AT Jergins Trust v. COMMISSIONER OF INTERNAL REVENUE

• Decision Date: 05 March 1931
• Docket Number: Docket No. 29940.
• Citation: 22 BTA 551
• Parties: A. T. JERGINS TRUST, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Board of Tax Appeals

22 B.T.A. 551 (1931)

A. T. JERGINS TRUST, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 29940.

Board of Tax Appeals.

Promulgated March 5, 1931.

Thomas R. Dempsey, Esq., and A. Calder Mackay, Esq., for the petitioner.

Mason B. Leming, Esq., and C. A. Ray, Esq., for the respondent.

Respondent has determined deficiencies in income and profits taxes against petitioner for the years 1922, 1923, and 1924, in the respective amounts of $1,126.62, $3,368.92, and $61,458.34. It is alleged (1) that respondent erred in determining that the income of petitioner derived from the land owned by the city of Long Beach, Calif., constituted taxable income, and in refusing to hold that such income was exempt from Federal tax; (2) that he erred in denying to petitioner a loss in 1924 on account of the abandonment of one of its wells; (3) that he erred in denying petitioner the right to deduct from gross income expenditures made by it for labor, fuel, supplies, repairs, and kindred items in drilling and operating its wells; (4) that he erred in determining that petitioner made, in 1922, a binding election to capitalize such expenditures; and (5) that he erred in treating such expenditures as chargeable to capital account and returnable through depreciation. At the hearing petitioner abandoned contentions (3) and (4) and respondent amended his answer and claimed an additional deficiency on the ground that petitioner had no depletable interest in the land leased by it from the city of Long Beach.

FINDINGS OF FACT.

Petitioner is an association which was organized in April, 1922, by virtue of a declaration of trust executed pursuant to the laws of California. It was created for the purpose of entering into an oil and gas lease with the city of Long Beach, hereafter referred to as the city, which is and for many years has been a municipal corporation organized under the laws of California. The charter of said city authorized it to acquire and own its own water system and to purchase, hold, lease, use, and enjoy property of every kind and description and control and dispose of the same for the common good.

For some years prior to 1911 the city had obtained its water supply from two or more independent water companies, which in turn obtained their water from subterranean sources through wells which they had bored. The water mains of these companies were made of such material that water escaped therefrom and caused mud holes in the streets, which at that time were of dirt construction. When it was necessary to shut the water off from the mains, outside water would seep back into them and contaminate the water which thereafter came through them for the use of the city and its citizens. The escaping water became stagnant and created unsanitary conditions. Tules grew along one of the main streets for about a mile and a half. The mains were of such construction that they could not resist sufficient pressure to enable the fire department to fight fires. Under these conditions the city, in 1911, after having once rejected the proposition, by popular vote authorized a bond issue for the purpose of acquiring these water systems. With the money thus obtained the city acquired about 600 acres of land about three miles north of the city and the equipment and mains of the water companies. The land so acquired has ever since been used by the city for the purpose of a water plant and for the other purposes hereafter set forth. The city obtains its water from subterranean sources. In connection with this water system the city employed in 1922, 1923, and 1924, about fifty men, whose headquarters were on the said 600 acres, and now employs about 75 men on the premises. It maintains thereon a pumping plant service department, blacksmith shop, salvage yards, a garage, and a residence, all of which are used in connection with the water plant. At the time the city acquired this property there were on it three reservoirs, one of which has since been discontinued for the reason that it did not possess sufficient elevation. In addition to two oil and gas leases, of one of which petitioner is the lessee, the said tract of 600 acres has on it about 60 tenants who hold under leases or permits from the city. The business of these tenants includes airplane repair, hangars for aircraft, oil-well supplies, telephone, storage plants, cracking plants, oil-skimming plants, dehydration plants, gasoline absorption plants, and farming. These leases and permits were then and are of a temporary nature; can be terminated on short notice and are made subject to the right of the city to use the property for water purposes. Many of these leases and permits were granted by the city by reason of political and business pressure brought to bear on the city authorities.

