Buena Vista Farms, Inc. v. Comm'r of Internal Revenue, Docket No. 7173—74.
| Decision Date | 20 June 1977 |
| Docket Number | Docket No. 7173—74. |
| Citation | 68 T.C. 405 |
| Parties | BUENA VISTA FARMS, INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Held: B, a corporate farmer, held water primarily for sale in the ordinary course of its trade or business. Accordingly, the sale of 10 percent of its contractual right to receive payment in kind for water sold does not qualify as a sale or exchange of a capital asset under sec. 1221, I.R.C. 1954, and the gain attributable thereto is taxable as ordinary income. George H. Koster, for the petitioner.
Peter D. Bakutes, for the respondent.
Respondent determined a deficiency in petitioner's Federal income tax for the calendar year 1971 in the amount of $18,951.
Due to concessions, the sole issue remaining is whether the gain realized by petitioner on the sale of a portion of its contractual right to receive certain water was capital gain or ordinary income.
Certain facts were stipulated and are so found.
Petitioner Buena Vista Farms, Inc., was incorporated in the State of Delaware in 1965. At the time of filing the petition herein, its principal place of business was located in San Francisco, Calif. Petitioner timely filed a Federal corporate income tax return for the calendar year 1971 with the Director, Internal Revenue Service Center, Fresno, Calif.
In 1966 petitioner merged with Buena Vista Associates, Inc., a California corporation primarily engaged in the business of farming. Petitioner is the successor corporation to Associates and as such acquired all the assets and assumed all the liabilities of Associates. During all relevant periods both corporations conducted the same businesses and were engaged in the same day-to-day activities. Consequently, the term ‘petitioner’ will hereinafter refer to both Buena Vista Farms, Inc., and Buena Vista Associates, Inc.
The farming activities of petitioner consisted of leasing farmland to tenants for a specified rental in cash or crops. In addition, petitioner derived substantial income from the sales of water to tenants and other purchasers for irrigation purposes.
The assets of petitioner included 1,847 acres of land known as the Paloma Ranch and approximately 23,000 acres of farmland referred to herein as the lake property. These properties are located in the southwestern part of the San Joaquin Valley in Kern County, Calif. Paloma Ranch was crisscrossed by extensive pipelines installed by oil companies, and only minimal farming activities were conducted on the property.
The lake property was suitable for farming and was leased, solely for that purpose, by petitioner to the J. G. Boswell Co. (Boswell) from 1962 through 1970 under a long-term crop-sharing lease. The crops which were grown on this property consisted of cotton, different types of grain, and some specialty crops. Petitioner leased the lake property to five partnerships in 1971 for a cash rental. Petitioner's farming activities conducted in this manner were most successful, as the following chart demonstrates:
+------------------------------------------------+
¦ ¦Total ¦Farming ¦Farming income ¦
+------+---------+---------+---------------------¦
¦Year ¦income ¦income1 ¦as percent of total ¦
+------+---------+---------+---------------------¦
¦ ¦ ¦ ¦ ¦
+------+---------+---------+---------------------¦
¦1961 ¦$739,765 ¦$652,031 ¦88.1 ¦
+------+---------+---------+---------------------¦
¦1962 ¦985,051 ¦884,881 ¦89.8 ¦
+------+---------+---------+---------------------¦
¦1963 ¦948,306 ¦829,558 ¦87.5 ¦
+------+---------+---------+---------------------¦
¦1964 ¦1,105,811¦1,040,641¦94.1 ¦
+------+---------+---------+---------------------¦
¦1966 ¦1,832,203¦1,017,684¦55.5 ¦
+------+---------+---------+---------------------¦
¦1967 ¦1,553,558¦819,513 ¦52.8 ¦
+------+---------+---------+---------------------¦
¦1968 ¦1,116,947¦789,591 ¦70.7 ¦
+------+---------+---------+---------------------¦
¦1969 ¦1,233,283¦872,039 ¦70.7 ¦
+------+---------+---------+---------------------¦
¦1970 ¦1,294,392¦891,336 ¦68.9 ¦
+------+---------+---------+---------------------¦
¦1971 ¦2,960,414¦2,135,367¦72.1 ¦
+------------------------------------------------+
The southern portion of the San Joaquin Valley receives only approximately 5 inches of rainfall per year. Thus, water for agricultural purposes in the area was supplied by irrigation. As part of its farming activities, petitioner sold water to tenants for irrigation purposes. In addition, petitioner sold water for irrigation to other purchasers, though it did not maintain a sales force or solicit sales of water. Petitioner obtained this water from three principal sources: water underlying the property and brought to the surface by wells located on the property, water diverted from the Kern River pursuant to a water right equal to 4 percent of the measured flow of the river at a certain point, and water purchased from other suppliers when the first two sources were inadequate. Delivery was effectuated through an elaborate system of ditches, pipelines, drains, pumps, and wells maintained by petitioner. Petitioner derived substantial income from water which it sold to tenants (as needed, from day-to-day) pursuant to various written leases and to other purchasers as reflected by the following chart:
