦ ¦(2) Depreciation ¦960.94 ¦28,388.80 ¦ +-----------------------------------------------+--------------+----------¦ ¦ ¦---------- ¦----------¦ +-----------------------------------------------+--------------+----------¦ ¦ ¦ ¦$60,693.83¦ +-----------------------------------------------+--------------+----------¦ ¦1/2 ¦ ¦$30,346.91¦ +-------------------------------------------------------------------------+
So far as the petitioner could recollect, he never reported in his income tax returns any income which represented the reasonable value of the 76-acre tract.
After December 14, 1944, the date on which the Supreme Court of Texas denied a rehearing in the suit by Clara May Downey against Grace Keller and Humble, the petitioner was faced with a possible suit by Humble and another individual on the grounds that petitioner had not been made a party to the suit. Such suit never materialized. There were numerous other claims and attacks on the title to the 76-acre tract but all were disposed of without alteration or change in petitioner's title.
Respondent's statement in the deficiency notice is as follows:
It is held that you acquired your interest in the Keller tract as your separate property in December 1944, at which time your interest had a fair market value of $224,778.00, which amount therefore has been included herein in your separate income for the year 1944.
It is further held that the amount $85,719.38 distributed to you in December 1944 by Humble Oil & Refining Company arose out of a contractual right having its inception in the year 1937 prior to your marriage, and such amount therefore is held to be your separate income for the year 1944.
It is further held that the amount $85,719.38 was received as a cash fee and not as production proceeds from a mineral interest theretofore owned by you, and therefore no depletion is allowable in respect of said amount.
It is further held that the above amounts of $224,778.00 and $85,719.38 were received by you as compensation for personal services covering a period of thirty-six calendar months or more from the beginning to the completion of such services, and therefore the tax attributable to such amounts has been computed herein under the provisions of section 107(a) of the Internal Revenue Code.
Title to an undivided one-fourth of one-half interest in the 76-acre tract was conveyed to petitioner by Clara May Downey on September 27, 1937. This interest in the property was conveyed to petitioner as compensation for work done for Clara May Downey prior to September 27, 1937, and for certain work done in the future.
The sum of $85,719.38, which was paid petitioner by Humble for his share of the oil and gas produced from the tract, was separate income. As separate income, this sum was taxable entirely to petitioner.
Petitioner has an economic interest in the oil and gas deposits in and on the 76-acre tract, and the sum of $27,427.86 is the allowable deduction for depletion for the year 1944.
OPINION.
Issue 1.
JOHNSON, Judge:
The first issue is, when did petitioner receive compensation for legal services performed and to be performed? Was it in 1937 or in 1944? The compensation in question is the reasonable value of the undivided one-fourth of a one-half interest in a 76-acre tract. Petitioner contends that he received his compensation in 1937. He maintains that he received title to his interest in this property when the 1937 agreement was executed and delivered by Clara May Downey, or, in the alternative, in 1943, when the ‘Confirmation Deed‘ was executed and delivered. In opposition, respondent contends that petitioner received his compensation in 1944. Respondent argues that the 1937 agreement conveyed no present interest to the petitioner, and, further, petitioner's interest in the land came into being when Clara May Downey's title was finally cleared by the Supreme Court of Texas in 1944, and then only in consideration of petitioner's performance of his prior agreement.
Reduced to its simplest terms, the question is, when was title to a one-eighth interest in the 76-acre tract conveyed to petitioner? Because of the well established rule that all real property is exclusively subject to the laws of the country within which it is situated, Conflict of Laws, 11 Am.Jur. 328, and the many cases cited therein, we must look to the laws of Texas to resolve the question as to when title passed. The Texas statutes, Vernon's Annotated Revised Civil Statutes, provide:
Article 1288. Instrument of conveyance.
No estate of inheritance or freehold, or for a term of more than one year, in lands and tenements, shall be conveyed from one to another, unless the conveyance be declared by an instrument in writing, subscribed and delivered by the party disposing of the same, or by his agent thereunto authorized by writing. Act Feb. 5, 1840; P.D. 671; G.L. vol. 2, p. 327.
Article 1294. Must be witnesses or acknowledged.
Every deed or conveyance of real estate must be signed and acknowledged by the grantor in the presence of at least two credible subscribing witnesses thereto; or must be duly acknowledged before some officer authorized to take acknowledgments, and properly certified to by him for registration. R.S. 1879, 554.
Article 1292 gives an example of a form which shall be sufficient as a conveyance of the fee simple of any real estate. While the firm of the 1937 agreement is not in the recognized form of a deed, with the exception of witnesses' signatures and the acknowledgment the 1937 agreement complies with the Texas statutes for the conveyance of property. In the agreement there are words of immediate grant, the parties are named, there is a description of the land, in writing, subscribed and delivered by Clara May Downey to petitioner. The courts of Texas have recognized the rule that an acknowledgment and the signature of witnesses are only required for purposes of notice and registration. And further, an instrument such as we have here, without an acknowledgment or the signature of witnesses, is binding between the parties thereto when it is executed by the grantor. Clapp v. Engledow, 18 S.W. 146, 82 Tex. 290; Mondragon v. Mondragon, 257 S.W. 215, 113 Tex. 404; Hughes v. Sloan, 62 S.W.2d 194.
