Weaver v. Comm'r of Internal Revenue

• Decision Date: 28 June 1979
• Docket Number: Docket No. 1437-76.
• Citation: 72 T.C. 594
• Parties: LLOYD WEAVER, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

72 T.C. 594

LLOYD WEAVER, PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 1437-76.

United States Tax Court

Filed June 28, 1979.

Petitioner executed three agreements with owners of rock, sand, and gravel deposits. Under the 1969 Newson agreement, petitioner obtained exclusive extraction rights until exhaustion of the minerals, subject to the owner's right to cancel without cause on 120 days' notice. Petitioner paid 15 cents per cubic yard “rents.” Under the 1972 Munroe agreement, petitioner obtained exclusive extraction rights for 3 years, made no advance payment, and agreed to pay 20 cents per cubic yard for extracted minerals. Under the 1971 Coe agreement, which was nonexclusive and terminable at will, after May 1972, during the years in issue (1972 and 1973), petitioner agreed to pay 15 cents per cubic yard. In no case did petitioner agree to any minimum production. Petitioner spent money clearing the three sites, constructing and maintaining roads and drainage, and refilling the sites. He also spent $100 to purchase an access easement to the Munroe and Coe properties.

Held, on the facts, production under the Munroe and Newson agreements and the Coe agreement through May 1972 was depletable. Held, further, production under the Coe agreement after May 1972 was not depletable since the agreement could be canceled without notice. Victor Chini, for the petitioner.

Louis J. Zeller, for the respondent.

HALL, Judge:

Respondent determined deficiencies in petitioner's income tax of $2,686.15 for 1972 and $3,447.05 for 1973. Due to a concession by respondent, the issue remaining is whether petitioner had an economic interest in the Newson, Munroe, and Coe properties which entitled him to deductions for depletion under section 611(a).¹

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly.

At the time he filed his petition, Lloyd Weaver was a resident of Hastings, N. Y.

During the years in issue, petitioner was self-employed, doing business as the Lloyd Weaver Construction Co. His business included the extraction and sale of sand, gravel, and stone. These materials were extracted from petitioner's property or, pursuant to agreements, from property owned by others. In this case we are concerned with three such agreements: the Newson, the Munroe, and the Coe agreements.

The Newson Agreement

On July 15, 1969, petitioner entered into a written agreement with Albert and Grace Newson² which gave petitioner the exclusive “option and right” to extract and remove sand, stone, and gravel from about 20 acres of property owned by the Newsons. As consideration, petitioner agreed to pay the Newsons “as rent” 15 cents per cubic yard of mineral extracted and removed from the premises. Upon test sampling proving satisfactory to petitioner, he was required to and did make an advance payment of $600 to be credited subsequently against one-third of “rents” owed weekly as the minerals were removed. He made no other initial payments for the right to extract minerals. There was no required minimum to be extracted. Petitioner was not required to sell the extracted materials to any particular party.

Petitioner's extraction rights were to continue until the materials were exhausted, subject to the Newsons' right to cancel with or without cause upon 120 days' notice. The notice period was sufficient under the circumstances to extract significant portions of the available mineral on the site after notice, had the Newsons given notice. It was provided, however, that if the Newsons decided to sell the property, petitioner had a 30-day option “to meet any sales price quoted.” Petitioner, in fact, purchased this property for $20,000 on April 16, 1973. Petitioner was still mining the property in 1976.

Petitioner could not assign the agreement, except to obtain credit, without the Newsons' consent.

The Munroe Agreement

On February 10, 1972, petitioner entered into a written agreement³ which gave him the exclusive right to extract stone, sand, and gravel from property owned by Thomas H. Munroe, Sr. As consideration, petitioner agreed to pay Munroe 20 cents per cubic yard of materials extracted and removed. No advance, minimum, or other type payment was required. Petitioner was free to sell the material to any one he chose.

The agreement provided that gravel material removed from the Munroe site was to remain Munroe's property until petitioner delivered the material to a jobsite and paid Munroe the amount due. If the material were stockpiled before delivery upon property other than Munroe's, the stockpile was to be identified as Munroe's and the property owner was to be notified in writing that the material belonged to Munroe.

This contract was to remain in effect until April 1, 1975, unless extended by mutual written agreement of the parties. The contract was not subject to cancellation by either party, and no stated minimum extraction was required.

