O'Connor v. Comm'r of Internal Revenue
| Decision Date | 04 January 1982 |
| Docket Number | Docket Nos. 3483–78–3485–78,381–79. |
| Citation | 78 T.C. 1 |
| Parties | ROBERT G. O'CONNOR AND MARY A. O'CONNOR, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioners O'Connor entered into an agreement with petitioner Bush which purports to be a lease to Bush of a portion of land for the purpose of mining clay to be used by Bush to manufacture bricks. Petitioners O'Connor claim that this was a sale resulting in capital gain treatment. Petitioner Bush claims that this was a lease and that it is entitled to depletion on the clay mined. The Commissioner determined that the petitioners O'Connor received ordinary income from the lease of clay deposits but that petitioner Bush was not entitled to depletion because it did not acquire an economic interest in the clay deposits. Held, petitioners O'Connor retained an economic interest in the clay deposits so that payments made by Bush to the O'Connors represent ordinary income subject to depletion. Held, further, Bush acquired an economic interest in minerals in place under the lease agreement and is entitled to percentage depletion on the O'Connor clay deposits. Kenneth L. Campbell, for the petitioners in docket Nos. 3483–78, 3484–78, and 3485–78.
James T. O'Hare, William Waller, and Teresa H. Johnson, for the petitioners in docket No. 381–79.
Vallie C. Brooks, for the respondent.GOFFE, Judge:
The above docketed cases were consolidated for trial, briefs, and opinion because their issues for decision involve a common transaction. The Commissioner determined deficiencies in Federal income tax together with additions to such tax as follows:
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¦ ¦TYE ¦ ¦Additions to tax ¦
+------------+------------+------------+------------------------------¦
¦Docket No. ¦Dec. 31— ¦Deficiency ¦Sec. 6651(a)(1)2 ¦Sec. 6653 ¦
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¦ ¦ ¦ ¦ ¦ ¦
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¦3483-78 ¦1971 ¦$8,336.67 ¦$2069.55 ¦0 ¦
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¦ ¦1972 ¦11,927.07 ¦0 ¦0 ¦
+------------+------------+------------+------------------+-----------¦
¦ ¦1973 ¦18,848.68 ¦0 ¦$942.43 ¦
+------------+------------+------------+------------------+-----------¦
¦3484-78 ¦1974 ¦18,729.74 ¦0 ¦936.49 ¦
+------------+------------+------------+------------------+-----------¦
¦3485-78 ¦1974 ¦3,101.00 ¦0 ¦0 ¦
+------------+------------+------------+------------------+-----------¦
¦381-793 ¦1971 ¦17,103.00 ¦0 ¦0 ¦
+------------+------------+------------+------------------+-----------¦
¦ ¦1973 ¦15,925.66 ¦0 ¦0 ¦
+------------+------------+------------+------------------+-----------¦
¦ ¦1975 ¦694.00 ¦0 ¦0 ¦
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1 These are the deficiency amounts regarding Herbert Materials, Inc. All issues concerning the tax liabilities for petitioners John B. Herbert, Mary H. Herbert, James A. Skinner, Jr., and Beverly J. Skinner have been settled.
There are two issues for decision: (1) Whether certain payments made by petitioner Herbert Materials, Inc. (Bush)4 to petitioners O'Connor, pursuant to an agreement under which Bush mined clay deposits on land owned by the O'Connors, represent payments from the sale of a capital asset or ordinary income, and (2) whether petitioner Bush is entitled to depletion on clay mined from the property.
The remaining elements of the proposed deficiencies have been settled by the parties.
The additions to tax are also not before this Court. The petitioners O'Connor have conceded all the proposed adjustments made by the Commissioner except those relating to the strip-mining transaction. Respondent has not made any specific concessions. The parties in the docketed cases involving the additions to tax, however, have stipulated that the only issue for decision concerns the tax implications of the strip-mining agreement. The additions to tax have not been raised by any of the parties in their trial memoranda, nor were they raised at trial on on brief. No evidence was offered to demonstrate why the additions to tax should not be applied. We, therefore, find that the additions to tax have been conceded by petitioners.
Some of the facts were stipulated. The stipulations of facts and attached exhibits are incorporated herein by this reference.
