§§1.263(c)-1, 1.612-4. (Secs. 263, 612; '86. Code.) Rev. Rul. 70-414, 1970-2 C.B.
132. 378.16 Intangible drilling and development costs; allocation; partnership.
tracts by a taxpayer for the purchase of natural or wet gas as and when produced for the purpose of extracting therefrom casinghead gasoline does not entitle the taxpayer to an allowance for depletion. G.C.M. 8253 superseded. §1.611-1. (Sec. 611, ’86 Code.) Rev. Rul. 68–330, 1968-1 C.B. 291. 378.5 Depletion; partnerships; separate property treatment. Although section 613A(c)(7)(D) provides that the depletion allowance should be computed separately by the partners, the effect of section 703(b) is to restrict certain elections, including those with respect to separate property treatment, to the partnership itself. §§1.614–8, 1.703–1. (Secs. 613A, 614, 703; ’86 Code.) Rev. Rul. 84-142, 1984-2 C.B. 117. 378.6 Drilling equipment; steel casing and downhole equipment. Expenditures for steel casing and associated downhole equipment placed in wells drilled for the production of oil and gas must be capitalized. The equipment is placed in service and subject to depreciation when an oil or gas zone is found and the-well is made capable of production. The adjusted basis of equipment that is abandoned in dry holes is deductible as a loss. §§1.165-2, 1.167(a)-11, 1.612-4. (Secs. 165, 167, 612; ’86 Code.) Rev. Rul. 78–13, 1978–1 C.B. 63.
Oil and gas properties (See also: Depletion) 378.1 Aggregation of operating mineral interests; redetermination. Guidelines are provided to aid in determining what constitutes an “operating unit” in the case of oil and gas properties. §1.614-2. (Sec. 614, ’86 Code.) Rev. Proc. 64-23, 1964-1 (Part 1) C.B. 689. 378.2 “Carved-out” oil payment sold by executor of estate. The executor of an estate sold to an unrelated third party an oil payment which he had reserved when he distributed the remaining interest in the oil and gas properties to the beneficiaries. The proceeds from the sale of this production payment were used to satisfy Federal and state tax obligations of the estate. The production payment was in an amount and payable out of a portion of the production so as to be completely paid out before the end of the economic life of the properties from which it had been created. Since the beneficiaries owned the oil payment and underlying mineral interest, this is a “carved-out” oil payment. Therefore, its sale results in the present realization of expected future income by the estate, and the gain is ordinary income, subject to depletion. §1.61–1. (Sec. 61, ’86 Code.) Rev. Rul. 66-201, 1966-2 C.B. 19. 378.3 Charitable contributions, intangible drilling and development cost property. The taxpayer donated to an educational institution certain items obtained in the course of drilling oil and gas wells. The items came within the definition of ordinary income p r o p e r t y i n section 1.170A-4(b)(1). The taxpayer previously deducted the costs of obtaining the items as intangible drilling and development costs and has a zero basis in them. Therefore, the taxpayer’s charitable contribution deduction is zero. §§1.170A-4, 1.612-4, 1.1212-1, 1.1231-1. (Secs. 170, 612, 1221, 1231; ’86 Code.) Rev. Rul. 82-9, 1982-1 C.B. 39. 378.4 Contract to purchase natural or wet gas. The acquisition by assignment of certain con-
378.7 Extraction costs; advance rulings. Advance rulings will be issued on the tax treatment of the cost of lifting or extracting oil, gas, or other minerals where such costs are paid or incurred in connection with production payments. Rev. Proc. 68-40 revoked. (Sec. 601.201, S.P.R.) Rev. Proc. 71–8, 1971–1 C.B. 676. 378.8 Federal Power Commission regulations. F.P.C. regulations relating to the filing of rate schedules and applications for certificates by natural gas producers do not affect the determination of whether an association under a joint operating agreement is taxable as a corporation. (Sec. 7701, ’86 Code.) Rev. Rul. 56-630, 1956–2 C.B. 964. 378.9 Foreign petroleum deposits; sublicensee. Whether, under prescribed circumstances, a sublicensee, the wholly owned domestic subsidiary of a parent company which also controls the foreign licensee, acquired under the sublicensing agreement an economic and operating interest in petroleum products located in a foreign country. §§1.611-1, 1.614-2. (Secs. 611, 614; ’86 Code.) Rev. Rul. 68–551, 1968–2 C.B. 261. 378.10 Gas injected into hydrocarbon reservoir. Costs incurred for purchased liquefied petroleum gas injected into a hydrocarbon reservoir to increase recovery of native oil, to the extent not recoverable with subsequent production, are deductible in the year such losses can be determined; the remaining costs must be allocated and offset against sale proceeds. Modified to provide that costs incurred after November 5, 1973, for such unrecoverable gas are capital expenditures subject to depreciation. However, the undepreciated portion of such gas is deductible as a loss in the year it can be determined that the remaining gas did not benefit production and the project is a failure. §§1.162-1, 1.165-1, 1.167(a)-1, 1.263(a)-1, 301.7805-1. (Secs. 162, 165, 167, 263, 7805; ’86 Code.) Rev. Rul. 70-354, 1970-2 C.B. 50; Rev. Rul. 73-469, 1973-2 C.B. 84. 378.11 Geothermal steam wells. For taxable years 1960 through 1962, geothermal steam wells were gas wells for purposes of the percentage depletion allowance and the deduction for intangible drilling and development costs. (Secs. 263, 611, 613; ’86 Code.) Arthur E. Reich, 52 T.C. 700, Nonacq., 1979-1 C.B. 2.