Respondent cites such cases as Browne v. King, 235 S.W. 522; Sutton v. Commissioner, 95 F.2d 845, affirming 35 B.T.A. 348; Magee v. Young, 198 S.W.2d 883, 145 Tex. 485, in support of his contentions that an instrument such as we have here does not convey a present interest in the property. None of the cited cases control the present situation.
An examination of the 1937 agreement shows that Clara May Downey expressly conveyed an interest to petitioner. While at the time of her conveyance there was a cloud on her title, she, nevertheless, could convey any interest she had in the 76-acre tract. The removal of the cloud on her title by the Texas Supreme Court in 1944 did not then create a new interest, or did not then vest a title in her or the petitioner. The most that could be said for the effect of the court's action was that the cloud on the titles previously acquired was removed. It is proper for us to conclude that the 1937 agreement was binding between the parties, and that by it title to the one-eighth interest in the 76-acre tract was conveyed to petitioner in 1937.
Our present decision is in conformity with a similar case, Broadway v. Stone, 15 S.W.2d 230. There, the court was called upon to interpret the legal effect of an instrument consisting of a power of attorney and a conveyance of a portion of the client's interest in the land to the attorney. The instrument provided that the attorney was to recover certain interests for the clients and in consideration for his work the clients ‘hereby granted‘ an interest in the property in dispute. The court held that a present interest was conveyed by the instrument.
In arriving at our conclusion we have given careful consideration to respondent's contentions. Certain of these arguments are worthy of mention, namely, it is contended that no present interest was conveyed by the 1937 agreement, the contract between petitioner and Clara May Downey was not a closed transaction inasmuch as petitioner was required to work in the future, and all transactions and litigation were carried on in Clara May Downey's name.
With regard to the first, the language in the instrument is unequivocal. It states:
I hereby bargain, sell and convey unto Mr. Blake an undivided one-fourth (1/4th) part of all my right, title and interest in said tract of land, and * * * (is) the only fee to be paid for the services rendered herein. * * *
These are not words conveying a future interest. There is no condition which must be met prior to the passage of title. There is no evidence indicating an intent of the parties contrary to the express language in the agreement, nor is there an ambiguity which calls for a construction or interpretation of the agreement. The agreement must speak for itself, and it speaks as a conveyance of a present interest to petitioner.
We must agree with the respondent that the agreement requires the petitioner to perform services in the future. We do not consider this agreement to render future services a condition precedent or subsequent. However, if there were a condition then we must apply the rule established in Manton v. City of San Antonio, 207 S.W. 951. There, the court held, where consideration had already been paid, that the condition in a contract will be treated as a condition subsequent. In our case petitioner had already performed some work. This was consideration already paid, and any condition would therefore be a condition subsequent. Even with a condition subsequent, title would have passed in 1937.
Finally, respondent attaches a stigma to the fact that petitioner did not use his name in the suit filed against Grace Keller and Humble. Petitioner's answer to this was that he was fearful of being made a party to the proceeding because it might create an unfavorable impression upon a jury. We think that the petitioner adequately explained his position in this respect.
Now that we have determined when title passed to petitioner, this passage of title must be reduced to terms of compensation, section 22, Internal Revenue Code, to ascertain the year the receipt of this title is taxable income to petitioner. Respondent's contention that petitioner's 1944 gross income is to be increased by the value of his interest in the tract, determined as of December 14, 1944, cannot be sustained. This contention is bottomed on the erroneous theory that the 1937 agreement conveyed no present interest to the petitioner.
By the terms of the 1937 agreement the conveyance of a one-eighth interest to petitioner was the ‘only fee to be paid for the services rendered herein. ‘ Petitioner received his interest in the property in 1937. Thus, he received the compensation for his services in 1937. Section 42 provides: ‘The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer.‘ This means, in general, that a cash basis taxpayer reports income in the year it is received; an accrual basis taxpayer reports income when his right to receive it arises. Spring City Foundry Co. v. Commissioner, 292 U.S. 182. Since petitioner's right to the income arose in 1937, and since he received it in that year, either on a cash basis or an accrual basis, the reasonable value of the property should not have been included in gross income in 1944.
Issue 2.
Our conclusion in the first issue that the petitioner received his compensation from Clara May Downey in 1937 precludes any need for discussion of the second issue.
Issues 3 and 4.
Issue 3 involves the question whether the cash payment ($85,719.38) received by petitioner in 1944 was separate income or community income to petitioner and his wife. Issue 4 requires us to determine whether this cash payment should be prorated, not only over the years but also between petitioner and his wife. Petitioner and his wife each reported half of this sum, less deductions, on their 1944 returns. Respondent contends that the cash payment received from the sale of oil and gas was entirely taxable to petitioner as his separate income.
