North Am. Oil Consol. v. Commissioner

NORTH AMERICAN OIL CONSOLIDATED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. North Am. Oil Consol. v. Commissioner Docket Nos. 8714, 16107. United States Board of Tax Appeals 12 B.T.A. 68; 1928 BTA LEXIS 3602; May 24, 1928, Promulgated *3602 1. Assessment and collection of taxes for 1917 held not barred by statute of limitations. 2. Deduction claimed for an amount paid the Oil Industry Association disallowed for lack of evidence. 3. Cost of replacing derricks damaged by fire held not deductible as expense. 4. Portion of proceeds of oil paid attorneys for legal services in defending title to property and securing land patents, held to be capital expenditures. Further held that depletion is allowable in each year in amounts equal to the sums paid to the attorneys. 5. Respondent sustained in disallowing deductions claimed on account of expenditures in 1918 and 1919 for gasoline engines. 6. Value of petitioner's land holdings in one section for invested capital and depletion purposes determined, and quantity of oil reserves for depletion purposes determined. 7. Respondent sustained in reduction of invested capital on account of fire losses, depletion, and taxes for prior years, subject to correction of amounts to reflect changes effected by this decision. 8. Income in 1916 impounded by court order and released to petitioner in 1917 held not taxable to petitioner in 1917. *3603 9. Capital expenditures made in 1910 and 1911 should be reduced to reflect depletion before inclusion in capital sum remaining in 1916 for purposes of computing invested capital and depletion for 1917 and subsequent years. Charles D. Hamel, Esq. and Lee I. Park, Esq., for the petitioner. A. George Bouchard, Esq., for the respondent. ARUNDELL *69 In this proceeding the petitioner seeks a redetermination of the income and profits taxes for the years 1917, 1918, and 1919, for which the Commissioner has determined deficiencies of $109,239.61, $62,228.66, and $59,097.03, respectively. The petitioner alleges error on the part of the Commissioner: (1) In proposing an additional tax for the year 1917, after the assessment and collection of such tax was barred by the statute of limitations provided by section 250(d) of the Revenue Act of 1921 and section 277 of the Revenue Act of 1924; (2) In disallowing as a deduction in 1917, $8,000 paid to the Oil Industry Association; (3) In disallowing as deductions amounts spent for the repair and replacement of oil derricks damaged by fire as follows: 1917, $5,271.50; 1918, $7,096.41; (4) In including*3604 in taxable income for 1917, $20,441.18, representing 4 per cent of the oil recovered during the year from section 2, and paid to the petitioner's attorneys for legal services in defending title to property; (5) In disallowing as expense for the year 1917, $5,765.94 spent for gas pumping enginees, sucker rods, small receiving oil tanks, well casing and tubing, and for the year 1918, $17,598 and for the year 1919, $5,049.28 expended for gasoline engines used in operating the pumps at the various oil wells; (6) In determining inadequate amounts as depletion deductions for 1917, 1918, and 1919 on account of oil extracted during such years from section 16, township 32 south, range 23 east. This issue involves the determination of the value of the oil deposit in section 16 at March 1, 1913; (7) In reducing invested capital for 1917 in an amount of $33,882.51 and in 1918 in an amount of $1,589.04, representing profits realized in 1917 and 1918 on a 1914 contingent sale; (8) In reducing invested capital for 1918 in an amount of $1,646.19 and for 1919 in an amount of $5,146.19, representing fire losses in 1917 and 1918, respectively; (9) In reducing invested capital on account of*3605 depletion sustained during prior years by the following amounts: 1917, $602,820.96; 1918, $707,819.73; 1919, $819,751.89; (10) In reducing invested capital for 1918 in an amount of $65,274.34 and for 1919 in an amount of $33,217.57, representing additional taxes for the previous year, pro rated over the taxable year; (11) In reducing invested capital in all years by $1,638,611.21, representing excess valuation of property. This issue involves the determination of the value of property acquired for stock and bonds on February 10, 1910, and August 25, 1910. *70 The Commissioner, in his answers to the various petitions and amendments thereto, alleges affirmatively: (a) That he erred in failing to include as taxable income in 1917 an amount of $253,150.96 received by the petitioner in that year, representing the revenue derived from section 2, township 32 south, range 23 east, which amount was impounded during the litigation between the petitioner and the United States in 1916 and 1917 and released in 1917; (b) That he erred in determining invested capital and depletion allowance for 1917 by adding to the capital sum remaining in 1916 the amount of $287,687.03, representing*3606 the cost of well development on section 16 during 1916, whereas this amount was expended as follows: 1910, $51,727.64; 1911, $235,959.39; that the additions to capital should have been made in 1910 and 1911 in the amounts thus expended instead of 1916; that the invested capital for 1917 as shown in deficiency letter dated September 28, 1925, should be decreased by $131,930.22, and that the depletion allowance for 1917 as shown by said deficiency letter should be reduced by $11,224, that the invested capital for 1918 and 1919 as shown by the deficiency letter of April 9, 1926, should be decreased by $120,706.22 and $112,420.62, respectively, and that the depletion allowances for 1918 and 1919 as shown by said letter should be reduced by $8,285.60 and $8,029.67, respectively; (c) That he erred in allowing depletion deductions in 1918 and 1919 based upon discovery value of oil wells located in section 2, township 32 south, range 23 east; (d) That he erred in allowing as a deduction for 1918, $21,730.60 and for 1919, $35,795.45 paid to attorneys for legal services in perfecting title to a portion of the petitioner's property and alleges that the sums paid were capital expenditures. *3607 At the hearing the petitioner conceded and abandoned issue number (7) and the respondent conceded and abandoned his affirmative allegation designated issue (c). FINDINGS OF FACT. The petitioner is a corporation organized in 1910 under the laws of the State of California with principal office at 915 Balfour Building, San Francisco, Calif. On February 10, 1910, the petitioner acquired from Louis Titus in exchange for 82,500 shares of capital stock of a par value of $8,250,000 and $825,000 face value of bonds, certain properties in accordance with a resolution adopted by the directors in a meeting of February 10, 1910. The portions of the resolution dealing with the lands involved in this proceeding were as follows: *71 WHEREAS, Louis Titus has offered to sell and to convey to this corporation, free and clear of all encumbrances, the following lands situate, lying and being in the County of Kern, State of California, described as follows, to-wit: North half of Northeast quarter of Southeast quarter (N 1/2 of NE 1/4 of SW 1/4), South half of Southwest quarter (S 1/2 of SW 1/4) of Section Sixteen (16); * * * and to sell and convey to this corporation all his*3608 interest in the following lans, situate in the County of Kern, State of California, described as follows, to-wit: The South half of Southeast quarter (S 1/2 of SE 1/4); Northwest quarter of Southeast quarter (NW 1/4 of SE 1/4); South half of Northeast quarter (S 1/2 of NE 1/4) of Southeast quarter (SE 1/4); South half of Southwest quarter of Northeast quarter (S 1/2 of SW 1/4 of NE 1/4); South five (5) acres of North half of Southwest quarter of Northeast quarter (N 1/2 of SW 1/4 of NE 1/4); North half of Southwest quarter (N 1/2 of SW 1/4), of Seection Sixteen (16); * * * East half of Northeast quarter (E 1/2 of NE 1/4); Northwest quarter of Northeast quarter (NW 1/4 of NE 1/4); North fifteen (15) acres of North half of Southwest quarter of Northeast quarter (N 1/2 of SW 1/4 of NE 1/4), in Section Sixteen (16); * * * All In Township Thirty-two (32) South, Range Twenty-three (23) East, Mount Diablo Base and Meridian; and to sell to this corporation all personal property and equipment now upon and used in connection with, or in the operation of, said lands or leases, or any part thereof; all in consideration of the issuance to said Louis Titus of Eighty-two Thousand Five Hundred*3609 (82,500) shares of the capital stock of this corporation, fully paid up, and the delivery to him of First Mortgage Six Per Cent Gold Bonds of this corporation aggregating Eight Hundred and Twenty-five Thousand ($825,000.) Dollars, in par value of said bonds, which bonds are to be secured by a First Mortgage on the lands and leases so conveyed by said Louis Titus; and in further consideration of the assumption by this corporation of all obligations of the leases so offered to be assigned, and of the assumption by this corporation of liability for all unpaid bills incurred for labor or material used upon any of said lands or leases, and in further consideration of the assumption by this corporation of all bills and obligations of Hartford Oil Company, a corporation, which bills and obligations have heretofore been assumed by said Louis Titus. Part of the obligations assumed by the petitioner represented the balance of the purchase price still owing upon certain of the lands described above. On August 25, 1910, the petitioner purchased the fee to 135 acres in the northeast quarter of section 16, of which land the petitioner was lessee, in accordance with a resolution adopted in*3610 a meeting of the board of directors on August 10, 1910, which