Oil and gas properties 378.12 Gross income from property; casinghead gas. The taxpayer, a producer of oil and gas from leasehold interests, received a lump sum payment under a contract to sell casinghead gas. Held, the lump sum payment was “gross income from the property” and taxpayer was, therefore, entitled to depletion on the total amount received under the contract. (Sec. 114, ’39 Code; Sec. 612, ’86 Code.) Malloy & Co., 33 B.T.A. 1130, Acq., in result, 1964-2 C.B. 6.
The intangible drilling and development costs that are subject to an option to charge to capital or expense are limited to those that are attributable to a fractional share of the operating interest that the carrying party received as his “permanent” interest upon the exercise of an option by the carried party to convert a retained overriding royalty into 50 percent of operating interest when cumulated gross production from an oil and gas well equaled a specified amount. The remainder of such costs, including the depreciable equipment furnished, is attributable to the fraction of the operating interest 378.13 Gross income from property; dry gas. held by the carried party upon his exercise of the The value of dry gas manufactured from wet gas option, and must be capitalized by the carrying and used as fuel in a gasoline absorption plant is party as the depletable capital cost of the interest includable in determining “gross income from the acquired. Modified by Rev. Rul. 80-109. property” for percentage depletion purposes, but §1.612-4. (Sec. 612, ’86 Code.) the value of dry gas reinfected into the geological Rev. Rul. 70-336, 1970-1 C.B. 145. formation is not includible. §1.613-3. (Sec. 613, ’86 Code.) 378.20 Intangible drilling and development Rev. Rul. 68–665, 1968-2 C.B. 280. costs; capital or expense; operating interest.A 378.14 Gross income from property; natural taxpayer agreed to drill and operate oil wells on gas. Rather than selling at the well head, taxpayer each of two noncontiguous tracts in exchange for processed in its gasoline extraction plants, natural the entire operating interest in each tract until the gas which it had produced and in which it had an aggregate gross income from both tracts equaled economic interest. Held, gross income for deple- the cost of developing and operating both tracts tion purposes is determined from the representa- and a 75% operating interest in each tract thereafThe taxpayer’s deduction for intangible driltive market or field price, calculated by computing ter, a weighted average of actual prices paid by buyers ling and development costs is limited to the porof raw gas in the years at issue. (Secs. 23(m), tion of those costs attributable to the 75% operating interest in each tract. Rev. Rul. 70-336 114(b), ’39 Code; Secs. 611, 612, ’86 Code.) §§1.263(c)–1, 1.612-4, 1.614–1, Shamrock Oil and Gas Corp., 35 T.C. 979, Acq., modified. 301.7805-1. (Secs. 263, 612, 614, 7805; ’86 1966-1 C.B. 3. Code.) Rev. Rul. 80-109, 1980-1 C.B. 129. 378.15 Installation of production facilities. Capital expenditures incurred in installing certain facilities for the production of oil and gas are not 378.21 Intangible drilling and development intangible drilling and development costs subject costs; capital or expense; operating interest.A to the option provided by reg. 1.612-4. Such carrying party who drills, completes, equips, and expenditures are recoverable only through operates the first well in return for the entire operdepreciation allowances. Mim. 6754 superseded. ating interest in an oil and gas lease, until he §§1.263(c)-1, 1.612-4. (Secs. 263, 612; ’86 recoups one-half of the costs, and thereafter owns an undivided one-fourth operating interest may Code.) only deduct one-fourth of the intangible drilling Rev. Rul. 70-414, 1970-2 C.B. 132. and development costs provided he makes a 378.16 Intangible drilling and development proper election. The remaining three-fourths of costs; allocation; partnership. The provisions of such costs must be capitalized and included in his a partnership agreement to allocate to the partners basis in the lease, recoverable through depletion. the intangible drilling and development costs §§1.263(c)-1, 1.611-1, 1.612-4. (Secs. 263, 611, incurred in a partnership’s oil and gas drilling ven- 612; ’86 Code.) ture will be recognized, if the partnership properly Rev. Rul. 71-206, 1971-1 C.B. 105. elects to deduct these costs and if the principal purpose of the allocation is not the avoidance or eva- 378.22 Intangible drilling and development sion of Federal income tax. §§1.263(c)-1, costs; capital or expense; operating interest.A 1.612-4, 1.702-1, 1.704-1. (Secs. 263, 612, 702, carrying party who drills, completes, equips, and 704; ’86 Code.) operates an oil and gas well in return for the entire Rev. Rul. 68-139, 1968-1 C.B. 311. operating interest in the lease during the period of complete recoupment (payout) of such costs, and 378.17 Intangible drilling and development thereafter owns an undivided one-half operating costs; amounts paid to promoter-operators. interest may deduct all the intangible drilling and Taxpayer entered into oil and gas ventures which development costs provided he makes a proper paid the promoter-operators to drill the wells. The election. At the end of the complete payout period promoter-operators subcontracted the work of he must capitalize 50 percent of the remaining cutting the holes and paid the subcontractors less undepreciated basis of lease and well equipment, than the amounts they received. Held, taxpayer if any, as the depletable leasehold acquisition costs may deduct as intangible drilling and develop- of the operating interest acquired. §1.612-4. (Sec. ment expenses his share of the amounts paid the 612, ’86 