Estate of Walker v. CIR

• Decision Date: 12 July 1972
• Docket Number: No. 71-1331 to 71-1333.,71-1331 to 71-1333.
• Citation: 464 F.2d 75
• Parties: ESTATE of Marian H. WALKER, Deceased, et al., Appellants, v. COMMISSIONER OF INTERNAL REVENUE (three cases).
• Court: U.S. Court of Appeals — Third Circuit

464 F.2d 75 (1972) ESTATE of Marian H. WALKER, Deceased, et al., Appellants, v. COMMISSIONER OF INTERNAL REVENUE (three cases).

Nos. 71-1331 to 71-1333.

United States Court of Appeals, Third Circuit.

Argued March 16, 1972.

Decided July 12, 1972.

Courtney H. Cummings, Jr., Killoran & Van Brunt, Wilmington, Del., for appellants.

Jane Edmisten, Department of Justice, Tax Division, Appellate Section, Johnnie M. Walters, Asst. Atty. Gen., Meyer Rothwacks, David English Carmack, Attys., Tax Division, Department of Justice, Washington, D. C., for appellee.

Before MAX ROSENN and JAMES ROSEN, Circuit Judges, and VAN ARTSDALEN, District Judge.

OPINION OF THE COURT

MAX ROSENN, Circuit Judge.

The sole issue of this appeal is whether the Tax Court erred in finding that Mrs. Walker and her estate received ordinary income from the sale of sand and gravel (fill) on her land.¹

Appellant and the Government agree on the applicable principles of law. Burnet v. Harmel, 287 U.S. 103, 53 S.Ct. 74, 77 L.Ed. 199 (1932), held that mineral royalties paid under a lease were ordinary income to the taxpayer. However, if the minerals were sold outright, the taxpayer could take capital gain under the applicable provisions of the Internal Revenue Code, now embodied in 26 U.S.C. § 1231. Whether the necessary sale took place depended on whether the taxpayer had retained an economic interest in the minerals in place. A taxpayer retained such an interest if he had: (1) acquired by investment the interest in the minerals in place; and (2) looked to the extraction of the mineral for the return of his capital. Commissioner of Internal Revenue v. Southwest Exploration Co., 350 U.S. 308, 314, 76 S.Ct. 395, 100 L.Ed. 347 (1956). See also, Palmer v. Bender, 287 U.S. 551, 53 S.Ct. 225, 77 L.Ed. 489 (1933). In other words, the critical question that must be answered in determining the tax status of the income derived from the sale of the minerals is whether or not the taxpayer looks to payments dependent on extraction for his return. Rutledge v. United States, 428 F.2d 347, 351 (5th Cir. 1970). If the payments are not so conditioned capital gain accrues, Richard L. Ellis, 56 T.C. 1079 (1971); otherwise, ordinary income is generated. Dingman v. United States, 429 F.2d 70 (8th Cir. 1970); Laudenslager v. Commissioner of Internal Revenue, 305 F.2d 686 (3d Cir. 1962).

Where the parties differ in this case is in the evaluation of the particular contracts signed by the taxpayer, Mrs. Walker, and the contractors who removed the fill from her land. In 1922, Mrs. Walker and her husband purchased their farm, which they operated commercially until Mr. Walker's death in 1961. After the death, an appraiser evaluated the various uses to which the property could be put and concluded that the land, which fronted on a busy highway, could be valuable commercially. However, it would have to be graded before much of the area fronting on the road could be leased or sold.

In 1963, Mrs. Walker concluded an agreement with a contractor which provided that the contractor would grade part of her property and, as the grading progressed, purchase the fill he removed at sixteen cents a cubic yard. The relevant operative provisions of the contract stated:

1. Owner hereby retains the Contractor to grade the property of the Owner, described in Exhibit `A\' hereto, by removing fill dirt and other minerals therefrom, said grading operation, however, is subject to the following terms and conditions:

(a) All material removed by Contractor from the property described in Exhibit `A\' hereto shall become the property of the Contractor upon payment to Owner of the sum of Sixteen Cents (16¢) per cubic yard of material removed; said payment to be made on or before the Fifteenth day of each month for material removed for the preceding month, said payments to be made in accordance with the cross sectionings and measurements of the material removed made by or on behalf of Contractor;

(b) Grading and the removal of material shall start at the Southeasterly right-of-way line of Route No. 13 and proceed Southeasterly to the right-of-way line of the Pennsylvania Railroad Company; provided, however that the grading of that portion of said property extending Southeasterly from Route No. 13 to a distance of Four Hundred (400) feet shall be graded to an elevation of One (1) foot above Route No. 13 and such portion of said grading shall be completed by the Contractor during the 1963 calendar year.

