
    ELIZABETH SNEED POOL AND LEW J. HAILE, AS EXECUTORS AND TRUSTEES OF THE ESTATE OF JOSEPH T. SNEED, JR., DECEASED v. THE UNITED STATES
    [No. 214-52.
    Decided March 2, 1954]
    
      
      Mr. Arthur Glover for plaintiffs. Messrs. Russell c& Glover were on the brief.
    
      Mr. John A. Rees, with whom was Mr. Assistant Attorney General H. Brian Holland, for defendant. Messrs. Andrew D. Sharpe and Lee A. Jackson were on the brief.
   MaddeN, Judge,

delivered the opinion of the court:

The plaintiffs are the executors of the estate of Joseph T. Sneed, Jr., who died in October, 1940. At the time of his death he owned a one-half interest in a tract of 9,900.66 acres in Dallam County, Texas. The land was subject, at that time, to a mineral lease to the Pure Oil Company. The lease was dated March 23,1940, was for a primary term of 10 years, and called for a delay rental of $1 per acre per year. It reserved to the lessors a one-eighth royalty interest, which gave Joseph T. Sneed, Jr., a one-sixteenth royalty interest, since he was the owner of a one-half interest in the land.

The Government’s taxing authorities put a valuation of $5.00 per acre, upon the lessor’s mineral interest in the land, in assessing Mr. Sneed’s property for estate tax purposes. Mr. Sneed’s one-half was thus assessed at $2.50 per acre, or a total of $24,751.65. The basis for the valuation of the mineral interest was that the land was under lease to the Pure Oil Company and that a delay rental of $1 per acre per year was provided for in the lease. No mineral interest value whatever was attributed to some 7,000 acres of other land, apparently contiguous to the land here involved, in which other land the deceased also owned a one-half interest, the apparent reason for the distinction being that there was no mineral lease on the other land.

In 1944 the Pure Oil Company drilled in the extreme northeast corner of the land, which was rectangular in shape. At a depth of 6,779 feet, granite was encountered and the well was plugged. The Marland Oil Company had, in 1928, under a former lease, drilled a test well near the southern boundary of the tract, about midway between the east and west boundaries. This well was drilled to a depth of 3,500 feet and abandoned. On March 5, 1945, the Pure Oil Company by a written communication to the plaintiffs surrendered and canceled its mineral lease on the land.

The Commissioner of Internal Eevenue determined that the estate of Joseph T. Sneed, Jr., had a net income in 1945 of $76,997.76, of which $61,261.81 was taxable to the estate, the balance being taxable to certain distributees. The estate paid an income tax of $36,672.03 for the year. Later, but within the time stipulated in the law, the executors of the estate filed a claim for the refund of $18,591.54 of the tax that they had paid on behalf of the estate. The basis of the claim was that the estate was entitled to a deduction of $24,751.65 from its 1945 income, because in that year the estate’s mineral interest, which the Government had assessed for estate tax purposes at that figure, had been determined to be worthless and had been abandoned. The claim for refund was disallowed, and the plaintiffs brought this suit.

Section 23 (e) of the Internal Eevenue Code, provides that in computing the net income of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise may be deducted (1) if incurred in trade or business; or (2) if incurred in any transaction entered into for profit, though not connected with the trade or business.

Treasury Eegulations 111, promulgated under the Internal Eevenue Code, provide:

Sec. 29.23. (e)-l. Losses by Individuals. * * *
(b) In general losses for which an amount may be deducted from gross income must be evidenced by closed and completed transactions, fixed by identifiable events, bona fide and actually sustained during the taxable period for which allowed. Substance and not mere form will govern in determining deductible losses. Full consideration must be given to any salvage value and to any insurance or other compensation received in determining the amount of losses actually sustained. See section 113 (b). * * *
* * * * *
Sec. 29.162-1 [as amended by T. D. 5458, 1945 Cum. Bull. 45]. Income of Estates omd Trusts, (a) In ascertaining the tax liability of the estate of a deceased person or of a trust, there are deductible from the gross income, subject to exceptions, the same deductions which are allowed to individual taxpayers. * * *
$ ' $ $ $ $

Our question is whether the estate suffered a “closed and completed” loss of its mineral interest in the land during the year 1945. The Government urges that the mineral interest was still owned by the estate after the surrender by the Pure Oil Company of its lease, and indeed, more fully owned than before the surrender, since, after the surrender, the estate owned one-half the minerals in the land whereas before the surrender it owned only one-sixteenth.

