Cook v. Commissioner

*92 The respondent has asserted a deficiency in income taxes for 1925 in the amount of $3,133.06. The petitioner alleges that the respondent *93 erred in disallowing deduction of an item of $10,000 which the petitioner claimed as a loss sustained in the taxable year. In an amended answer filed at the hearing the respondent seeks to have the tax deficiency increased and alleges that he has erroneously allowed a deduction of $11,507, which he now seeks to restore to petitioner's taxable income for the year under review.

*1583 The parties have stipulated as true the following statement of facts:

During the year 1925, the petitioner resided in El Dorado, Arkansas, where he was actively engaged in the business of drilling wells in the El Dorado Oil Field. The petitioner was interested in several partnerships engaged in the production of oil and gas. He also owned undivided interests in producing oil properties. The petitioner's principal business was that of contract oil well drilling, which business was operated under the name of Cook Drilling Company, a sole proprietorship.

On or about August 29, 1925, the petitioner and J. B. Sewell purchased from Harry Ezzell, and others, an oil and gas lease covering the southeast quarter of the northwest quarter of Section 18, Township 17 South, Range 14 West, Union County, Arkansas, consisting of forty acres for a consideration of $20,000, each paying $10,000 for a one-half interest.

This lease was purchased jointly, but shortly thereafter it was agreed to divide the lease, the petitioner acquiring the north half, and J. B. Sewell the south half, and an assignment to show this division was made. The Ezzell lease was to run for five years from the date*1584 of acquisition, August 29, 1925. The lease provided for an annual rental of $1 per acre, unless oil or gas was produced in commercial quantities.

On September 3, 1925, the petitioner organized the Cook Drilling Company, a corporation, under the laws of Arkansas, and turned into this corporation certain assets, for which he received $95,000 par value capital stock. There was also sold for cash, $3,500 of the par value of the capital stock. The outstanding capital stock on December 31, 1925, was $98,500, $95,000 of which was owned by the petitioner.

After the corporation was organized, the petitioner made a proposition to the other stockholders of the Cook-Drilling Company, whereby the corporation was to drill a well on the Ezzell lease; and if it was a producing well the corporation would have full benefit. But if there was a dry hole, the petitioner was to pay all of the expenses of drilling the well and the cost of the lease.

Pursuant to this agreement, the petitioner assigned the Ezzell lease to the corporation on September 8, 1925, and was credited on the corporation's books with $10,000, the price he had paid for it. The Cook Drilling Company then began the drilling*1585 of a well on the Ezzell lease, expending the sum of $11,507. The well was completed as a dry hole sometime before the end of the year 1925; and on December 31, 1925, there was charged to the petitioner on the books of the corporation, the sum of $21,507, representing the original cost of the lease and the cost of drilling the dry hole.

The lease was finally released by the Cook Drilling Company on or about November 22, 1930, and the petitioner had no control over the property other than his control as the principal stockholder and president of the corporation.

In the determination of the deficiency, the respondent disallowed the sum of $10,000, representing the amount claimed by the petitioner as a loss sustained on the Ezzell lease in his return for the year 1925.

*94 OPINION.

LANSDON: The law here invoked by the parties to support their respective contentions is found in the provisions of the Revenue Act of 1921, reading as follows:

SEC. 214. (a) In computing net income there shall be allowed as deductions:

(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * *

* * *

(4) Losses sustained*1586 during the taxable year and not compensated for by insurance or otherwise, if incurred in trade or business; * * *

(5) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business; * * *

The petitioner seeks to deduct, as a loss under section 214, supra. the cost to him of the lease which he transferred to the corporation in that year, under conditions and circumstances above set forth. The petitioner's business in the year was drilling oil wells and contract oil-well drilling, which he carried on as an individual business proprietorship known as "Cook Drilling Company." He also has interests in a number of copartnerships engaged in buying, selling, and speculating in oil properties. Obviously, he was engaged in all of these activities for profit. He purchased this lease and transferred it to his corporation, which agreed to develop it under the terms provided; and, as an inducement, he agreed to indemnify it against loss in carrying out such terms. Whether this was a transaction entered into for profit, or merely good business to get from*1587 under his obligations of that lease, it was, to say the least, well within the regular line of business in which he was engaged in that year, as shown by the statement of facts. Upon the bringing in of the dry hole, he immediately became indebted to the corporation in the sum of $21,507, under his indemnity agreement. The corporation at once entered a charge in the above amount in its books against the petitioner which canceled the credit of $10,000 it had given the petitioner as purchase price of the lease. Through this process the petitioner lost whatever property he ever had in the lease and his right to collect his sale price to the corporation. Whether allowable under subparagraph (4) or (5) of section 214(a), supra, it is clear that the petitioner's investment in the lease, in the regular course of business, was lost to him in 1925, and he should be entitled to take credit for the same on his taxable income for that year. On this issue the petitioner is sustained. ; *1588 ; ; ; ; .

*95 In respect to the second point in controversy, the burden is upon the respondent to show that the disputed expense item set forth in his amended answer was claimed as a deduction by the petitioner in his income-tax return and erroneously allowed. This he failed to do. The statement attached to the deficiency letter was incomplete and failed to show what items figured in the computation of the tax; and the return, put in evidence, merely shows, under "Expense & Deductions," that the petitioner claimed a gross credit of $21,507, for "Ezzell Lease & Dry Hole." Assuming that that claim included the drilling-expense item which the respondent seeks to restore to petitioner's income, we can not further assume, in the absence of proof, that it was allowed even in part. The respondent alleges that it was allowed, but has failed to sustain the burden of establishing the fact. In view of this*1589 lack of proof, we must hold in favor of the petitioner on this last issue raised in respondent's amended answer. .

Decision will be entered for the petitioner.