* * * * * *

(h) Contractor shall have the right at all times to stock pile top soil and other materials upon any portion of the property shown on Exhibit `A\' hereto until such time as said top soil is to be restored and/or such material is sold by Contractor for construction or other purposes;

Two further provisions of the contract provided that the contractor would amesite a driveway on the farm and that he would have an option to grade and remove the fill on the rest of the property at eighteen cents (18¢) a cubic yard for the first million cubic yards removed and at twenty cents (20¢) a cubic yard thereafter.

The work began, the driveway was amesited, and the fill removed. The Zoning Commission of New Castle County inquired whether there was a commercial sand pit on the property, but taxpayer's counsel wrote back that taxpayer was simply having her property graded. The matter was not further pursued.

In 1965, an amendment to the original agreement was signed, providing for the contractor to grade additional parts of the farm. While it incorporated most of the provisions of the 1963 agreement, it added the following language:

Contractor agrees to grade said additional property of the Owner as described in Exhibit `A\' hereto, all in accordance with this Agreement and in accordance with the provisions of said agreement dated March 18, 1963, and to complete such grading operations within a reasonable time, due allowance to be made for delays occasioned by strikes, weather, equipment shortages, acts of God, lack of demand or market for fill or other minerals to be removed from said additional property of the Owner described in Exhibit `A\' hereto, or for other causes beyond the Contractor\'s reasonable control. (Emphasis supplied).

After the taxpayer's death in October, 1966 her children agreed to the grading of the remaining 2.1 acres of the property under an oral agreement presumably incorporating the terms of the prior agreements. As of the time of trial, the grading of the second and third sections had as yet to be completed, and no rezoning or commercial development had been attempted.

When the taxpayer and her estate claimed capital gains on the income from the sale of the fill, the Commissioner responded by claiming it was ordinary income and offering the taxpayer a 5% depletion allowance.²

In deciding whether the taxpayer has sold or merely leased the mineral interest involved, each case must be evaluated on its facts. Wood v. United States, 377 F.2d 300 (5th Cir. 1967). While such a case by case approach may make for certain fine distinctions, if not contradictions, in the relevant body of case law,³ the operative provisions of the 1963 and 1965 contracts in this case support the conclusion that Mrs. Walker and her estate retained the requisite interest in the sand and gravel until its extraction so that the money generated from their removal was ordinary income within the contemplation of Burnet v. Harmel, supra.

The taxpayer argues that once the contractor signed the contract he was compelled to remove all the fill as part of his obligation to grade the property.⁴ Appellant concludes that this obligation was effectively a passing of all Mrs. Walker's interests in the material, and that she was at that point assured of compensation.

However, we find that the taxpayer was entirely dependent on the actual extraction of the fill for her repayment.⁵ The contract states that the material would become the property of the contractor only upon the payment of sixteen cents (or eighteen cents) per cubic yard, and those payments were not due until the fill was taken from the property.

The taxpayer argues that Mrs. Walker was assured of payment for all the materials because the grading had to be done within a reasonable time. However, with the exception of one section of grading, there was no specific completion date set in any part of the contract. There is not even a provision in the original agreement requiring the job to be completed within a reasonable time. Even if that were the case, the requirement that the job be completed within some period is not sufficient to undermine the lease-type terms, which do not give the contractor any interest in the fill until he removes it from the property.⁶

Further, the 1965 contract clarifies the fact that the taxpayer did not make an outright sale of her mineral interest, but only agreed to sell fill as it was extracted. In this...