Questions as to the interest in community income are controlled by state law. Poe v. Seaborn, 282 U.S. 101; Hopkins v. Bacon, 282 U.S. 122. Under Texas law the fact that a taxpayer's separate property produced the income, such as rents, does not make the income his separate property under Texas law. See Commissioner v. Terry, 69 F.2d 969, affirming 26 B.T.A. 1418. However, royalties paid for the removal of oil and gas from separate land of either spouse are ‘increases of lands‘ and constitute separate income. Commissioner v. Wilson, 76 F.2d 766, reversing a Memorandum Opinion of the Board of Tax Appeals; Welder v. Commissioner, 148 F.2d 583, affirming a Memorandum Opinion of this Court; Dolores Crabb, 41 B.T.A. 686, affd. this issue 119 F.2d 772; remanded, 47 B.T.A. 916, affd. 136 F.2d 501. This rule arises from the Texas doctrine that oil and gas in place are a part of the realty and capable of separate ownership, and accordingly that royalties represent the proceeds of a sale of property rather than the rents and services therefrom. See Mertens Law of Federal Income Taxation, volume 3, section 19.16, page 34.
The respondent must be sustained in that the $85,719.38 was taxable as the separate income of the petitioner and is not community income of petitioner and his wife.
Since the petitioner is on a cash basis and since he received the income in 1944, the $85,719.38 is includible in his gross income in 1944. There is no reason to prorate it over the years prior to 1944.
Issue 5.
Next, is petitioner entitled to a depletion deduction based on his interest in the 76-acre tract? Section 23(m) of the Code provides that under the rules and regulations of the Commissioner a reasonable allowance for depletion of oil and gas wells may be deducted from gross income. The owner of an economic interest in mineral deposits is allowed annual depletion deductions. Regulations 111, section 29.23(m)-1.
It is settled that the same basic issue determines both to whom income derived from the production of oil and gas is taxable and to whom a deduction for depletion is allowable. Anderson v. Helvering, 310 U.S. 404. We have already determined that petitioner is the owner of an undivided one-eighth interest in the 76-acre tract, and the proceeds from the sale of his proportionate share of the gas and oil are taxable to him as separate income. Petitioner, as the owner in fee simple of an undivided interest in oil and gas producing property, has an economic interest in such property. He is entitled to a deduction for depletion based upon his interest in the property. Anderson v. Helvering, supra; also, see Burnet v. Harmel, 287 U.S. 103; Commissioner v. Happold, 141 F.2d 199, affirming a Memorandum Opinion of this Court, entered December 1, 1942. The parties have stipulated that $27,427.86 is the allowable deduction for depletion; therefore, the cash payment received by petitioner from Humble in December 1944 shall be reduced by this sum when determining his taxable income.
Issue 6.
Is petitioner entitled to a deduction for depreciation of oil well equipment for the years 1944, 1945, 1946 and 1947? Section 23(l), Internal Revenue Code, provides that a reasonable allowance may be deducted in computing net income for exhaustion, wear, and tear of property used in the trade or business, or property held for the production of income. Petitioner claims, under the terms of the operating agreement between Clara May Downey and Humble, that he owned a one-eighth interest in the depreciable equipment used on the 76-acre tract. Respondent contends that petitioner has failed to show that the equipment had a value separate and apart from the land, or that the equipment had a basis, or the length of the useful life.
In computing petitioner's one-eighth interest in the proceeds from the sale of oil and gas for the December 1944 cash payment, Humble charged petitioner $3,363.25 for depreciable equipment. Petitioner in 1944 reported this $3,363.25 as an addition to the $85,719.38 and then reduced the resulting aggregate income by a depreciation deduction of $960.94. Petitioner and respondent have stipulated the following:
If Petitioner is entitled to a deduction for depreciation of equipment used in connection with operation of the 76.52-acre tract for production of oil and gas, the amount of the deduction to which he is so entitled for each year involved in this proceeding will be determined by the parties under Rule 50.
The evidence on this issue is limited to the stipulations that Humble reduced petitioner's cash payment by $3,363.25 for ‘depreciable equipment,‘ and that petitioner in turn reported this sum as income. Neither party has proved petitioner's ownership or the lack of ownership in that equipment. However, ownership is not a prerequisite to the right to a depreciation deduction. See Helvering v. F. & R. Lazarus & Co., 308 U.S. 252. The test is whether petitioner would suffer an economic loss as the result of a decrease in value of the property due to depreciation. Weiss v. Wiener, 279 U.S. 333; Atlantic Coast Line Railroad Co., 31 B.T.A. 730 affd. 81 F.2d 309. Petitioner has not qualified under this test. He has not shown that he has or that he will suffer an economic loss on the equipment in question. Therefore, on this issue the respondent must be sustained.
Decision will be entered under Rule 50.