The chance of finding oil or gas on the land was the only thing that gave value to the so-called mineral interest in the land. When that chance was reduced to zero value, the mineral interest was “lost,” within the meaning of Section 23 (e) and of the Eegulations. The chance was reduced to zero value by the action of the Pure Oil Company, which had paid some $50,000 in delay rentals for the privilege of taking oil from the land if it could find any there, in concluding that there was no prospect of finding any, and canceling its lease. The value, or absence of value, of the chance of striking oil on land is determined, for the landowner, by the judgment of the oil companies. It is economically impossible for the land owner to make his own exploration, and his judgment, as against that of the companies which are in the business of exploring for oil, would be unreliable. Hence, when those who are in the oil business have decided that there is no reasonable prospect of finding oil on the owner’s land, his mineral interest has, in fact, disappeared. The Government’s own expert valued the mineral interest in the non-leased adjoining land at zero in 1940, simply because that was the value which the oil companies had placed upon it, as shown by their not having leased it. We follow the admonition of the Kegulations, “Substance and not mere form will govern in determining deductible losses.”

The Government suggests that the two test wells, the 1928 one on the southern border of the tract and the 1944 one in the northeast corner, were not adequate tests on which to base a decision that there is no oil in the tract. But we do not decide that there was no oil in the tract. All that we decide is that those whose judgment determines whether a mineral interest in the tract is of value decided that it was of no value. That decision made the mineral interest worthless so far as the owner was concerned. See United States v. S. S. White Dental Mfg. Co., 274 U. S. 398.

The Government urges that the mineral interest was merely a part of the total ownership of the land and that, therefore, so long as the land itself had value, there was no “closed and completed” loss, but merely a diminution in the total value of the land. This is a troublesome question. It is doubtless true that if the value of one’s land was increased by the fact that oil companies had leased the surrounding land, but he had not leased his land, because, for example, he demanded a more favorable royalty than prospective lessees were willing to give him, and then when the surrounding land was tested it was found that there was no oil in the neighborhood, and his land dropped back to its former value, he could not claim a deductible loss. But when, as in the case before us, the mineral interest in the land had been transferred by lease, reserving a royalty tó the owner, we think that the custom in oil-producing areas is to regard the mineral interest as a separate thing from the rest of the ownership of the land. The various states in which oil is found differ in their analyses of the legal interests which arise out of oil leases. Texas has, perhaps, gone as far as any state in recognizing mineral interests as susceptible of ownership and transfer separate from other interests in the land. See Lemar v. Garner, 121 Tex. 502, 50 S. W. 2d 769. The fact that, in assessing the assets of the estate of Mr. Sneed for estate tax purposes, the Government separately valued and listed the mineral interest in the land proves something as to how the interest was regarded.

The Treasury Department issued General Counsel’s Memorandum 3890 (1953 Prentice-Hall Tax Service PP 13494) which seems to say directly that a lessor’s royalty interest in an oil lease is a separate item of property which becomes worthless when it is found that there is no oil in the property, and is then a proper subject of a deductible loss.

The plaintiffs are entitled to recover $18,591.54, with interest as provided by law.

It is so ordered.

Whitaker, Judge/ LittletoN, Judge; and JoNes, Chief Judge, concur.

FINDINGS OF FACT

The court, having considered the evidence, the report of Commissioner Wilson Cowen, and the briefs and argument of counsel, makes findings of fact as follows:

1. Plaintiffs reside in Texas; they are the duly authorized and acting executors and trustees of the Estate of Joseph T. Sneed, Jr., deceased, and they maintain an office with a principal place of business for such estate at Amarillo, Texas.

2. Joseph T. Sneed, Jr., died on October 15, 1940. At the date of his death he owned a one-half interest in the surface estate and a one-half interest in the mineral estate on and under 9,900.66 acres of land located in Dallam County, Texas. This property was subject to a mineral lease owned by The Pure Oil Company.

3. At the date of his death Joseph T. Sneed, Jr., owned one-half of the one-eighth royalty provided in the mineral lease held by The Pure Oil Company. The royalty interest of Joseph T. Sneed, Jr., was equal to one-sixteenth of the oil, gas, and other minerals lying in, on, or under the said land. The seven-eighths working interest in the said minerals was owned by The Pure Oil Company.