reads as follows: RESOLVED, that this corporation purchase from Lockwood Company, a corporation, all the right, title and interest now owned or claimed by said Lockwood Company in or to the Northeast quarter and the South half of Section 16, in Township 32 South, Range 23 East, M.D.B. & M., including the remainder in fee owned by said Company in about one hundred and thirty-five (135) acres *72 in the Northeast quarter of said Section, a claim to an interest in fee in a triangular piece of land along the southerly boundary of the Southeast quarter of said Section, and an undivided one-half interest in two strips of land along the Southerly and Westerly boundary lines of the Southwest quarter of said Section and that with said lands, this corporation purchase a release from any and all obligations to said Lockwood Company incurred by it under all leases of lands of which this company is lessee in said Section 16, and also purchase a release of all its obligations of every kind now owned or held by or owing to said Lockwood Company, except the promissory note of this corporation, dated May 17, 1910, for the sum of*3611 $38,116.25, and that in consideration of the transfer of said interests in land and of the release of said obligations by said Lockwood Company to this corporation, this corporation pay to said Lockwood Company the sum of $2,244.50 and deliver to said Lockwood Company bonds of this corporation aggregating $200,000 in face value thereof, and also issue and deliver to said Lockwood Company 2,000 shares of the capital stock of this corporation. On March 1, 1909, Louis Titus, acting on behalf of the Hartford Oil Co., one of the predecessors of the petitioner, acquired from the Lockwood Company an option to purchase for $180,000 the W. 1//4, containing about 80 acres of land; the NE. 1//4, containing about 40 acres of land; the S. 1/2 S. 1//4, containing about 40 acres of land, all in section 16, township 32 south, range 23 east, M.D.B. & M. By the same agreement, Titus also acquired for the Hartford Oil Co. an option to lease from the Lockwood Company the N. 1//4, containing about 80 acres, and the N. 1/2 S. 1/*3612 /4, containing about 40 acres, all in section 16, township 32 south, range 23 east, M.D.B. & M. On June 1, 1909, the option of March 1, 1909, was exercised by Titus, acting on behalf of the Hartford Oil Co. On July 20, 1909, the Hartford Oil Co. acquired the SE. 1/4 of the SE. 1/4 of section 16, township 32 south, range 23 east. On November 27, 1909, the contract of March 1, 1909, was revised in the following particulars: Whereas, the parties now desire to modify said agreement, it is now therefore, agreed, that there shall be released from said agreement of sale, the following described property, to-wit: The North half (1/2) of the Northeast quarter (1/4) of the Southeast quarter (1/4) of said Section, and also the South half (1/2) of the Southeast quarter (1/4) of the Northeast quarter (1/4) of said Section; and said land shall not be purchased by the party of the second part, but shall be retained by the party of the first part. The purchase price of the entire One Hundred and sixty (160) acres agreed to be purchased, shall be reduced at the rate of Eleven hundred and twenty-five ($1,125.00) dollars per acre for each acre above released from said*3613 contract. It is further agreed, that the party of the first part will sell to the party of the second part, and the party of the second part will buy from the party of the first part, the North half (1/2) of the Southwest quarter (1/4) of said Section Sixteen (16), and pay therefor the sum of Eleven hundred and twenty-five ($1,125.00) dollars per acre. The party of the second part will also buy from the party of the first part a strip of land along the South side of and *73 being a portion of the North half (1/2) of the Southwest quarter (1/4) of the Northeast quarter (1/4) of said Section, which strip of land shall be sufficient in width to contain five (5) acres of land and shall include the present well and buildings now understood to be upon said five (5) acres. If, upon a survey, it should be determined that a wider strip of land is needed in order to include said well, and said buildings, then said strip of land shall be wide enough in any event to include said well and said buildings, and the party of the second part will pay therefor at the rate of Eleven hundred and twenty-five ($1,125.00) dollars per acre. It is further understood and agreed, that the lease*3614 now held by the party of the second part upon the One hundred and twenty (120) acres of land in said Section, shall be cancelled and annulled, but that the party of the second part shall receive from the party of the first part a lease upon the West half (1/2) of the Northeast quarter (1/4) of said Section, save and except such portions of said land as have heretofore or herein agreed to be sold to said second party. Said lease shall be upon the terms and conditions of said original lease for said One hundred and twenty (120) acres, save and except that the party of the second part shall be required to keep in operation only one string of tools on said property, and shall be allowed Ninety (90) days from date in which to commence operation upon the first well on said lease, and the party of the second part shall not be required to drill more than One (1) well to each four (4) acres of said leased land. It is further understood and agreed that inasmuch as there is an apparent shortage in said Section, that all payments and settlements under this and the previous agreement between the parties hereto, shall be adjusted according to the Buffington Survey, it being understood, however, *3615 that in the event that the party of the first part can, within two (2) years from the date hereof, deliver the full amount of land called for in said contracts, or any land in addition to the Buffington Survey, and can make up said shortage by adding to the Southerly line of the Southeast quarter (1/4) of said Section, and/or adding to the Westerly line of the North half (1/2) of the Southwest quarter (1/4) of said section, that then, and in that event, the party of the second part shall be bound to accept said additional acreage and pay therefor at the rate of Eleven Hundred and Twenty-five ($1,125.00) Dollars per acre. It is further understood that all sums due under this and the previous contract between the parties hereto shall be paid at the rate of Ten Thousand ($10,000) Dollars on December 1, 1909, and the balance at the rate of Five Thousand ($5,000) Dollars per month, payable on the first day of each and every month until the entire sum is paid, and that deferred payments shall bear interest at the rate of Six per cent (6%) per annum, payable monthly, said interest to begin for the additional land purchased under this contract on the first day of December, 1909. *3616 On February 3, 1910, Louis Titus, acting on behalf of the Louis Titus Pool, leased from the Lockwood Company the E. 1//4; the NW. 1//4; and the north 15 acres more or less of the N. 1///4. The lessor retained one-fifth of all money received from the sale of oil. On February 4, 1910, Louis Titus, acting on behalf of the Louis Titus Pool, purchased from the Lockwood Company the N. 1///4 sec. 16, T. 32 S., R. 23 E., M.D.B. & M., containing twenty acres of land, more of less, for $30,000. *74 The record does not show the date of purchase of the S. 1//4, sec. 16, T. 32 S., R. 23 E., M.D.B. & M. It was, however, turned over to the petitioner on February 10, 1910, and the petitioner does not contend that it was acquired by the Hartford Oil Company prior to that date. It was acquired at a total cost of $78,480. The oil possibilities in a portion of it at that time were doubtful. The costs of the lands in section 16, township 32 south, range 23 east, which were acquired by the petitioner on February 10, 1910, to the predecessors of the*3617 petitioner were as follows: Cost Hartford Oil Co., Fee SE 1/4 of SE 1/4 $42,000.00 Hartford Oil Co., Fee N 1/2 of SW 1/4; W 1/2 of SE 1/4; S 1/2 of NE 1/4 of SE 1/4; S 1/2 of SW 1/4 of NE 1/4; 5.5 acres of N 1/2 of SW 1/4 of NE 1/4 205,616.25 Hartford Oil Co., Lease S 1/2 of SW 1/4 10,000.00 Louis Titus Pool, Fee S 1/2 of SW 1/4 68,480.00 Louis Titus Pool, Fee N 1/2 of NE 1/4 of SE 1/4 30,000.00 Louis Titus, Lease, N 1/2 of NE 1/4; N 1/2 of SE 1/4 of NE 1/4; 15 acres of N 1/2 of SE 1/4 of NE 1/4 Nothing Total 356,096.25 The petitioner did not acquire a small area in the northwest corner of the southwest quarter, nor a small area in the southwest corner of the southwest quarter of section 16. At the time section 16 was acquired by the petitioner, the geological structure of the district had been worked out and the existence of oilbearing sands established. It was apparent that an anticlinal axis crossed the southwestern portion of section 16, and extended for several miles northwest and southeast. From a geological point of view section 16 was favorably situated for the accumulation of oil in the underlying sands. The development northwest*3618 and southeast of section 16 established that there existed in those sections a zone or streak in the sands which contained a lighter and more valuable oil than was found to the southwest in the foothills. Persons interested in the field generally believed that this streak or zone extended from the middle of section 30, township 32, range 24, southeastward into the Maricopa District and northwestward across sections 14, 10, 15, the northeast portion of 16, 9, portions of 5, and section 6 in township 32, range 23, and thence northwest across section 31, township 31, range 23, and sections 24, 25, and 36 of township 31, range 22. Several wells were drilled in this zone, of the highly