Code.) promoter-operators in excess of the drilling costs. Rev. Rul. 71-207, 1971-1 C.B. 160. (Sec. 263, ’86 Code.) G.F. Hedges, Jr., 41 T.C. 695, Nonacq., 1964-2 378.23 Intangible drilling and development C.B. 8. costs; capital or expense; operating interest.A 378.18 Intangible drilling and development carrying party who drills and completes an oil and costs; capitalize or expense; election. Taxpayer gas well in return for the entire working interest in deducted intangible drilling costs in a nonproduc- the lease until 200 percent of the drilling and tive well without clearly indicating whether the development plus the equipment and operating deduction was for a loss or expense item. Held, an costs necessary to produce that amount are election in the following year to expense intangi- recouped, and after such recoupment relinquishes ble drilling costs for productive wells was permiss- all rights in the interest to the lessee, is the owner ible. (Sec. 114(b), ’39 Code; Sec. 612, ’86 Code.) of all the working interest during the complete Hawkeye Petroleum Corp., 18 T.C. 1223, Non- pay-out period and may exercise the option to deduct all intangible drilling and development acq., 1953–1 C.B. 7. costs. §§1.263(c)–1, 1.612-4. (Secs. 263, 612; ’86 378.19 Intangible drilling and development Code.) Rev. Rul. 75-446, 1975-2 C.B. 95. costs; capital or expense; operating interest.
378.24 Intangible drilling and development costs; drilling to acquire arrangement. Only half of the intangible drilling and development costs of drilling the first well paid by a taxpayer for an assignment of an undivided one-half of the oil and gas operating interest in the tract of land is subject to the option to charge such costs to expense or to capital. §§1.263(c)–1, 1.612-4. (Secs. 263, 611, 612; ’86 Code.) Rev. Rul. 70-657, 1970-2 C.B. 70. 378.25 Intangible drilling and development costs; election. Section 263, as amended by the Energy Tax Act of 1978 to grant an option to deduct intangible drilling and development costs incurred with respect to geothermal wells, does not permit a new election for the treatment of such costs for oil and gas wells. §§1.263(c)–1, 1.612-4. (Secs. 263, 612; ’86 Code.) Rev. Rul. 80-2, 1980-1 C.B. 61. 378.26 Intangible drilling and development costs; funds furnished by related taxpayer. A corporation’s intangible drilling expenses were furnished in the form of a loan by a drilling contractor who was also a principal stockholder. The contractor used the cash method of accounting while the corporation applied the accrual method. The loan by the contractor was not repaid within two and a half months after the end of the taxable year. Held, the intangible drilling expenses were paid during the taxable year by the corporation from the contractor’s loan, entitling the corporation to the claimed deduction. (Secs. 23(m), 24(c), ’39 Code; Secs. 267, 611, ’86 Code.) Island Gas, Inc. 30 T.C. 787, Acq., 1958-2 C.B. 6. 378.27 Intangible drilling and development costs; offshore platforms. Costs, including expenditures for engineering and design specification, incurred to acquire offshore platforms through contracts with builders in connection with oil and gas production properties are to be capitalized and recovered through depreciation. However, costs to transport the platform in its component form, performed under separate contract, including specifications relating thereto, and costs to set the platform in position at the site may be capitalized or expensed. §§1.263(c)–1, 1.612-4. (Secs. 263, 612; ’86 Code.) Rev. Rul. 70-596, 1970–2 C.B. 68. 378.28 Intangible drilling and development costs; operating interest; allocation of investment. A taxpayer’s investment in an oil and gas venture under a contract designating a dollar amount as intangible drilling and development costs is deductible pursuant to an election under section 263(c) only to the extent that such costs would have been incurred in an arms-length transaction with an unrelated drilling contractor. The remainder of the total investment is the basis of the taxpayer’s working interest. §§1.263(c)-1, 1.612-4. (Secs. 263, 612; ’86 Code.) Rev. Rul. 73-211, 1973-1 C.B. 303. 378.29 Intangible drilling and development costs; operating interest. The proper treatment is shown for an arrangement under which, in consideration for drilling an oil and gas well at a designated location on a leased tract of land, the driller receives from the lessee of the land an assignment of the entire working interest in the drill site and an undivided fraction of working interest in the remainder of the tract. §§1.61–2, 1.263(c)–1, 1.1001-1, 1.451-1, 1.612-4, 1.614-1, 301.7805-1. (Secs. 61, 263, 451, 612, 614, 1001, 7805; ’86 Code.) Rev. Rul. 77–176, 1977-1 C.B. 77. 378.30 Intangible drilling and development costs; partnership. The election to charge to expense intangible drilling and development costs incurred in connection with the oil operations of a partnership that files its return and computes its income on Form 1065 is exercisable by the part-
Oil and gas properties nership. The partnership election is controlling irrespective of the elections of the individual partners as to their own operations. §§39.23(m)–16, 39.183-1. (Secs. 23(m), 183, ’39 Code; Secs. 167, 702, ’86 Code.) Rev. Rul. 54-42, 1954-1 C.B. 64. 378.31 Intangible drilling and development costs; prepaid. Intangible drilling and development costs paid by a cash basis taxpayer in a taxable year prior to the year in which payment was required under the drilling contract and before any work was performed under the contract are not deductible in that year. Rev. Rul. 71–252 distinguished. §§1.263(c)–1, 1.461-1, 1.612-4. (Secs. 263, 461, 612; ’86 Code.) Rev. Rul. 71-579, 1971-2 C.B. 225.