On the date the petitions in docket Nos. 3483–78, 3484–78, and 3485–78 were filed, the petitioners O'Connor resided in Nashville, Tenn. Docket No. 3483–78 concerns the income tax liability of petitioners Robert and Mary O'Connor for the taxable years 1971, 1972, and 1973. During each of the taxable years 1971, 1972, and 1973, the petitioners O'Connor were husband and wife. They filed a joint Federal income tax return for each of these years using the cash receipts and disbursements method of accounting with the Director, Internal Revenue Service Center at Memphis, Tenn. The petitioners O'Connor are now divorced. Both Robert and Mary O'Connor filed individual Federal income tax returns for the taxable year 1974 with the Director, Internal Revenue Service Center at Memphis, Tenn. Docket No. 3484–78 concerns Robert O'Connor's income tax liability for the taxable year 1974, and docket No. 3485–78 concerns Mary O'Connor's income tax liability for the taxable year 1974.
Petitioner Herbert Materials, Inc., formerly W. G. Bush & Co., is a corporation organized under the laws of the State of Tennessee which had its principal office and place of business in Nashville, Tenn., on the date the petition herein was filed. Bush filed a consolidated corporate Federal income tax return for the taxable years 1971 through 1975 with the Director of the Internal Revenue Service Center at Memphis, Tenn., using the accrual method of accounting.
No issues for decision remain concerning petitioners John B. Herbert, Mary H. Herbert, James A. Skinner, Jr., and Beverly J. Skinner, due to concessions made by the parties.
Bush has been engaged since 1867 in the business of manufacturing and selling masonry-related construction products, consisting primarily of clay bricks, and was so engaged during the years at issue. In the manufacture of brick, the producer tries to arrange for an adequate supply of clay within a reasonable distance of its plant in order to avoid excessive costs for transporting the clay. Bush considers it desirable to stockpile at least a year's supply of clay for use in the manufacture of brick. When its own clay deposits began to run out in 1966, Bush considered obtaining new sources of clay. This could be done by purchase of the clay under a material contract, or by mining the clay from land which it either owned or leased. A long-term lease of the mineral rights to land with quantities of clay offers a brick manufacturer the advantages of assured supply without a large up-front capital investment.
In 1964, the petitioners O'Connor purchased a 300-acre farm which was located about 11 miles from downtown Nashville, fronting on the Cumberland River. The property was purchased in the joint names of Mr. and Mrs. O'Connor and was owned jointly by them until their divorce. Mr. O'Connor (hereafter all references to petitioner O'Connor in the singular will refer to Mr. O'Connor) learned that his farmland contained blue plastic clay that might be suitable for the manufacture of bricks. He contacted a representative of Bush from whom he had previously purchased bricks. Bush had Mr. Richard Warden, at that time a plant engineer, survey the O'Connor property. The property was divided into cross sections, core samples of the clay were taken in each section, and a detailed mining plan was prepared.
Petitioners O'Connor and petitioner Bush entered into an agreement on July 8, 1966. The agreement states that the O'Connors ‘lease to Bush for the purpose of mining clay’ the described real property, which constitutes a portion of the O'Connors' property known as tract A. The lease is for a term of 7 years commencing on July 1, 1967, and expiring June 30, 1974. Bush is given the option to renew and extend the agreement for up to 3 additional years. Bush agrees to pay the O'Connors $40,000 but is not required to pay O'Connor for the first 160,000 cubic yards of clay mined. The O'Connors are entitled to keep the $40,000 even if no clay is ever mined by Bush. After 160,000 cubic yards of clay are mined from the premises, the O'Connors are entitled to $0.25 per cubic yard for additional clay mined, with the payments to be made monthly for clay mined and delivered. Bush agrees to make reasonable efforts to mine clay from tract A and obtain at least 80 percent of its requirements therefrom. The agreement provides that Bush shall at all times manage the property and have full and exclusive control of the mining operations thereon. Bush is required to make all improvements necessary for mining the clay, including construction of dikes, access roads, and drainage ditches. The O'Connors remain liable for all real property taxes. The lease is subject to forfeiture at the option of the O'Connors if the property is acquired or condemned by eminent domain, if Bush is in violation of the agreement, or if Bush becomes bankrupt or insolvent.
Petitioner Robert O'Connor and petitioner Bush also executed a hauling agreement on July 8, 1966, whereby O'Connor would load and transport the clay to Bush's brickyard.
On April 29, 1968,...
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