productive type called "gushers," which resulted in naming this zone the "gusher zone." Prior to February, 1910, a few wells had been drilled on section 16. Four wells were drilled in the southwest quarter. These wells struck oil but the production from them, if there was any at all, was *75 inconsequential. These wells appeared to represent the southwest margin of profitable development and indicated that the prospect of striking oil in the southwest quarter was rather doubtful. One well was*3619 drilled southwest of the center of the northeast quarter, which showed lots of oil but so much water was mixed with the oil that there was no commercial production. Two wells were drilled in the southeast quarter. Well No. 2 produced about 100 barrels a day and Well No. 3 about 200 barrels a day. These wells were near the west line in the southwest quarter of the southeast quarter. A number of wells had been drilled in the northeast quarter of section 17, and in sections 8, 22, 23 and 26, which encountered the oil-bearing sands between sea level and an elevation of 500 feet above sea level. A large part of section 16 shows the oil-bearing sands at the same elevation. A well was drilled in the center of section 9, township 32, range 23, in October, 1909, by the C.C.M.O. Company. A "showing" of oil only resulted. This well encountered the oil sand at about 600 feet below sea level. A well was drilled in the southwest corner of the northwest quarter of section 15, known as the Jade, encountering the sand some 300 feet below sea level. A well was drilled in the southwest quarter of section 14, known as the Bedrock, encountering the sand about 800 feet below sea level. In*3620 September, 1909, the Standard Oil Co. brought in a good well in section 14, township 32, range 23, encountering the sand about 1,200 feet below sea level. In November, 1909, the St. Lawrence Oil Co. drilled a well in the southwest corner of the SE. 1/4 sec. 5, T. 32, R. 23, that produced about 500 barrels a day, encountering the oil sands approximately at sea level. In November, 1909, the C.C.M.O. Company drilled a well in section 6, township 32, range 23, which produced 1,000 barrels a day. At the well the oil sand was encountered at approximately 500 feet above sea level. Other wells drilled prior to February 10, 1910, were as follows: Date Description Designation Remarks April, 1909 Sec. 7, T. 12, R. 25 Lady Washington Showing of oil. July, 1909 Sec. 10, T. 32, R. 24 Gasser. October, 1909 Sec. 14, T. 31, R. 22 Bear Creek Considerable heavy oil Do Sec. 30, T. 32, R. 24 Standard Oil Showing of oil. November, 1909 Sec. 36, T. 12, R. 24 Wellman Large well. January, 1910 Sec. 35, T. 32, R. 23 Hamilton No. 1 Commercial producer. June, 1909 Sec. 31, T. 31, R. 23 Crandall No. 1 Large producer. September, 1909 Sec. 31, T. 31, R. 23 Crandall No. 2 Production. October, 1909 Sec. 31, T. 31, R. 23 No. 2 Midway Crude 406 barrels a day. *3621 At this time it was known that numerous anticlines, and synclines had resulted from the folding of the oil sands, causing many *76 abrupt changes in the dip of the sands, within short distances. The Spellacy Hill anticline extended from section 18, township 32, range west. These were all minor folds in the McKittrick formation Another anticline was located crossing the southwestern portion of section 6, township 32, range 23, and extending into township 31, range 22, and a third was located from section 35, township 32, range 23, southeast to section 11, township 11 north, range 24 west. These were all minor folds in the McKittrick formation. which as a whole was tilted to the northeast. In March, 1910, the Lakeview gusher came in on section 25, township 12, range 24, and produced from 40,000 to 70,000 barrels a day. This well encountered the oil sands at approximately 1,400 feet below sea level. In May, 1910, the Regal #1 gusher came in on the northwest quarter, sec. 14, T. 32, R. 23. This well encountered the oil sands at a depth of approximately 1,300 feet. In May, 1910, a 6,000-barrel well came in on section 30, township 31, range 23. This well encountered*3622 the oil sands at a depth of more than 1,100 feet below sea level. Between February 10, 1910, and March 1, 1913, three wells were drilled in the northeast quarter of section 16. Well No. 67, located in the northwest corner, produced 100 barrels a day and Well No. 71, in the northeast corner, produced about 50 barrels a day. Well No. 67 was considered a profitable well. About 11 wells were drilled in the southwest quarter, of which two were water wells, and one, No. 34, produced on an average 300 barrels a day, and 16 wells were drilled on the southeast quarter, one of which was a water well. The wells which were abandoned prior to March 1, 1913, were Nos. 1, 4, 5, 47, and 48, in the southwest quarter, Nos. 4, 7, and 19 in the southeast quarter. At Well No. 71 the oil sand is shown to be approximately 700 feet below sea level and at Well No. 67 approximately 300 feet below sea level. At March 1, 1913, numerous wells had been drilled within the socalled "gusher zone" between section 30, township 32, range 24 and section 31, township 31, range 23. Between Well No. 2 of section 6, township 32, range 23 and the southeast corner of section 5, some 35 producing wells were drilled, *3623 one of which was called a gusher and produced 500 barrels a day. Eight producing wells drilled in section 9 had a showing of oil. In section 16, 4 wells were drilled, one producing 100 barrels a day, and one 50 barrels a day. In section 10, 11 wells were drilled, one of which was designated a producer. In section 15, some 14 wells were drilled, scattered over the section; the majority of which proved to be producers. In section 14, 15 producing *77 wells were drilled, one of which, the Regal No. 1, was a gusher. In section 23 approximately 20 producing wells were drilled. In section 24, 20 producing wells were drilled. In section 30, township 32, range 24, 4 producing wells are of record, of which one well was a "gusher." The production by years from section 16 during the period from 1910 to 1919, both inclusive, was as follows: Year Production in barrels 1910 - Feb.-Dec 86,434 [1911] 425,083 [1912] 580,775 1913 (1/1-3/1) 84,513 1913 (3/1-12/31) 308,828 [1914] 315,130 [1915] 193,832 [1916] 176,509 [1917] 144,675 [1918] 106,799 [1919] 103,500 The production by years from section 22, during the period from 1910 to October 31, 1915, was as follows: *3624 Year Production in barrels [1910] 628,291.94 [1911] 1,342,504.05 [1912] 1,028,559.95 [1913] 728,495.22 [1914] 608,124.19 1915 (1/1-10/31) 285,390.26 The production by years from section 26 during the period from 1910 to October 31, 1916, was as follows: Year Production in barrels [1910] 153,508.90 [1911] 371,003.64 [1912] 400,845.27 [1913] 366,606.62 [1914] 266,925.06 [1915] 186,609.95 1916 (1/1-10/31) 133,499.25 Testimony was given as to various sales of oil properties. In December 1908, Barlow sold eight acres in section 25, township 32, range 23, for $25,000 cash. At the time of the sale there was no development on that tract. The line of strike had not been definitely established. Production had been obtained on section 25. In January, 1908, M. J. Laymance gave a lease on 20 acres in section 19, township 30, range 22, with option to purchase in fee until January 1, 1909, for $3,000 an acre. This option was exercised. In January, 1908, there were no wells on the property but there were producing wells on the adjoining section 20. This property was from 16 to 18 miles from section 16, owned by the petitioner. In April, 1909, *3625 Laymance bought the NW. 1/4 and SE. 1/4 sec. 36, T. 12, R. 24, for $160,000, a rate of $500 an acre. No wells were on the property and the nearest development was in section 1, about a mile distant. Later the northwest quarter of the northwest quarter sold for $80,000, of which 20 acres were later sold for $3,000 an acre. *78 In the latter part of 1909, or the first part of 1910, Laymance purchased a leasehold on 320 acres in section 20, township 31, range 23, with an option to purchase the fee. He exercised the option and later within the year while drilling sold the property for $2,000 an acre. In the latter part of 1909 Laymance purchased a Government location on all of section 2, T. 32 S., R. 23 E., for $128,000. There was sold in June, 1910, 480 acres in section 30, township 31, range 23, for $1,500,000 cash and $1,500,000 face value of Associated Oil bonds. Just prior to this sale in May, 1910, a well came in on this property producing 6,000 to 7,000 barrels a day. In September, 1910, the lessor's 20 per cent interes in 40 acres of section 2, township 11, range 24, was sold for $300,000. Prior to this sale the Lakeview gusher came in and was instrumental*3626 in consummating this sale. W. H. Cooley purchased 160 acres of unpatented land consisting of the E. 1//4 and W. 1/2 of the SE. 1/4, sec. 31, T. 31, R. 23, in December, 1908, at $2,000 an acre. In December, 1909, he sold the north 80 acres at $3,000 an acre. At the time of this sale a well had been drilled on the south 80 acres, producing 406 barrels a day, and the spectacular gusher in section 6, township 32, range 23, had been completed. S. G. Tryon and associates sold 20 acres of patented land in the NW. 1//4 sec. 36, T. 12, R. 24, in November or December, 1909, for $3,000 an acre. In June, 1910, 160 acres of unpatented land, being the S. 1/2 S. 1/2 sec. 32, T. 31, R. 23, was sold for $1,500 an acre. In the summer of 1910 there was sold unpatented land in the NW. 1/4 sec. 32, T. 32, R. 24, as follows: 20 acres, W. 1///4, for $4,000 an acre; 40 acres, SW. 1//4, at $3,000 or $3,250 an acre; and 80 acres, E. 1/2 of the NW. 1/4, at $3,250 an acre. The interest of the North American Oil