designated areas of the country, is required to sell all of its production to that country at the competitive world market price, and, except for a provision for a cash settlement if the foreign country terminates the agreement, must recover its investment solely from production, is entitled to a depletion allowance and may exercise the option to capitalize or deduct its intangible drilling and development costs. §§1.263(c)-1, 1.612-4. (Secs. 263, 612; ’86 Code.) Rev. Rul. 73-470, 1973-2 C.B. 88.
378.37 Intangible drilling and development costs; recoupment; partly-owned interests. Intangible drilling and development costs incurred by a taxpayer in drilling an oil and gas well under an agreement with the owner of oil and gas rights in a lease to receive an undivided part 378.32 Intangible drilling and development interest therein after completion of the well and to costs; prepaid. Intangible drilling and develop- receive the entire operating interest income until ment costs incurred and paid, pursuant to a con- recoupment (payout) of all such expenditures, are tract, by a cash basis taxpayer, who had elected in fully allowable as a deduction provided the proper a prior year to treat such costs as expenses, are election is made under reg. 1.612-4. No portion of deductible in the year paid even though the work such costs is required to be capitalized as depletis performed in the following year. This Ruling able leasehold acquisition costs. However, at paywill not be applied for taxable years ending on or out, a portion of the undepreciated basis in the tanbefore June 7, 1971, to require adjustment where gible equipment must be capitalized as depletable such costs were treated in accordance with Rev. leasehold acquisition costs. §§1.263(c)-1, Rul. 170. Rev. Rul. 170 revoked; distinguished by 1.612-4. (Secs. 263, 612; ’86 Code.) Rev. Ruls. 71-579 and 80-71. §§1.263(c)-1, Rev. Rul. 69-332, 1969-1 C.B. 87. 1.461-1, 1.612-4, 301.7805-1. (Secs. 263, 461, 378.38 Intangible drilling and development 612, 7805; ’86 Code.) costs; shut-in wells; minimum tax. For purposes Rev. Rul. 71-252, 1971-1 C.B. 146. of the tax on preferences, intangible drilling and 378.33 Intangible drilling and development development costs incurred in respect of a shut-in costs; prepaid. An oil and gas limited partnership natural gas well are included in the computation of made advance payments, at a fixed rate per well, net income from oil and gas. (Sec. 57, ’86 Code.) for the costs of drilling oil and gas wells to the parRev. Rul. 84-128, 1984-2 C.B. 15. ent of its corporate general partner. The parent owned no drilling equipment and subcontracted 378.39 Intangible drilling and development the actual drilling of the wells to independent dril- costs; turnkey agreements. An individual who ling contractors, who were paid on a footage and acquired an interest in an oil and gas lease from the day work basis upon completion of the contracts. original lessee well driller, under an agreement These prepayments are not deductible until paid to that required no payment for dry holes but paythe independent contractors. Rev. Rul. 71–252 ment of a specified amount to the driller at the distinguished. §§1.263(c)-1, 1.461-1, 1.612-4. completion of each of a stated number of wells that were completed as producers, has made capital (Secs. 263, 461, 612; ’86 Code.) expenditures that are not intangible drilling and Rev. Rul. 80-71, 1980-1 C.B. 106. development costs. §§1.263(c)-1, 1.612-4. (Secs. 378.34 Intangible drilling and development 263, 612; ’86 Code.) costs; prepaid. The taxpayer was a 50-percent Rev. Rul. 75-304, 1975-2 C.B. 94. limited partner in a limited partnership, both using the fiscal year ending June 30. Prior to June 30, 378.40 Lease bonus income; installment con1973, the partnership paid $160,000 to a drilling tract. Cash-method taxpayers who receive an contractor under a binding contract to drill six oil installment bonus contract as consideration for an and gas wells on designated well sites. After June oil or gas lease must include its value in gross 30, 1973, the contractor drilled only one of the six income for the year in which the lease is executed wells at a cost of $32,000. In 1974, the partnership if the obligation is transferable and readily salesuccessfully sued the contractor for failure to per- able. §§1.61–1, 1.446–1, 1.451–1. (Secs. 61, 446, form under the contract. The taxpayer deducted on 451; ’86 Code.) Rev. Rul. 68-606, 1968-2 C.B. 42. its 1973 return its share of the prepaid intangible drilling costs incurred by the partnership. The prepaid intangible drilling expenses under the bind- 378.41 Lease bonus income; nominal producing contract are deductible in the year of prepay- tion. Taxpayers took a depletion deduction on a ment despite the contractor’s failure to perform cash bonus received for granting an oil lease. services in subsequent years. (Secs. 263, 446; ’86 There was nominal rather than commercial production from the lease before it was abandoned. Code.) Stradlings Building Materials, Inc., 76 T.C. 84, Held, the production was sufficient that the depletion claimed did not