+-------------+
¦1960¦$7,498 ¦
+----+--------¦
¦1961¦0 ¦
+----+--------¦
¦1962¦22,996 ¦
+----+--------¦
¦1963¦41,184 ¦
+----+--------¦
¦1964¦17,948 ¦
+----+--------¦
¦1965¦0 ¦
+----+--------¦
¦1966¦177,016 ¦
+----+--------¦
¦1967¦399,175 ¦
+----+--------¦
¦1968¦256,012 ¦
+----+--------¦
¦1969¦295,090 ¦
+----+--------¦
¦1970¦308,012 ¦
+----+--------¦
¦1971¦708,437 ¦
+-------------+
Petitioner consistently reported amounts received from water sales as ordinary income and claimed corresponding deductions for expenses incurred in delivering water, maintaining and repairing water delivery facilities, and purchasing water, on its Federal income tax returns. In addition, petitioner maintained a separate income account in its general ledger entitled ‘Water Income’ for recording receipts from sales of water, and listed ‘inventory-water’ and ‘water-inventory’ as an asset on its balance sheets from 1963 through 1967.
In 1964 the State of California (hereinafter referred to as the State) embarked upon the construction of the California Aqueduct. The purpose of the aqueduct was to transport water from northern to central and southern California.
Due to its extremely dry condition, soil in portions of the San Joaquin Valley is subject to severe settling when water soaks the soil. The problem is generally known as shallow subsidence. To alleviate this problem, the State decided to preconsolidate or soak the soil in certain portions of the aqueduct's pathway prior to the construction of the aqueduct.
In conjunction with this project, negotiations ensued between the California Department of Water Resources and petitioner concerning the furnishing of water by petitioner to the State for a portion of its preconsolidation requirements. During the course of the negotiations, there was no threat or discussion of condemnation of petitioner's water supplies. These negotiations culminated in an agreement entitled ‘Preconsolidation Water Agreement’ (agreement) and dated June 1, 1964, which provided inter alia:
A. As part of the facilities of the State Water Resources Development System being constructed by State pursuant to the California Water Resources Development Bond Act, State proposes to construct an aqueduct with appurtenant pumps, structures and equipment running generally in a southeasterly direction through the southern portion of Kern County;
B. State desires to acquire during the period of construction of said aqueduct a supply of water, ranging in quantity from a minimum of 47,000 acre-feet to a maximum of $76,400 acre-feet, to be used for preconsolidation of soils in the construction of said aqueduct;
Now, THEREFORE, Associates hereby agrees to sell, exchange, deliver and transport water to State and State hereby agrees to purchase and exchange water with Associates and to compensate it in accordance with the following provisions, to each and all of which the parties hereby mutually agree:
1. Quantity: Associates shall deliver and State shall take hereunder not less than 23,500 acre-feet nor more than 38,200 acre-feet of water together with the transportation loss water hereinafter described.
4. Transportation Losses: The maximum and minimum quantities of water to be supplied to State by Associates * * * are quantities measured at Terminal Point as above identified. It is recognized that there may be channel losses between various Delivery Points and Terminal Point, and Associates agrees to supply all such losses, but shall be compensated for the same by State in manner hereinafter provided in subparagraphs 9(b) and 9(c)(3).
9. Compensation and Price: State shall compensate Associates for water supplied and services rendered hereunder as follows:
(b) In accordance with the provisions of paragraph 10, State shall deliver to Associates 131,600 acre-feet of water in exchange for the first 23,500 acre-feet of Associates' water delivered to and measured at the Terminal Point, and in exchange for an agreed transportation loss of 9,400 acre-feet to be incurred in transporting the first 47,000 acre-feet or any part thereof of water under both this contract and the contract of State with Kernco.
(c) State shall compensate Associates for the remaining quantities of water required to be delivered by Associates pursuant to this contract as follows:
(2) Within ninety (90) days after the end of each calendar month during which water is delivered hereunder,...
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