Consolidated in section 22, township 32 south, range 23 east, was sold in 1915 for $350,000. *3627 Prior to the sale that property had produced 4,621,275.61 barrels of oil. More than half of petitioner's property in section 22 (S. 1//4; NW. 1//4; the southern part of the N. 1//4) was known to be south of the line of strike and therefore unproductive. The interest of the North American Oil Consolidated in the lease of the 160 acres in section 26, township 32 south, range 23 east, was sold in 1916 for $175,000. Prior to January 1, 1913, that property had produced 1,878,998.69 barrels of oil. The interest sold was a lease of four-fifths working interest. In 1910 the petitioner purchased about 40 acres, being the E. 1//4 sec. 15, T. 32, R. 23, for $40,000. This purchase was primarily to obtain a site for sidetracks, warehouses, shops, etc. *79 The stock of the petitioner sold in 1910 at from $17.50 to $20 per share and during 1911 and 1912 for $20 per share; 5,466 shares being sold in 1910, 2,129 shares in 1911, and 470 shares in 1912. The petitioner paid to Spellacy October 26, 1910, $2,500 and March 20, 1911, $40,000 for the purpose of clearing title to a part of section 16. *3628 On September 27, 1909, President Taft issued an order withdrawing from location practically all of the oil territory on the west side of San Joaquin Valley, included in which was section 16, township 32 south, range 23 east. That withdrawal order did not disturb vested rights in the land which had been acquired prior to September 27, 1909. In a very short time, operators and others in the district began to realize the Government meant business. To operators and dealers, it meant that all open lands which they had been in the habit of appropriating by one means or another were going to be very difficult to obtain; that land upon which wells were drilling at the time of the order would be in a much better position; that Government land upon which wells were producing at the time of the order were fairly safe; but that after all, patented land was the only thing that was unassailable. As a result operators and oil men generally became alarmed at the condition of titles on unpatented lands and began to look covetously at patented land which they felt was worth while. Section 16 was a school section belonging originally to the State of California, and sold by the State to some person. *3629 The oil reserves in the land owned or leased by the petitioner in section 16 were 5,476,805 barrels on February 10, 1910, and 4,300,000 barrels at March 1, 1913. The respondent, in computing invested capital, allowed an amount of $622,527.01, as representing the value of the property in section 16, acquired for stock and bonds, and the $42,500 of expenditures made in perfecting title. However, in computing invested capital for the years at issue the respondent reduced capital stock and surplus by $1,638,611.21 instead of $877,472.99, the correct amount based upon the valuation allowed. This amount, $877,472.99, represents the difference between $1,500,000 at which section 16 was entered in the books, and $622,527.01, the value allowed by the respondent. On March 8, 1913, the petitioner entered into a contract with the General Petroleum Co. for the sale of oil at 35 cents per barrel, but on March 1, 1913, the company was selling oil to the Sandard Oil Co. under contract at 50 cents a barrel. The corporation income and profits-tax returns of the petitioner for the calendar year 1917 were filed on March 27, 1918. The income-tax return showed an income-tax liability of $9,886.07. *3630 The excess-profits-tax *80 return showed excess profits tax liability for 1917 of $897.90. A "waiver" dated January 19, 1923, consenting to - Determination, assessment and collection of the amount of income, excess profits or war profits taxes due under any return made by or on behalf of the said company for the year 1917 * * * irrespective of any period of limitations, was filed on January 26, 1923. A "waiver" dated January 2, 1924, consenting to - Determination, assessment and collection of the amount of income, excess profits, or war profits taxes due under any return made by or on behalf of the North American Oil Consolidated for the year 1917 * * * irrespective of any period of limitations, was filed on January 10, 1924. A "waiver" dated January 12, 1924, consenting to - Determination, assessment, and collection of the amount of income, excess profits, or war-profits taxes due under any return made by or on behalf of said corporation for the years 1917 and 1918 * * * irrespective of any period of limitations, was filed on January 17, 1924. A "waiver" dated December 10, 1924, consenting to the - Determination, assessment, and collection of the*3631 amount of income, excess-profits, or war profits taxes due under any returns made by or on behalf of the said taxpayer for the year 1917 * * * for a period of one year after the expiration of the statutory period of limitations within which assessments of taxes might be made for the year or years mentioned or the statutory period of limitations as extended by Section 277(b) of the Revenue Act of 1924, or by an waivers already on file with the Bureau, was filed on December 22, 1924. The last "waiver" dated November 17, 1925, reads as follows: Treasury Department Internal Revenue Service Form 872A INCOME AND PROFITS TAX WAIVER FOR TAXABLE YEARS ENDED PRIOR TO JANUARY 1, 1922 NOVEMBER 17, 1925. In pursuance of the provisions of existing Internal Revenue Laws The North American Oil Consolidated, a taxpayer of San Francisco, California, and the Commissioner of Internal Revenue hereby waive the time prescribed by law for making any assessment of the amount of income, excess-profits, or war-profits taxes due under any returns by or on behalf of said taxpayer for the year (or years) 1917 under existing revenue acts, or under prior revenue acts. This waiver of the time*3632 for making any assessment as aforesaid shall remain in effect until December 31, 1926, and shall then expire except that if a notice of a deficiency in tax is sent to said taxpayer by registered mail before said date and (1) no appeal is filed therefrom with the United States Board of Tax *81 Appeals then said date shall be extended sixty days, or (2) if an appeal is filed with said Board then said date shall be extended by the number of days between the date of mailing of said notice of deficiency and the date of final decision by said Board. (Seal) NORTH AMERICAN OIL CONSOLIDATED, Taxpayer. (Signed) By T. C. KIERULFF, President. (Signed) FRANK EVANS, Secretary. (Signed) D. H. BLAIR, Commissioner. The 60-day letter was mailed to the petitioner on September 28, 1925. During the year 1917 the petitioner paid $8,000 to the Oil Industry Association. During the years 1917 and 1918 certain of the petitioner's oil derricks were damaged by fire. In repairing and rebuilding these oil derricks the petitioner made expenditures as follows: [1917] $5,271.50 [1918] 7,095.41 The respondent allowed as a fire loss in 1917 the amount of $1,646.19, *3633 and as a fire loss in 1918 the amount of $3,500. He reduced invested capital for 1918 in the amount of $1,646.19 and for 1919 in the amount of $5,146.19 on account of fire losses. An oil derrick is a structure erected for the purpose of suspending tools for drilling, the tools consisting of the necessary equipment in the drilling of a well. After the well is drilled it is necessary to maintain the derrick for the purpose of redrilling or for pulling the cubing, making the necessary repairs to the well, baling, etc. The petitioner acquired section 2, T. 32, R. 23 E., M.D.B. & M., Kern County, California, by purchase on July 15, 1913. Some time prior to November 30, 1915, suit was instituted by the United States Government to oust the North American Oil Consolidated from possession of the premises and on February 3, 1916, the following order was entered in the District Court of the United States for the Southern District of California, Northern Division, Ninth Circuit, in Equity No. A-48: UNITED STATES OF AMERICA, Plaintiff, vs. NORTH AMERICAN OIL CONSOLIDATED, PIONEER MIDWAY OIL COMPANY, UNION OIL COMPANY OF CALIFORNIA, PRODUCER'S TRANSPORTATION COMPANY, WALTER P. FRICK, *3634 JOHN F. CARLSTON, CLARENCE J. BERRY, DENNIS SEARLES, WALTER H. LEIMERT AND WICKHAM HAVENS, Defendants. ORDER APPOINTING RECEIVER. This suit coming on to be heard on motion of the complainant for the appointment of a receiver and for an injunction, and having been heard on the 30th day of November, 1915. *82 IT IS NOW CONSIDERED, ORDERED AND ADJUDGED that HOWARD M. PAYNE be, and he hereby is, appointed receiver of all the property described in the Bill of Complaint herein claimed by the defendants, to-wit: All of Section Two (2), Township Thirty Two (32), South, Range Twenty-three (23) East, Mount Diablo Base and Meridian, and situated in Kern County, State of California. and of the oil, gas and all other property of every kind now situated on the said land, or already extracted therefrom, and still in the possession of defendants; and the defendants, and each of them, their agents, attorneys and employees, are enjoined from removing said oil, gas, or other property, or any part thereof, from said land, or in any manner interfering with the order of this Court, and are enjoined from further producing oil from said land, except by permission and under the direction*3635 of the said receiver. Said receiver is directed to receive, and the said defendants are directed to surrender to said receiver all moneys in their hands or in the hands of any person or corporation for them, which are the proceeds of the sale of oil or gas produced from said lands hereinbefore described, and such persons holding such funds