have to be restored to income. Acq., 1981-1 C.B. 2. (Sec. 23(m), ’39 Code; Sec. 611 ,’86 Code.) Dolores Crabb, 41 B.T.A. 686, Nonacq., 1968-1 378.35 Intangible drilling and development costs; properties outside U.S. A taxpayer who C.B. 3. holds the working or operating interest in oil and gas properties located outside the U.S. has the 378.42 Leasehold interest sold; installment option to capitalize or expense the intangible dril- reporting. The sale by a lessee of his entire leaseling and development costs incurred with respect hold interest (or an undivided portion thereof) in to those properties if he is required to report the oil and gas in place is a sale of “real property” income therefrom. §§1.263(c)-1, 1.612-4. (Secs. used in the trade or business within the meaning of section 1221 and, therefore, his interest is not a 263, 612; ’86 Code.) “capital asset” as defined therein. Where such Rev. Rul. 67-34, 1967-1 C.B. 72. lease has been held for more than six months and 378.36 Intangible drilling and development is then sold or exchanged, it qualifies as a “real costs; properties outside U.S. A domestic corpo- property used in the trade or business” as defined ration that, under its agreement with a foreign in section 1231 and is subject to the treatment procountry, furnishes all the funds for exploration, vided by that section. Income from such sale may development, and production of gas and oil within be reported on the installment basis under section
453. I.T. 3693 superseded. §§1.453-1, 1.1221-1, 1.1231–1. (Secs. 453, 1221, 1231; ’86 Code.) Rev. Rul. 68-226, 1968–1 C.B. 362. 378.43 Leases; acquisition fees. Fees paid for services rendered in connection with the acquisition of noncompetitive government oil and gas leases, must be capitalized as part of the cost of acquisition of the leases acquired and may be recoverable through depletion. Distinguished by Rev. Rul. 71-191. §1.611-1. (Sec. 611, ’86 Code.) Rev. Rul. 67–141, 1967–1 C.B. 153. 378.44 Leases; acquisition fees; option fees. An explanation is provided of the tax treatment of (1) fees paid to a corporation that provides expert geological advice and files applications to acquire noncompetitive federal oil and gas leases, (2) fees paid for an option to sell an interest in any leases acquired, and (3) fees allocable to the corporation’s practice offering to purchase a specified fractional interest in acquired leases. Rev. Rul. 77–395 modified and clarified; Rev. Rul. 71–191 distinguished. §§1.165-1, 1.263(a)-1, 301.7805-1. (Secs. 165, 263, 7805; ’86 Code.) Rev. Rul. 80-176, 1980–2 C.B. 97. 378.45 Leases; acquisition fees; 5-year program. A fee paid by an investor to participate in a five-year program to acquire federal oil and gas leases is a capital expenditure includible in the basis of any leases acquired. Furthermore, since an investor who does not acquire any leases during the five-year term of the program receives a refund of the fee paid, the investor has not sustained any uncompensated loss within the meaning of section 165(a). §1.165-1. (Sec. 165, ’86 Code.) Rev. Rul. 83–137, 1983–2 C.B. 41. 378.46 Leases; advance royalties; cash bonuses; percentage depletion. Taxpayers who received advance royalty or lease bonus income from lessees of their oil and gas property interests in 1975 are entitled to an allowance for percentage depletion for that year even though no oil or gas was produced until 1976. §1.613A. (613A, ’86 Code.) Engel, 464 U.S., Ct. D. 2023, 1984-1 C.B. 148. 378.47 Leases; advance to investors. A group of investors contracted to sell natural gas from its leases to a gas company pursuant to an agreement calling for the interest-free advance of money by the purchaser to develop the leases. No income is realized by a cash method member of the group as a result of the loan. (Sec. 61, ’86 Code.) Charles E. Marsh, 73 T.C. 317, Nonacq., 1980-2 C.B. 2. 378.48 Leases; attempted acquisition. Fees paid by an individual for expert geological advice and filing service rendered in connection with an unsuccessful attempt to acquire specific noncompetitive government oil and gas leases are deductible under section 165(c)(2). Rev. Rul. 67–141 distinguished. §1.165-1. (Sec. 165, ’86 Code.) Rev. Rul. 71–191, 1971–1 C.B. 77; Rev. Rul. 79-346, 1979-2 C.B. 17. 378.49 Leases; COST well drilling expense. An explanation is presented of the tax treatment of the expenses of drilling a Continental Offshore Stratigraphic Test (COST) well to obtain geological information on an offshore area to be used in determining whether to bid on leases for oil and gas drilling in the general area of the COST well. §§1.263(a)-1, 1.263(c)-1, 1.612-4. (Secs. 263, 612; ’86 Code.) Rev. Rul. 80-342, 1980–2 C.B. 99. 378.50 Leases; drawing to select lessee. An amount equal to the difference, if any, between the fair market value and the cost of a lease obtained by a taxpayer by means of a drawing conducted by the Bureau of Land Management of the Department of the Interior is not a prize nor includable in the taxpayer’s gross income when he obtains the lease. §§1.61-1, 1.74-1. (Secs. 61, 74; ’86 Code.) Rev. Rul. 67-135, 1967-1 C.B. 20.