On April 3, 1922, the city, as lessor, and the petitioner, as lessee, entered into an oil lease on about 140 acres of its water system property, the pertinent parts of which read:

WITNESSETH: Lease Term and Description of Land: For and in consideration of * * * the lessor does hereby lease, demise and let unto the lessee, and the lessee does hereby take and accept from the lessor for the term and time and for the purposes and under and in accordance with the stipulations, agreements and conditions hereinafter set forth, all that certain real property situated in the County of Los Angeles, State of California, and particularly described as follows: Here follows a description of the property leased with certain exceptions and encumbrances which it is not necessary to set forth. and finally subject to the reservation that no derrick shall be erected, no well drilled, no pipe line laid, no excavation made, no improvement placed and no work done upon the west half of Farm Lot fifty-nine (59) without first having obtained the consent of the city manager of the lessor, or his successor, to the location thereof, and that no building, or other structure, shall be constructed or placed on any land within one hundred fifty (150) feet of any of the reservoirs, whether in use or not, upon said lands.

This lease is granted by the lessor and accepted by the lessee for the purpose and with the exclusive right, subject to the terms, provisions and conditions hereof to explore and drill for, develop, collect, obtain, take, save, remove, market and otherwise use, enjoy and dispose of any and all kinds of oil, gas and other hydrocarbon substances which may be found in, upon or beneath the surface of said lands; together also with the rights, subject to compliance with the terms, provisions and conditions hereof, to use and enjoy the necessary rights of way for ingress and egress in, upon and across said lands for operation thereon under this lease; together also with the rights, subject to compliance with the terms, provisions and conditions hereof, to build, erect, operate, maintain and enjoy derricks, rigs, boilers, tanks, tankhouses, pumping stations, pipe lines, telephone, power and light lines and other structures, apparatus and equipment suitable for use only in connection with the drilling for, developing, producing, collecting, saving, disposing of and transporting from said lands of said substances produced therein or therefrom, for the term of five (5) years from and after the date hereof, and so long thereafter as oil, gas or other hydrocarbon substances are produced, collected and saved from said lands in paying commercial quantity.

Possessory Rights: The possession by the lessee of the lands herein described, with the exception of those portions of the lands herein expressly excepted or reserved by the lessor, shall be solely and exclusively for the purposes hereof, excepting that the lessor, in addition to the reservations herein contained, reserves the right to occupy and use the same for agricultural, grazing and such other purposes as the lessor may deem necessary or desirable insofar as same shall not at any time of use interfere with any of the rights or necessary operations of the lessee; and the lessee shall conduct his operations upon said lands so as to interfere as little as possible with the reserved uses of said lands in the lessor.

Property Protection: The lessee shall, during the full term hereof, or during such part of said term as he shall continue to occupy the herein demised lands for the purposes hereof, protect all works, structures and improvements of the lessor, together with all water stored in reservoirs or tanks, situated and located upon said lands against any and all damage and injury of whatsoever kind or character resulting from any of the operations conducted on said lands by the lessee.

* * * * * * *

Drilling Obligations: The lessee shall, within five (5) days following the date hereof, actively commence the work of erecting a derrick on some portion of said lands not reserved to use of lessor as hereinabove provided for, and shall actively and continuously, in a good and workmanlike manner, complete such derrick and install therein and on said lands the necessary drilling equipment, power plant and apparatus for the drilling of an oil well and thereupon shall at once commence the actual drilling of a well for the discovery and production of oil and other hydrocarbon substances; and after commencing the drilling of such well, the lessee shall drill continuously without interruption, except such interruptions as may be caused by strike, lockout, act of God, unavoidable accident, or other cause beyond the control of the lessee, until such well shall have been drilled to a depth of thirty-seven hundred (3700) feet or until oil, gas or other hydrocarbon substances shall be produced therefrom in paying and commercial quantity; and the lessee shall upon said condition continue to drill at least one well on said lands each year until there shall have been so drilled upon said lands at least one well for each ten (10) acres in area thereof; provided that if...