4. The Commissioner of Internal Eevenue made an audit of the Estate Tax Eeturn filed by the Estate of Joseph T. Sneed, Jr., deceased. Concerning the valuation proposed and finally used on the mineral estate in question, the Commissioner made the following findings:

The nonproducing properties located in Dallam County, Texas, consist of 17,458.26 acres, 9900.66 acres of which are leased to the Pure Oil Company at $1.00 per acre per annum. The undersigned engineer recommends a fair market value based on $5.00 per acre for the acreage under lease. Taxpayer’s interest is one-half. The acreage not under lease has small speculative value at the present time. Accordingly, it is recommended that the minerals under the residue be valued with the land.

On the basis of the findings made by the Commissioner, the mineral interest of Joseph T. Sneed, Jr., at the time of his death in the 9,900.66 acres of land leased to The Pure Oil Company was valued at $24,751.65, and this value was used for Federal Estate Tax purposes.

5. A map of the lands covered by the oil and gas lease held by The Pure Oil Company appears in Defendant’s Exhibit 2 and is made a part hereof. Such leased premises were roughly rectangular in shape with a length more than twice the width.

During the period between December 24, 1926 and April 15,1928, which was prior to the date the lease to The Pure Oil Company was executed, the Marland Oil Company had drilled a test well on Section 36, which was located near the southern border and at approximately the center of the premises covered by the lease to The Pure Oil Company. This well was drilled to a depth of 3,500 feet and abandoned as a dry hole.

During the year 1944, The Pure Oil Company drilled a test well on Section 13, which well was located in the extreme northeast corner of the leased premises. The well was drilled to a depth of 6,779 feet, at which depth granite was encountered and the well was plugged on August 15, 1944.

6. On March 5, 1945, The Pure Oil Company wrote the plaintiffs as follows:

We advise you that we have surrendered and cancelled the oil and gas leases which we held on your lands in Dallam County, Texas, described as:
9900.36 acres in Secs. 7 to 20 inc., and Secs. 35, 36, 37, 38 Block 18, Capitol Syndicate subdivision and 320 acres, being Sy2 of Sec. 36, Blk. 18, Capitol Syndicate subdivision
A release of lease has been filed with the County Clerk of Dallam County and is of record in Book 103 page 567.

7. For the year 1945, the Commissioner of Internal Kev-enue finally determined the net income of the Estate of Joseph T. Sneed, Jr. amounted to $76,997.56, which amount was distributed as follows:

Mrs. Brad Love Sneed_$15,000.00
Betty Love Sneed_ 735. 75
Estate of Joseph T. Sneed, Jr_ 61,261.81
Total___$76,997.56

The tax assessed to the Estate of Joseph T. Sneed, Jr. and paid by said estate on said $61,261.81 amounted to $36,672.03. The stated tax was paid as follows:

March 15, 1946_$11,092.52
June 6,1946_ 11,092.52
September 9, 1946_ 11,092.51
December 11,1946_ 3,134.10
October 21, 1948_ 260.38
Total Tax_$36,672. 03
October 21, 1948, Interest_ 28.66
Total_$36,700.69

8. For the calendar year 1945, the plaintiffs, in filing the return for the Estate of Joseph T. Sneed, Jr., did not claim and the Commissioner of Internal Revenue in making his determination did not allow as a deduction, in computing the income of the estate, any loss because of worthlessness of said mineral properties or any loss because of said lease forfeiture.

9. Plaintiffs timely filed a formal claim for refund on behalf of the Estate of Joseph T. Sneed, Jr., deceased, praying for a refund of tax and interest paid on behalf of the estate for the calendar year 1945, in the amount of $18,591.54, or such other amount as legally might be refundable. Said claim set forth as grounds that the income of the Estate of Joseph T. Sneed, Jr. should be adjusted by deducting from the amount thereof as determined by the Commissioner of Internal Revenue the sum of $24,751.85 representing a loss sustained by the estate when the mineral estate heretofore described was shown to have been worthless and was abandoned by the lessee thereof in the year 1945.

10. Plaintiffs’ claim for refund was disallowed in its entirety by defendant and plaintiffs were so notified by defendant by registered letter dated June 22,1950.

CONCLUSION OF LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes that as a matter of law the plaintiffs are entitled to recover, and it is therefore adjudged and ordered that they recover of and from the United States eighteen thousand five hundred ninety-one dollars and fifty-four cents ($18,591.54), together with interest thereon as provided by law.  