are directed to pay same to said receiver; and the said receiver is directed to collect any notes, accounts, or other evidence of debt due or payable on account of oil and gas produced from said land and sold by or for said defendants, or any of them. The said receiver is given power and directed to operate any oil or gas well or wells on said property, or to permit them to be operated by the respective defendants now in possession of or operating same, or who have heretofore operated on said lands; or to close said wells, if he deems it necessary or advisable to do so in order to conserve the oil and gas in said lands and prevent said property from being damaged or the oil and gas from being wasted. The said receiver is directed to ascertain the quantity of oil and gas heretofore extracted by said respective defendants, and what disposition*3636 has been made thereof, and keep an account thereof, and to keep an accurate account of all oil and gas hereafter produced from said lands, and to sell said oil and gas for the best price obtainable. For the purpose of making an investigation and determining the condition of wells drilled on said lands, and particularly for the purpose of determining whether water is infiltrating the oil sands or reservoirs on said lands, and for the further purpose of ascertaining the amount of oil and gas heretofore produced, the price at which the same has been sold, and the value thereof, the receiver is directed and empowered to examine the logs of the wells and the books of account kept by the defendants or any of them in the development and operation of said lands. For the purpose of preventing damage to said lands by the infiltration of water into the oil lands and otherwise, and for the purpose of protecting and operating the said property and carrying out the provisions of this order, the said receiver is authorized to employ such assistants and incur such expense, to be paid out of the moneys coming into his hands as receiver, as he shall deem necessary, subject to the approval of this*3637 Court. A bond in the sum of Ten Thousand (10,000) Dollars, to be approved by this Court, shall be given by the receiver within fifteen days from the filing of this order; provided the solicitor for the complainant or for the defendants, or either of them, may at any time upon one days's notice to counsel for the opposite parties, apply to the court for an increase in the amount of said bond. *83 The moneys coming into the hands of the said receiver shall, unless otherwise directed by the Court, be deposited in a bank or banks in special interest bearing accounts in the joint name of the receiver and the clerk of this court, and subject to the joint check and control of such persons, except so much of said funds as may be necessary to pay the monthly current expenses of the receiver in executing the orders of this court, and such sums as may be necessary for such purposes shall be deposited in a bank or banks to the credit of such receiver, as receiver for the respective defendants, and shall be subject to the receiver's check. The amount of compensation to be paid to the receiver in this suit is to be determined hereafter. This 2 day of February, 1916. M. T. DOOLING, *3638 United States District Judge. On June 5, 1917, the following decree was entered in this case: FINAL DECREE. This cause came on for hearing at a former day of this court and was argued by counsel and now, upon consideration thereof, it appearing to the Court that plaintiff is not entitled to the relief demanded in the complaint, or any part thereof, and there is no equity in the bill - It is therefore ordered, adjudged and decreed that the suit be and the same is hereby dismissed, that the injunction heretofore issued is dissolved, and the order appointing a receiver vacated; Provided, however, that the Court will retain jurisdiction to settle and adjust the accounts of the receiver, who is hereby ordered and directed to make and file his final account within thirty days from the filing of this decree. R. S. BEAN, Judge. Dated this 5th day of June, 1917. Decree entered and recorded June 7th, 1917. WM. M. VAN DYKE, Clerk. (Res. Ex. III) The cause was appealed (; *3639 ) and it was finally disposed of by the Supreme Court of the United States in its mandate dated March 21, 1922, which provided as follows: UNITED STATES OF AMERICA, ss: THE PRESIDENT OF THE UNITED STATES OF AMERICA. To the Honorable the Judges of the United States Circuit Court of Appeals for the Ninth Circuit. Greeting: Whereas, lately in the United States Circuit Court of Appeals for the Ninth Circuit, in a cause between the United States of America, appellant, and North American Oil Consolidated, Pioneer Midway Oil Company, Union Oil Company, of California, Producers Transportation Company, Walter P. Frick, John F. Carlston, Clarence J. Berry, Dennis Searles, Walter H. Leimert, and Wickham Havens, appellees, No. 3340, wherein the decree of the said Circuit Court of Appeals, entered in said cause on the 5th day of April A.D. 1920, was in favor of the said appellees, North American Oil Consolidated, et al., *84 and against the said appellant, as by the inspection of the transcript of the record of the said United States Circuit Court of Appeals which was brought into the Supreme Court of the United States by virtue of an appeal*3640 agreeably to the act of Congress, in such case made and provided, fully and at large appears. And whereas, in the present term of October, in the year of our Lord one thousand nine hundred and twenty-one of the said SUPREME COURT this cause having been called to the attention of the Court by Mr. Solicitor General Beck, of counsel for the appellant, and it appearing to the Court that a stipulation of counsel for the respective parties to dismiss this appeal has been filed, Therefore, in pursuance of said stipulation, it is now here ordered, adjudged and decreed by this Court that this appeal be, and the same is hereby, dismissed. MARCH 21, 1922. You, therefore, are hereby commanded that such proceedings be had in said cause, as according to right and justice, and the laws of the United States ought to be had, the said appeal notwithstanding. Witness, the Honorable William H. Taft, Chief Justice of the United States, the twenty-third day of March, in the year of our Lord one thousand nine hundred and twenty-two. WM. R. STANSBURY, Clerk of the Supreme Court of the United States. (Res. Ex. IV) Pursuant to the authority contained in the order appointing*3641 him, the receiver permitted the property to remain in the physical possession of, and to be operated by, the petitioner. At all times during the receivership the income from the oil produced from section 2 was entered on the books of the petitioner as its income. The income from said section 2 was not included in the petitioner's original return for 1916, which was filed in March, 1917, but was included in its amended return for 1916, which was filed on March 27, 1918. By letter dated March 23, 1918, attached to the amended return the respondent was fully advised as to all the facts regarding the litigation and receivership. A revenue agent made an examination of the petitioner's books in 1920. The net income impounded in the hands of the receiver from section 2 during the period from February 2, 1916, to December 31, 1916, and released in June, 1917, by the final decree of the United States District Court vacating the order appointing the receiver, was $171,979.22, of which $10,126.04 was turned over to Wheeler and Bowie in accordance with the terms of a contract dated January 1, 1916, between petitioner and Wheeler and Bowie. On January 1, 1916, the petitioner entered into*3642 the following contract with Charles S. Wheeler and John F. Bowie: THIS AGREEMENT, made this 1st day of January, 1916, by and between NORTH AMERICAN OIL CONSOLIDATED (a corporation), hereinafter referred to as the "COMPANY", party of the first part, and CHARLES S. WHEELER and JOHN F. *85 BOWIE (copartners), Attorneys-at-Law, hereinafter referred to as the "Attorneys", parties of the second part. WITNESSETH: Said partis, in consideration of a cash retainer heretofore paid by the Company to the Attorneys and of the promises and agreements on the part of each of them to be performed as hereinafter specified, agree and covenant, respectively, as follows: The Attorneys shall furnish all legal services necessary or proper and take all legal steps and proceedings to bring to final judgment and conclusion, in so far as the interests of the Company are concerned, three (3) certain actions now pending in the District Court of the United States for the Southern District trict of California, Northern Division, entitled "UNITED STATES OF AMERICA, Plaintiff, vs. NORTH AMERICAN OIL CONSOLIDATED, ET AL, Defendants, in Equity, Number A 48", and "UNITED STATES OF AMERICA, Plaintiff, *3643 vs. RECORD OIL COMPANY, NORTH AMERICAN OIL CONSOLIDATED, ET AL, Defendants in Equity, Number A 41", and "UNITED STATES OF AMERICA, Plaintiff, vs. CONSOLIDATED MUTUAL OIL COMPANY, NORTH AMERICAN OIL CONSOLIDATED, ET AL., Defendants, in Equity, Number A 42." Said Attorneys shall further render all legal services necessary or proper to prosecute and procure the issuance of patents from the United States in respect of applications for patent now pending in the United States Land Office, in behalf of certain applicants, who have agreed to convey to the Company, which applications cover all of Section two (2), in Township thirty-two (32) South; Range twenty-three (23) East, M.D.B. & M., in the county of Kern, State of California, containing approximately six hundred and fifty (650) acres of land. The Company agrees to supply and to advance to the Attorneys all necessary and proper