Oil and gas properties 378.51 Leases; equipment; additional firstyear depreciation allowance. Equipment used, accessory to and necessary for the operation of oil and gas wells on a lease, is “tangible personal property” for purposes of the additional first-year depreciation allowance. Rev. Ruls. 61-142 and 65-308 distinguished. §1.179-3. (Sec. 179, ’86 Code.) Rev. Rul. 67-99, 1967-1 C.B. 68.
378.59 Legal fees; overriding royalty ownership suits. Taxpayer deducted legal fees incurred in two court proceedings, one, a declaratory judgment action in which taxpayer’s title to an overriding royalty interest was in dispute and the other involving a claim to overriding royalty payments deposited in a local court. Held, only the portion allocable to the declaratory judgment was a nondeductible capital expenditure in the defense of title; the portion allocable to collecting accumu378.52 Leases; first year payments. Examples lated royalties was a deductible expense to recover illustrate certain first year payments made by a ordinary income. (Sec. 212, 263; ’86 Code.) leasee upon obtaining an oil and gas lease that are Vincent Boagni, Jr., 59 T.C. 708, Acq., 1973-2 delay rentals that may be capitalized or expensed C.B. 1. at the election of the lessee or are lease bonuses that must be capitalized. Rev. Ruls. 56–252 and 378.60 Lifting cost; personal holding compa67-15 superseded. §§1.162–1, 1.612-3. (Secs. nies. In the case of oil and gas producing proper162, 612; ’86 Code.) ties, lifting costs constitute a portion of the cost of producing oil and gas and must be subtracted from Rev. Rul. 80-49, 1980-1 C.B. 127. gross sales in computing gross income for the pur378.53 Leases; first year rental; rights pose of determining whether personal holding assigned. A first year rental payment on a non- company income is at least 80 percent of the corcompetitive governmental oil and gas lease poration’s total gross income for a taxable year. application must, be capitalized as depletable costs §§1.61-3, 1.542-2. (Secs. 61, 542; ’86 Code.) of the overriding royalty retained; amounts Rev. Rul. 60-344, 1960-2 C.B. 186. received from a third party for the assignment of the rights under the lease application and upon 378.61 Limitation on losses; amount at risk; granting of the lease are bonus payments and are grantor trust. The owner-grantor of a trust is at gross income from the property in the taxable year risk under section 465(b) only for the amount of received. Rev. Rul. 56-252 amplified. §1.612–3. cash transferred to the trust that was used as part of the purchase price of an interest in an oil and gas (Sec. 612, ’86 Code.) activity described in section 465(c) with the balRev. Rul. 69-467, 1969-2 C.B. 142. ance of the purchase price represented by the 378.54 Leases; rental income; personal hold- trust’s note, secured by the interest, upon which ing company. Sums received by a personal hold- the grantor was not personally liable. (Sec. 465, ing company under a lease agreement that are des- ’86 Code.) ignated as rent, fixed in amount and payable in Rev. Rul. 78-175, 1978-1 C.B. 144. advance semiannually for the use of, or the right production payments; to use, oil and gas property constitute rents under 378.62 Mineral section 543(a)(2). I.T. 3401 superseded. advance for unproven property. If an investor advances money to an oil and gas producer for the §1.543-1. (Sec. 543, ’86 Code.) right to the lesser of twice the amount advanced or Rev. Rul. 70-153, 1970-1 C.B. 139. a certain percentage of net proceeds from the sale 378.55 Leases; royalties; personal holding of hydrocarbons produced from a particular propcompany. Amounts received by a personal hold- erty, and the only indication that hydrocarbons ing company under a lease agreement with a dril- will be produced from the property is favor able ling company providing for the delivery to the les- geological and geophysical studies, the advanced sor of a one-eighth part of the oil and gas produced money will be treated as consideration for a royand for the sale of such oil and gas to the lessee for alty interest. §1.636–3. (Sec. 636, ’54 Code.) a stipulated price are royalties for purposes of Rev. Rul. 86-119, 1986-2 C.B. 81. computing personal holding company income. 378.63 Mineral production payments; “take §1.543-1. (Sec. 543, ’86 Code.) or pay” gas purchase contract. Payments Rev. Rul. 73-332, 1973–2 C.B. 195. received for gas that is to be taken in the future 378.56 Leases; royalty interest received for under a “take or pay” gas purchase contract are service. A corporate promoter, and attorney, and not mineral production payments and are includan employee of a closely held corporation, ible in gross income. §§1.451–1, 1.636–1. (Secs. received overriding royalty interests for services 451, 636; ’86 Code.) provided in connection with the acquisition/develRev. Rul. 80-48, 1980-1 C.B. 99. opment of oil and gas leases. Each has received a property interest, the fair market value of which is 378.64 Mineral production payments; “take includable in gross income under section 83. or pay” gas purchase contracts; inclusion.The deficiency taking amount in a “take or pay” gas §1.83-1. (Sec. 83, ’86 Code.) purchase contract determined at December 31, the Rev. Rul. 83-46, 1983-1 C.B. 16. last day of the contract year, must be included in 378.57 Leases; undivided interest; royalties the taxpayer’s gross income for its tax year ended based on production. No part of the royalty pay- June 30, the tax year in which the amount of the ments received by the lessor of an undivided inter- deficiency taking became fixed and determinable. est in oil and gas producing properties, under a §1.451-1. (Sec. 451, ’86 Code.) lease agreement providing that, from month to Rev. Rul. 84-31, 1984-1 C.B. 127. month, the royalty percentages could decrease