The Coe Agreement

Pursuant to a written contract,⁴ Hadwen and Verna Coe agreed to sell petitioner gravel from their gravel bed, a 10-acre site, during the period November 1, 1971, to June 1, 1972, in exchange for 15 cents per cubic yard of material taken. If the Coes desired to continue to allow extraction from their land after termination of the contract, petitioner had the first option to mine the property. Petitioner was not restricted with regard to whom he sold the gravel. No minimum amount of extraction or minimum payment was required.

Petitioner's written agreement with the Coes expired on June 1, 1972. Petitioner believed that he had extracted all the salable mineral from the Coe property by June 1, 1972. However, after that date, he had an opportunity to sell very coarse gravel which still remained there and accordingly secured Coe's agreement and recommenced extraction activities, but did not mine a great deal after May 1972.

Petitioner's Mining Procedure

Subsequent to the execution of each of these agreements, petitioner surveyed the land to delineate the exact location of the area with respect to which he had contracted, to insure that the roads were properly laid out, to insure that only the land under the contracts was cleared, and to avoid trespassing. The survey was not required to determine the existence of commercially marketable deposits, however, for petitioner knew such deposits existed when he signed each of the agreements. He then cleared the sites for operation, put in drainage, and built and maintained roads used to remove the materials. Each area mined was later reclaimed and refilled by petitioner, at a cost of about $1,000 per acre. Bulldozers and loaders owned by petitioner were used to clear and refill the land. During the years in issue, petitioner took deductions for depreciation of this equipment and for salaries paid to the operators.

On March 25, 1972, petitioner paid the Newsons $100 for a right-of-way across their property. The right-of-way was needed to gain access to both the Coe and Munroe properties.

On his income tax returns for 1972 and 1973, petitioner claimed percentage depletion deductions of $9,868.02 and $11,855.77, respectively, on account of minerals extracted from his own gravel pits and the gravel pits leased from the Newsons, Munroe, and the Coes. Respondent in his statutory notice determined that petitioner was not entitled to depletion deductions for the minerals extracted from the Newson, Munroe, and Coe properties. Accordingly, respondent disallowed $8,825.97 of the claimed 1972 deduction and $7,312.22 of the claimed 1973 deduction.

OPINION

Section 611(a) provides that “In the case of mines, oil and gas wells, other natural deposits, and timber, there shall be allowed as a deduction in computing taxable income a reasonable allowance for depletion.” This deduction “is permitted in recognition of the fact that * * * mineral deposits are wasting assets and is intended as compensation to the owner for the part used up in production.” Helvering v. Bankline Oil Co., 303 U.S. 362, 366 (1938). The deduction for percentage depletion is allowed as long as the minerals are being extracted and sold regardless of cost incurred by the taxpayer. Sec. 613; Burton-Sutton Oil Co. v. Commissioner, 328 U.S. 25, 34 (1946). The deduction is not dependent upon the particular legal form of the taxpayer's interest in the property. Anderson v. Helvering 310 U.S. 404 (1940). However, only individuals owning an economic interest in a depletable resource are entitled to the deduction for depletion. Palmer v. Bender, 287 U.S. 551, 557 (1933).

The test in determining whether a taxpayer possesses an economic interest is whether the taxpayer has (1) acquired by investment an interest in the mineral in place, and (2) whether he looks to the income from the extraction of the materials for a return of his investment. Palmer v. Bender, supra at 557. The investment must be such that it is necessarily reduced as the sand, stone, and gravel is extracted. See Kirby Petroleum Co. v. Commissioner, 326 U.S. 599 (1946). This test was adopted in section 1.611-1(b)(1), Income Tax Regs., which in pertinent part provides:

(b) Economic interest. (1) Annual depletion deductions are allowed only to the owner of an economic interest in mineral deposits * * *. An economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in mineral in place * * * and secures, by any form of legal relationship, income derived from the extraction of the mineral * * * to which he must look for a return of his capital. * * * A person who has no capital investment in the mineral deposit * * * does not possess an economic interest merely because through a contractual relation he possesses a mere economic or pecuniary advantage derived from production. * * *

The issue presented in this case is whether petitioner is entitled under section 611 to deductions for percentage depletion on sand, stone, and gravel...