costs and disbursements in connection with said court proceedings and land office proceedings and in any appeals or reviews thereof, as well as all necessary and proper traveling and incidental expenses of the Attorneys in connection therewith. The Company further agrees in the event of the successful termination*3644 of said court and land office proceedings in its favor, and not otherwise, that four (4%) per cent. of all the oil, gas, or other mineral produced from said Section two (2) or any part of said section, from and after the first day of January, 1916, shall be and become the property of the Attorneys and shall be marketed by the Company to the best advantage and the entire proceeds of the sale thereof paid over to the Attorneys. Successful termination of said court and land office proceedings, as intended by the parties hereto, means the issuance of patents by the United States Government, either covering the whole of said Section two (2) in favor of the applicants therefor who have agreed to convey the same to the Company, or the issuance of such patents covering any portion of said section, in which latter event said rights of the Attorneys shall attach to any and each portion patented. In the event that the Attorneys shall become entitled to said four (4%) per cent of oil, gas, or minerals, as hereinabove provided, the times, methods and manner of delivering the same or the proceeds of sale thereof by the Company to the Attorneys, and all incidental rights of the Attorneys in*3645 respect thereto, shall be the same as the rights of the parties of the first part, J. F. Carlston, W. H. Leimert, Wickham Havens, W. P. Frick, and Clarence J. Berry, in an agreement with said North American Oil Consolidated, dated the 11th day of July, 1913, and a further supplemental agreement between the *86 same parties, dated the 22nd day of July, 1913, save and except in the following particulars as to which the terms and conditions in said agreements contained, are agreed to be modified between the Company and the Attorneys, as follows: FIRST: The Attorneys shall not be entitled to any of said products or the proceeds thereof except in the event of the successful termination of said proceedings as hereinabove provided; but in the event of such successful termination, the Company shall account to the Attorneys for the proceeds of the sale of four (4%) per cent of such mineral products from the first day of January, 1916, to the date of such successful termination, after which date the rights of the Attorneys shall attach, as hereinabove specified. SECOND: The rights of the said Attorneys in respect of such four (4%) per cent shall be subject to the rights of the said*3646 Carlston and his associates so long as the said agreement and supplementary agreement shall remain in effect between said associates and the said Company, but said four (4%) per cent to which said Attorneys may become entitled shall be based upon the total production of minerals from the said property, without regard to the deductions in favor of said Carlston and his associates; and, furthermore, the rights of the Attorneys to such four (4%) per cent shall not terminate upon the event specified in said agreements for the termination of the rights of said Carlston and his associates, but on the contrary shall continue in accordance with all the terms and provisions, mutatis mutandis, of the said agreement and supplemental agreement relative to the times, methods and manner of making payments or deliveries and rights incidental thereto, such as inspection, checking of production, and securing continuity of production, storage of oil and conservation and protection of the premises, so long as there shall be any production of oil, gas, or other minerals from said premises, and the rights of the Attorneys to such four (4%) per cent upon attaching shall thereafter run with the land*3647 and bind the said Company and its successors and assigns. IN WITNESS WHEREOF, the said party of the first part has caused its corporate name to be subscribed and its seal to be hereto affixed by its officers thereunto duly authorized, and the parties of the second part have hereunto set their hands on the day and year first above written. NORTH AMERICAN OIL CONSOLIDATED, By (Signed) LOUIS TITUS, Its President. By (Signed) C. F. NANCE, Its Secretary. (Signed) CHARLES S. WHEELER, and (Signed) JOHN F. BOWIE. The following amounts represent 4 per cent of that part of the gross production from section 2, township 32 south, range 23 east, which was sold in 1917, 1918, and 1919, respectively: [1917] $20,441.18 [1918] 21,730.60 [1919] 27,136.91 These amounts were turned over to Wheeler and Bowie in the respective years in which received by the petitioner and deductions therefor were claimed in its income-tax returns for the respective years. *87 For the year 1917 petitioner also deducted on its return the sum of $15,354.36, which represented 4 per cent of the sales price of the oil produced and sold in 1916, but not paid to Bowie and*3648 Wheeler until 1917. The Commissioner disallowed as deductions the amounts claimed in 1917 and allowed as deductions the amounts claimed for the years 1918 and 1919. The litigation over section 2, township 32 south, range 23 east, was successfully terminated by the attorneys on March 23, 1922. On April 12, 1922, the United States patent to section 2 was issued to certain applicants who had agreed to convey to petitioner. During the year 1917 the petitioner expended $5,765.94 for pumping engines, sucker rods, small receiving oil tanks, well casing and tubing. This expenditure was disallowed as a deduction for business expenses in 1917 by the respondent. In accordance with the admission of the respondent at the hearing, under the circumstances in this case, the expenditures of $5,765.94 constituted an allowable deduction. During the year 1918, $17,598 and during the year 1919, $5,049.28 were expended for gasoline engines used in operating the pumps at the various oil wells. These amounts were added to capital and disallowed as expense deductions by the respondent. The respondent reduced invested capital on account of depletion sustained during prior years by the following*3649 amounts: [1917] $602,820.96 [1918] 707,819.73 [1919] 819,751.89 He reduced invested capital for 1918 by an amount of $65,274.35 and for 1919 by an amount of $33,217.57, representing additional taxes for the previous year, prorated over the taxable year. In computing invested capital and depletion allowances for the years 1917, 1918, and 1919, the respondent added the amount of $287,687.03 to the capital sum remaining in 1916, as shown by a valuation report dated July 30, 1925, which was stipulated in evidence solely for the purpose of showing respondent's computation of invested capital and depletion allowances. The sum so added was added as representing the capitalized cost of wells developed on section 16, township 32 south, range 23 east, during 1916. The amount involved was actually expended by petitioner in drilling wells during the years 1910 and 1911 as follows: $51,727.64 in 1910 and $235,959.39 in 1911, and these sums should have been added to capital account during the years 1910 and 1911. *88 OPINION. ARUNDELL: By amendment to its petition in Docket No. 8714 the petitioner claims that collection of any taxes for the year 1917 is barred*3650 by the statute of limitations. By the terms of Commissioner's Mimeograph 3085, promulgated April 11, 1923, the "waiver" of January 19, 1923, expired on April 1, 1924. Before the expiration date of the first "waiver" a second one was executed on January 2, 1924, and filed January 10 of the same year. A third was executed on January 12, 1924, and filed on January 17, 1924, which was identical with the January 2nd "waiver" except that the year 1918 was included. These latter "waives" were not affected by Mimeograph 3085, , and the period for assessment and collection of taxes for 1917 had not expired when the further "waiver" was filed on December 22, 1924, extending for an additional year the period for assessment and collection. The last "waiver," dated November 17, 1925, for the year 1917 was filed prior to the date the last mentioned "waiver" would expire. and provided that assessment could be made up to December 31, 1926. No provision for collection was included in this "waiver," but this becomes unimportant in view of the provisions of section 278(d) of the Revenue Act of 1924. *3651 . We are of the opinion that the statute has not expired either on the assessment or collection of taxes for the year 1917. Several witnesses testified that they knew section 16 in general, or had been over it; that they were familiar with various sales of land in this oil field and that the petitioner's land in section 16 was worth about $3,000 an acre on February 10, 1910, and in excess of that amount on March 1, 1913. Some of the witnesses predicated this value upon the favorable location of section 16 in relation to a theoretical "gusher zone" which was supposed to pass through the northeast quarter. The sales which were cited as a basis for comparison were very briefly presented, without any details that might make direct comparison possible. The sale of 8 acres for $25,000 in section 25, township 32, range 23, by Barlow was too remote in point of time to have much weight in a valuation as of 1910. The same may be said of the sale by Laymance of 20 acres in section 19, township 30, range 22, in January, 1909, and in addition this property being some 18 miles away, was exceedingly remote for direct comparison. *3652 The purchase by Laymance in section 36, township 12, range 34, at $500 an acre in April, 1909, and later sale of a part thereof at $3,000 an acre is of land over