or increase based on average daily gross production 378.65 Natural gas; drilling costs; underfor the previous three consecutive month periods, ground gas storage reservoir.The costs of drilis a production payment. §1.636-3. (Sec. 636, ’86 ling wells to adapt a subsurface aquifer formation for use as a natural gas storage reservoir are capital Code.) expenditures recoverable through depreciation. Rev. Rul. 76-34, 1976-1 C.B. 177. §§.167(a)-2, 1.263(a)-1, 1.612-4. (Secs. 167, 378.58 Leases; unproductive acreage relin- 263, 612; ’86 Code.) quished. Where a portion of a leased oil and gas Rev. Rul. 75–235, 1975-1 C.B. 97. property is unitized and the lessee of the property relinquishes the remaining leased acreage falling 378.66 Natural gas; easements; underground outside the productive unit boundaries, the lessor storage facilities; depreciation. The costs of is not required to restore to gross income any of the easements, surveys, engineering studies, testing, depletion allowance taken on the lease bonus property damage, and rights to use a subsurface income received. §1.612–3. (Sec. 612, ’86 Code.) aquifer reservoir for gas storage purposes are capital expenditures recoverable through depreciRev. Rul. 68–78, 1968–1 C.B. 294.
ation. §§1.167(a)–3, 1.263(a)-1. (Secs. 167, 263; ’86 Code.) Rev. Rul. 75-234, 1975-1 C.B. 96. 378.67 Natural gas; “take-or-pay” contracts; prepayments. Where a purchaser of natural gas for resale enters into a “take-or-pay” contract under which a liability arises to make a payment for a contract year’s gas not yet taken, the asset acquired by the incurring of the liability must be treated by the purchaser as a deferred charge. When title to the “make-up gas” vests in the purchaser, such gas enters into the computation of cost of goods sold. If the gas is not taken and the right to take the gas is not assigned, a loss for the amount paid is allowable for the year in which it can be determined that the gas will never be taken and that the amount paid will not be refunded. §§1.165-1, 1.461-1, 1.471-1. (Secs. 165, 461, 471; ’86 Code.) Rev. Rul. 66-64, 1966-1 C.B. 97. 378.68 Natural gas; unrecoverable; underground storage. The cost of natural gas injected into an underground aquifer reservoir and determined to be unrecoverable is a capital expenditure recoverable through depreciation. §§1.167(a)-1, 1.263(a)-1. (Secs. 167, 263; ’86 Code.) Rev. Rul. 75–233, 1975-1 C.B. 95. 378.69 Offshore Government; abandonment. Under described circumstances, a subleasee is entitled to an abandonment loss in the year he releases to the Government his leasehold interest in one of two contiguous offshore Government mineral properties. §1.614–1. (Sec. 614, ’86 Code.) Rev. Rul. 68–566, 1968–2 C.B. 281. 378.70 Operating costs; ABC or ACB transactions. The L. W. and Jane R. Brooks decision, holding that operating costs are deductible by the owners of operating interests in mineral properties burdened with production payments and acquired through ABC or ACB transactions will be followed. §1.162-1. (Sec. 162, ’86 Code.) Rev. Rul. 71-35, 1971-1 C.B. 51. depletion; statutory 378.71 Percentage merger. In the merger of two corporations that are business entities under common control; percentage depletion under section 613A will not be lost to the surviving corporation upon any of the proven oil and gas properties owned by the corporation merging into the surviving corporation when percentage depletion is otherwise available as of the effective date of the merger. §1.613A-1. (Sec. 613A, ’86 Code.) Rev. Rul. 83-167, 1983-2 C.B. 104. 378.72 Pipeline easements; depreciation. Costs of right-of-way easements for oil and natural gas pipelines are intangible assets depreciable over the useful life of the particular pipeline; such costs do not qualify for accelerated depreciation or investment credit. The associated clearing and grading costs are part of the pipeline construction costs and are tangible assets subject to depreciation over the useful life of the related pipelines; such costs qualify for accelerated depreciation and investment credit. Rev. Ruls. 60–317 and 65–264 revoked; modified by Rev. Rul. 72-403. §§1.167(a)-2, 301.7805-1. (Secs. 167, 7805; ’86 Code.) Rev. Rul. 71–120, 1971–1 C.B. 79; Rev. Rul. 71-448, 1971-2 C.B. 130. 378.73 Production payments; guarantor; ABC transactions. In view of the decisions in George H. Landreth and H. W. Donnell the Revenue Service explains its position on whether taxpayers who guarantee oil production payments in ABC transactions are taxable on the proceeds from the payments. The principle to be applied in determining the taxability is that the owner of the economic interest in minerals in place (i.e., the party who must look solely to production for a
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return of his invested capital and thus bears the ultimate risk of loss from a failure of production) is taxable on the income allocable to a production payment from such mineral deposit. §1.611-1. (Sec. 611, ’86 Code.) Rev. Rul. 69-262, 1969-1 C.B. 166. 378.74 Production payments; loan guaranty. Taxpayer sold working interests in oil and gas leases retaining production payments which he sold to a third party who borrowed the money from a bank using such payments as security. Taxpayer agreed to either find a purchaser for the note or purchase it himself at maturity. Held, taxpayer was not taxable on the income from production payments. The bank agreement did not constitute a guarantee of the production payments, and after their sale, he had no economic interest in them. The third party was not a mere straw man; if taxpayer had paid off the loan, he would have had a subrogation right against the third party whereby he could recoup his expenditure. (Sec. 611, ’86 Code.) George H. Landreth, 50 T.C. 803, Acq., 1969-1 C.B. 1.