five miles distant from section 16. The date of the sale is not given, but the record shows that a gusher came in *89 on this section in November, 1909, known as the "Wellman"; also a gusher came in on the adjoining section 35 in August, 1909. The sale in section 30, township 31, range 23, in June, 1910, for cash and bonds was just after a well producing 6,000 to 7,000 barrels a day came in on the property. The sale in section 2, township 11, range 24, in September, 1910, was admitted to have been consummated largely on the showing of the Lake View gusher which was only about a mile distant. The sale by Tryon in section 36, township 12, range 24, in November or December, of 1909, for $3,000 an acre was after a gusher came in on section 35, and probably after the Wellman gusher came in on section 36. The sales in section 32, township 32, range 24, in the summer of 1910, were apparently after the Lake View gusher came in less than 2 miles away, and after the gusher came in on section 30, township 32, range*3653 24, the property adjoining to the northwest. From these sales it is apparent that values depend largely upon local or nearby development. No sale was cited at rates of $3,000 an acre or over in 1909 or 1910 unless the property was near or associated with a gusher. The great divergence of values from $200 an acre to $6,000 an acre indicates the great difficulty of direct comparison. The land in section 16 was acquired in part by the predecessors of the petitioner and in part by the petitioner. Some of the prices were agreed upon in the middle of 1909, and therefore might be considered remote in point of time from February 10, 1910. However, there were certain transactions in 1910 that have some bearing on the value of this section. On February 4, 1910, Louis Titus purchased the N. 1///4 of section 16, 20 acres, for $30,000, or $1,500 an acre. This was only 6 days prior to the date of acquisition by the petitioner and was apparently an arm's-length transaction consummated on that date, since prior to that time Louis Titus had no options or leases or agreements on this land. On February 3, 1910, Titus acquired a lease on the E. 1/*3654 /4; the NW. 1//4; and the north 15 acres of the N. 1///4, no bonus being paid therefor, but providing for a one-fifth royalty. In so far as the east half of the northeast quarter is concerned, this transaction was at arm's length and Titus had previously no option agreements or leases on this portion which were effective at the time this lease was made. The land covered by this lease was purchased by the petitioner in August, 1910, when $200,000 par value of bonds and $200,000 par face value of stock, together with $2,244.50 in cash was paid over to the Lockwood Company. The petitioner has introduced evidence which convinces us that on August 10, 1910, the bonds had a market value of 80 per cent of the face value, and the stock 20 per *90 cent of par. Assuming that all of the consideration was paid for the 135 acres under lease, the rate would be approximately $1,500 per acre. This land included practically all of the area in section 16, which had been designated by the experts as lying within the "gusher zone." This sale was made after the Regal No. 1 gusher came in on section 14, a little over*3655 one mile to the east, and after the Lake View gusher came in on section 25, township 42, range 24, and the Standard gusher on section 30, township 32, range 24. The south half of the southwest quarter was also purchased by the Hartford Oil Co. on or before February 10, 1910, and the petitioner does not contend that it was purchased before February 10. This land was acquired for $78,480, or approximately $980 an acre. The transactions within section 16 that are evidence of value on February 10, 1910, are: 30 acres, N 1/2 of NE 1/4 of SE 1/4, purchased at $1,500 an acre. 135 acres, NE 1/4, fee subject to lease, purchased at $1,500 an acre. 80 acres, SW 1/4 purchased at $980 an acre. The purchase of the 135 acres in August, 1910, is considered a maximum value applicable to the 135 acres as of February 10, 1910, in view of the testimony as to general increase in values in this district. These transactions within section 16 itself covering over half the area, are certainly of material value in ascertaining the actual cash value of the entire holdings of the petitioner in section 16, and the weight that should be given to the theory of the "gusher zone" *3656 passing over the northeast quarter. There is evidence in the record which would raise some doubt as to the possibility of finding a "gusher" in the northeast quarter of section 16. The exhibits introduced in evidence disclose the depth at which various gushers penetrated the oil sands and we have set forth in our findings of fact this information as it applies to certain wells. The gushers located to the east and southeast of section 16 penetrated the oil sands at from 1,100 to 1,500 feet below sea level. The exhibits show that the deepest sands that could be drilled in section 16 were only about 700 below sea level. The "gushers" to the northwest encountered the sands at points where the oil sands were indicated at sea level or above sea level. It is also shown by the exhibits submitted that the "gushers" to the northwest are not located on the Spellacy Anticline, and therefore the conditions in that section are not indicative of what might be expected on the Spellacy Anticline. The development surrounding section 16 at February 10, and March 1, 1913, did not reduce this doubt but rather increased it since no "gushers" were found within a mile of section 16, although*3657 *91 numerous wells were drilled to the northwest and southeast and many wells were drilled to the east and north. The record shows that wells were drilled in section 9, one-half mile to the north; in section 15, very near the eastern line of section 16; in section 14, southwest corner. None of these wells, although located in the so-called "gusher-zone" are reported as being "gushers" or even commercial wells. By March 1, 1913, some 100 wells had been drilled in the "gusher zone" from section 6, township 32, range 23, to section 30, township 32, range 24, and only one real "gusher," the Regal No. 1, was developed. This well penetrated the sands at a point where the sands are indicated at a depth of 1,300 feet below sea level. It was subsequent to the date when this well came in that the petitioner was able to purchase the fee to 135 acres in the northeast quarter of section 16 at a price of some $1,500 an acre, indicating that the previous owners of the property placed little reliance on the possibility of a "gusher zone" being found in that area. The wells put down by the petitioner in the northeast quarter in 1911 also tended to disprove the "gusher zone" theory. *3658 Well No. 71 was drilled in the extreme northeast corner and produced about 50 barrels a day. Well No. 67 was in the northwest corner and produced 100 barrels a day. Both of these wells were in the theoretical "gusher zone." After a review of all the testimony we are of the opinion that the cost of section 16 to the petitioner was as follows: Leasehold on 135 acres in northeast one-fourth, acquired by the predecessor 7 days prior to February 10, 1910 No bonus value South one-half of southwest one-fourth, acquired on or before February 10, 1910, by predecessor for $ 78,480 $78,480.00 Balance of area comprising about 265 acres, valued at $ 1,500 an acre 397,500.00 475,980.00 Subsequently paid to perfect title 42,000.00 Fee title to 135 acres acquired in August, 1910, for bonds and stock, and cash 202,244.50 Total cost 720,224.50 Between February, 1910, and March 1, 1913, about 26 wells were drilled in the south one-half of section 16. One well, No. 34, produced from 300 to 400 barrels a day and was considered very valuable. The cost of this development was $51,727.61 in 1910 and $235,959.39 in 1911, a total of $287,687.03. The production*3659 from section 16 prior to March 1, 1913, was 90,414 barrels in 1910, 425,000 barrels in 1911, 580,775 barrels in 1912, and 84,513 barrels for two months in 1913, or a rate of 507,000 barrels a year. *92 The estimate of oil content at March 1, 1913, made by the petitioner's geologist was 4,300,000 barrels. The market price of oil at March 1, 1913, was not over 35 cents a barrel. In order to realize this production it would appear that some 60 or 70 additional wells would have to be driven. The average cost of wells in the south half of section 16 was $8,000 to $9,000 a well, and since wells in the north half of the southeast quarter and in the northeast quarter would have to be deeper, the average cost would be greater. Then, in order to develop this property, $700,000 to $800,000 would have to be spent in drilling wells. With all of these conditions in view and after considering the opinions of the various witnesses, we are of the opinion that the fair market value of the petitioner's oil land in section 16 was $700,000 exclusive of the value of development already completed. Accordingly the depletion rate would be based on this value and 4,300,000 barrels of oil. *3660 The petitioner is also entitled to a deduction based on the development expended in 1910 and 1911. These expenditures were capital expenditures subject to exhaustion based on the reserve in February, 1910, of 5,476,805 barrels. During 1917 the petitioner paid to the Oil Industry Association $8,000. No evidence was presented on this issue and consequently the action of the respondent is approved. During 1917 and 1918 it appears that certain damage was done to oil derricks by fire and certain sums were expended in restoring the derricks. The destruction of a derrick, or a part of a derrick, by fire resulted in a loss, and a loss of this character represents an allowable deduction under section 214(a)(4) of the Revenue Act of 1918. The amounts spent in restoring the property destroyed are capital expenditures. Accordingly, the action of the Commissioner in respect to this issue is approved. Nor do we find error in the action of the respondent in reducing invested capital for 1918 and 1919 in amounts equal to the amounts allowed as deductions for fire losses. No testimony was introduced relative to the expenditures for gasoline engines in 1918 and 1919. Expenditures*3661 of this nature are normally capital expenditures. The action of the Commissioner in disallowing the deductions is approved. During the years here involved the petitioner was in complete possession of section 2, except that from February 2, 1916, to June 5, 1917, it was operating under the supervision and control of a receiver. It accrued in each year on its books the income applicable to the oil produced and sold. During 1917, however, it did receive the amounts which had been held by the receiver representing income from February 2, 1916, to June 5, 1917. *93 The respondent affirmatively alleges that the amount impounded in the hands of the receiver in 1916 and released to petitioner in 1917 was income to the petitioner in the latter year. The respondent's principal argument in support of his claim herein is that petitioner was on the cash receipts and disbursements basis in the years 1916 to 1919, inclusive, and, as the amount here involved was not actually received by the petitioner until 1917 it must be taxable income in that year. We think it immaterial whether petitioner's accounts were kept on the receipts and disbursements basis or some other basis as permitted*3662 by section 13(d) of the Revenue Act of 1916. The fact is that the income was actually produced in 1916. The sole reason that it did not reach the petitioner in that year was because of the suit by the United States. By reason of that suit a receiver was appointed, who actually received the income, and who should have reported it for taxation. Section 13(c) of the Revenue Act of 1916; ; , affirmed, . If the receiver did not report it, that is no sufficient reason for taxing the petitioner on it in a later year. Accordingly, the amount of $171,979.22 received by petitioner in 1917 is not an item of income in that year. This amount is the amount stipulated as being the net income impounded in the hands of the receiver during the period February 2, 1916, to December 31, 1916. The amount which the respondent alleges should be included in 1917 income is $253,150.96. What the difference consists of we do not know. The burden being on the respondent to establish his affirmative allegation in regard to this amount, and he having*3663 failed to do so, we must hold that no part of it may be included in income for 1917. The parties have stipulated that the amounts paid to Wheeler and Bowie in 1917, 1918, and 1919 represented 4 per cent of gross production specified in the contract, also that $35,795.54 deducted in 1917 represented accruals for 1916 and 1917. Since the 4 per cent in 1917 amounted to $20,441.18, the accrual for 1916 must have been the difference, or $15,354.36. The agreement with Wheeler and Bowie provided that the petitioner would pay to them 4 per cent of all the oil, gas, or other mineral produced from section 2 in the event of the successful termination of certain court and land office proceedings and not otherwise; that "successful termination of said court and land office proceedings * * * means the issuance of patents by the United States government, either covering the whole of Section 2 in favor of the applicants therefore * * * or the issuance of such patents covering any portion of said section, in which latter event said rights of the Attorneys shall attach to any and each portion *94 patented"; that "the attorneys shall not be entitled to any of said products or the proceeds*3664 thereof except in the event of the successful termination of said proceeding * * * but in the event of such successful termination, the Company shall account to the Attorneys for the proceeds of the sale of 4 per cent of such mineral products from the first day of January, 1916, to the date of such successful termination after which date the rights of the Attorneys shall attach"; that "the rights of the Attorneys to such four (4%) per cent upon attaching shall thereafter run with the land and bind the said Company and its successors and assigns." The petitioner contends that the agreement with the attorneys conveyed to them an interest in the real estate, and consequently the proceeds derived from the sale of 4 per cent of the oil were not income to the petitioner since by the agreement the petitioner owned only a 96 per cent interest in the oil property. In support of this contention the petitioner cites the case of ; , which involved taxes assessed against the lessee of oil property. In that case the court said: But the contract in question vests no present title in a stratum in place. *3665 It leaves the title to the oil in the landowners until it is brought to the surface. The right vested in the plaintiff is an estate for years, so far as necessary for the purpose of taking oil therefrom, and it carries with it the right to extract the oil and remove it from the premises. This right constitutes, for the term prescribed, a servitude on the land and a chattel real at common law. We fail to see that the rights of the attorneys in this case are at all similar to the rights of the lessee in the Graciosa case. The attorneys had the right to receive 4 per cent of the oil produced. They had no right to extract oil or to enter upon the land for that purpose, a point on which the decision in the Graciosa case was largely based. If oil was not produced from section 2, the attorneys would have no claims which they could enforce. By no exercise of the imagination can we read into the agreement any assignment of a portion of the fee title to land, nor any title to an undivided interest in the oil stratum. The attorneys' rights begin only after oil has been produced, and then only to the extent of receiving 4 per cent of the oil produced or the proceeds of a sale thereof. *3666 We are, therefore, of the opinion that the attorneys did not acquire an interest in the real estate, and that all of the income derived from the sale of oil from section 2 was income of the petitioner. We have held that the expenses of defending title are capital expenditures. ; ; . Therefore, the amounts paid the attorneys in *95 1917, 1918, and 1919 are not deductible as expense, but are capital expenditures. The amounts paid the attorneys being capital expenditures, it follows that depletion is allowable in respect of such amounts. The question then arises as to how such allowances shall be computed. Ordinarily, depletion is allowable in respect of capital costs by spreading the cost over the remaining life of the oil reserves. But that method is inapplicable here for the reason that as the oil reserves were depleted the capital cost would be annually increased, which would necessitate an annual increase in the depletion rate and result in unreasonable depletion deductions. Such a method*3667 might do very well and might be the only one that could be used where the capital cost was applicable only to future production, but here the amount paid in any year is a part of the cost of both past and current production as well as that in the future. The solution that seems to us will produce a proper result is to allow as depletion in each year an amount equal to the 4 per cent paid to the attorneys. By this method, when eventually production ceases, the petitioner will have returned to it through the depletion allowances exactly the amount of its capital expenditure and the depletion deduction each year will be reasonable. In computing invested capital for the years in question surplus should be reduced by the depletion sustained due to the extraction of oil from the property. Such depletion should be based upon the cost of the oil properties and subsequent capital additions, the oil reserves applicable thereto and the oil extracted to the year in question. This is in accord with the several cases involving depletion sustained, previously passed upon by the Board, and is in accordance with the decision in *3668 , and . The depletion sustained should be recomputed in the light of the finding in this case. In accordance with the stipulation respecting the capital expenditures of $51,727.64 in 1910 and $235,959.39 in 1911, these amounts should be taken into capital accounts for the years in which expended, and the undepleted balances added to capital sum remaining in 1916 for the purpose of computing invested capital and depletion allowances for 19 7, 1918, and 1919. The reduction of invested capital for the years 1917, 1918, and 1919 on account of depletion sustained in prior years was alleged in the petitions as an error on the part of the respondent. This was not urged at the hearing, being only briefly mentioned by counsel for petitioner in his opening statement, and is not mentioned at all in petitioner's brief. We affirm the respondent's computation in principle, but adjustments will necessarily be made in the amounts *96 upon the basis of value of petitioner's lands for depletion purposes as found by this decision. *3669 The respondent's reduction of invested capital on account of prior years' taxes is likewise affirmed in principle, section 1207, Revenue Act of 1926; , but the amounts by which invested capital is reduced will need revision to conform to changes in taxes wrought by this decision. This is a matter to be settled under Rule 50. Judgment will be entered under Rule 50.