378.80 Swiss convention; net profits interest. Payments received by a Swiss corporation from its net profits interest in oil and gas mineral property located in the U.S. are not industrial and commercial profits within the meaning of Article II(1)(h) of the U.S.-Swiss Confederation Income Tax Convention but are rents or royalties taxable by the U.S. pursuant to Article IX(1) of the Convention. Rev. Rul. 73-419, 1973-2 C.B. 436. 378.81 Transfer; exception to disallowance for depletion; reorganization. An “F” reorganization involving a single entity does not cause a “transfer” of proven oil and gas properties within the meaning of section 613(c)(9)(A). §1.368–1. (Secs. 368, 613A; ’86 Code.) Rev. Rul. 83-62, 1983-1 C.B. 113. 378.82 Unitization; equalization payments. Guidelines are provided with respect to the unitization of oil and gas properties and the treatment of equalization payments connected therewith. §§1.614-8, 1.1031(b)-1. (Secs. 614, 1031; ’86 Code.) Rev. Rul. 68-186, 1968-1 C.B. 354.
378.75 Production payments; personal hold- 378.83 Unitization agreement; depletion. The ing company income. Gross income received by taxpayer joined in a unitization agreement for the a corporation from the sale of oil and gas produc- cooperative operation of oil wells in a certain pool. tion attributable to its working interests in oil and It provided that the rights of the participants were gas properties is not personal holding company thereby unitized for the life of the mineral deposit, income. §§1.543–1, 1.612-4, 1.614–2. (Secs. 543, absent unanimous consent to terminate. The taxpayer owned two separate properties which over612, 614; ’86 Code.) lay the pool. It had taken percentage depletion on Rev. Rul. 77-127, 1977-1 C.B. 158. one property and cost depletion on the other. Held, 378.76 Removal of offshore platforms and the taxpayer did not exchange its interest in the well fixtures; lease requirement; deduction. A two separate properties for a new depletable intercorporation using the accrual method of account- est measured by its total share of oil produced ing entered into long-term offshore oil and gas under unitized operation. (Secs. 23(m), 112(b), 114(b), ’39 Code; Secs. 611-613, ’86 Code.) leases with the federal government under which Belridge Oil Co., 27 T.C. 1044, Nonacq., the corporation was required to remove the platforms and well fixtures upon abandonment of the 1958-2 C.B. 9. wells or termination of the leases. The corporation may deduct the costs of removing services are performed by the corporation or by a separate contractor. §1.461–1. (Sec. 461, ’86 Code.) Rev. Rul. 80-182, 1980-2 C.B. 167. 378.77 Royalty interest. If a royalty interest in oil and gas in place is used by the owner in his trade or business, it is not capital asset but will be subject to the provisions of section 1231 if held for more than six months; if the royalty is held for investment, gain or loss on its sale is a capital gain or loss; and if the royalty is held for sale in the ordinary course of business, gain or loss on its sale is ordinary gain or loss. Rev. Rul. 55–526 superseded. §§1.1221-1, 1.1222–1, 1.1231–1. (Secs. 1221, 1222, 1231; ’86 Code.) Rev. Rul. 73-428, 1973-2 C.B. 303. 378.78 Sale v. lease. Taxpayer assigned his interest in oil and gas property for $900,000 retaining production payments totaling $2,850,000. Shortly before the assignment, it was estimated that the future net income from the property would be $2,308,800, but with unitization and a pressure maintenance program, such net income would be $4,408,530. Held, the expected life of the property with unitization was sufficient to pay out the production payment, and the $900,000 payment represents the selling price of the taxpayer’s interest and is taxable as a long-term capital gain rather than as a lease bonus. (Secs. 1221, 1231; ’86 Code.) Howard Glenn, 39 T.C. 427, Acq., 1970-2 C.B. xix. 378.79 Sand fracturing. Taxpayer purchased producing wells and sand fractured them to open new zones of production. Held, the fracturing costs were deductible production expenses not development costs. (Sec. 263, ’86 Code.) Producers Chemical Co., 50 T.C. 940, Acq., 1969-1 C.B. 21.
