Opinion
Docket Nos. 3968-68, 3978-68.
Filed June 25, 1970.
Petitioners received lump-sum cash payments in consideration of their executing agreements conveying, for a period of 25 years renewable for an additional 20 years, the rights to all of the water underlying their lands. The aquifer containing the water is not subject to recharge, and the purchaser could, and intended to, extract all the water. Held, petitioners did not retain an economic interest in the water in place, the agreements effected sales rather than leases, and the consideration received by petitioners is taxable as capital gain rather than ordinary income.
Clarence P. Brazill, Jr., for the petitioners.
John W. Dierker, for the respondent.
In these consolidated cases respondent determined deficiencies in petitioners' income tax for 1965 as follows:
Docket No. Petitioners Amount
3968-68 ............ Don C. Day and Catherine Day ........... $13,329.90 3978-68 ............ Dan Day and Roberta Day ................ 13,868.05 The only issue presented for decision is whether the consideration received by petitioners upon their conveyances of water rights to Pan American Petroleum Corp. constituted ordinary income or capital gain.FINDINGS OF FACT
At the time their petitions were filed Don C. and Catherine Day, husband and wife, and Dan and Roberta Day, also husband and wife, were legal residents of Meadow, Tex. Both couples timely filed their respective joint income tax returns for 1965 with the district director of internal revenue, Dallas, Tex. Don and Dan will hereinafter be referred to as petitioners.
During 1965 petitioners were engaged in the ranching and farming business and kept their records and filed their income tax returns on a cash basis.
Petitioners' farm properties are located in the Southern High Plains, an area of Texas and New Mexico south of the Canadian River and east of the Pecos River. It is a plateau, covering approximately 35,000 square miles (approximately 22 million acres), which stands high above the surrounding countryside.
Within the Southern High Plains plateau is a geological formation known as the Ogallala, which contains underground water, termed by hydrologists as "ground water," in significant quantities. The Ogallala formation, ranging in thickness from a few feet to several hundred feet, consists of interbedded layers of various materials, some of which are water-bearing, i.e., the void spaces between the particles of material contain water. The layers of materials are permeable in the sense that water can move through them. In general, both the bottom of the Ogallala formation and the land surface in the Southern High Plains slope from northwest to southeast at an average rate of about 10 feet per mile.
The Ogallala formation also exists outside of the Southern High Plains, and all subsequent references to the "Ogallala formation" are solely to that existing in the Southern High Plains.
Over a long period of time, during the Pliocene age (from 1 to 10 million years ago), streams flowing generally from the Rocky Mountains, from the west toward the east, deposited the materials which make up the Ogallala formation. Thereafter, part of the Ogallala formation was eroded away; the Canadian River carved out a valley to the north and the Pecos River turned south and carved out a valley to the west, thus creating the northern and western boundaries of the Ogallala formation. The eastern and southern boundaries of the Ogallala are, respectively, an escarpment (a steep cliff) similar to those cut by the Canadian River and Pecos River, and older formations which lie at a lower elevation. These boundaries distinctly separate the Ogallala from the surrounding countryside.
Underlying the entire Ogallala formation are rocks, referred to as "red beds," which were deposited in the Triassic and Permian geological time periods. The red beds range in thickness to several thousand feet and are relatively impermeable, thus forming a basin for the water in the Ogallala formation; as a consequence the water does not percolate downward to any appreciable degree. The geological formation below the Ogallala are, in general, non-water-bearing or contain only limited supplies of fresh or salty water.
Because the bottom of the Ogallala formation consists of the impermeable red beds and is above the surrounding countryside, the only source from which new water of any kind can move into the Ogallala formation is seepage from precipitation on the surface of the ground.
Precipitation in the Southern High Plains is irregular from year to year. It averaged approximately 20 inches annually between 1890 and 1968. This water is dissipated in one of four ways: (1) Evaporation, (2) transpiration (absorption by plants), (3) runoff, and (4) seepage downward (water thus entering the underground reservoir is known as recharge). More than 99 percent of the average annual rainfall is evaporated or absorbed by plants, and there is only a negligible amount of stream runoff from the surface. During periods of heavy precipitation, water collects in thousands of playa lakes, which are dry most of the time, dotting the Southern High Plains. Perhaps 90 percent of the water that collects in the playa lakes evaporates; the remainder eventually reaches the Ogallala ground water reservoir as recharge. The depth from the surface of the Southern High Plains to the water table — i.e., the top of the reservoir — ranges from less than 50 feet to more than 250 feet.
The Ogallala ground water reservoir is a water table aquifer, in which the water level in wells stands at the general level of the water table throughout the aquifer. Ground water in the saturated section of the reservoir responds to gravity and moves through the interstices of the permeable material away from areas of high pressure (recharge areas) and in the direction of areas of low pressure (discharge areas). The water moves from northwest to southeast at the rate of 60 to 200 feet per year.
Under natural conditions (prior to pumping) the Ogallala formation is in a state of dynamic equilibrium, i.e., the average annual natural recharge is approximately equal to the average annual natural discharge. The annual recharge varies from year to year, depending on the amount of rainfall; including all of the wet and dry years, the average annual natural recharge and discharge have approximated 3/20 to 1/2 inch in amount.
Withdrawal of water from the formation by pumping results in no increase in natural recharge and only a negligible decrease in natural discharge. The number of wells pumping water from the Ogallala reservoir has increased from 620 in 1934 to 8,000 in 1948 and 47,000 in 1958. More than 5 million acre-feet were pumped in 1960. Except for isolated variations in a few individual wells, from 1938 to 1969 there has been an increasing, substantial, and generally uniform decline in the water table in the Ogallala reservoir. The decline in the water table is almost in direct proportion to the increase in wells — the more concentrated the wells in an area, the greater the decline in the water table. Between 1958 and 1962 the amount of recoverable water in the entire Ogallala formation declined from 220 million acre-feet to 210 million acre-feet. Ground water in the Ogallala reservoir is in general, and under petitioners' lands in particular, a nonrenewable resource. If present pumping practices continue and if economic considerations do not intervene, the Ogallala reservoir will be exhausted (i.e., the water table will decline to such a point that no well will be able to pump water).
For more than 6 months prior to November 5, 1965, Don and Catherine owned section 35, block D-11, S. K. K. Survey, Terry County, Tex., and Dan and Roberta owned section 5, block D-14, C. M. R. R. Co. Survey, in the same county. Pan American Petroleum Corp. (hereinafter Pan American) was the operator of an oil field known as the Prentice Northeast Unit, located in Terry County, and needed water for use in waterflooding its wells. On November 5, 1965, each of the Day couples entered into a contract entitled "Conveyance of Water Rights and Agreement" with Pan American in consideration of $56,000. The contract executed by Don and Catherine — differing from the contract executed by Dan and Roberta only in the description of the property involved — provides, in pertinent part, as follows:
Waterflooding is a method of recovering oil, in which water is injected into the oil reservoir. See 7 Williams Meyers, Oil and Gas Law 439-440 (1964), and authorities cited therein.
THAT, we, the undersigned surface, water, and water rights owners, hereinafter referred to as "Grantors", for and in consideration of the sum of Ten Dollars ($10.00), and other good and valuable considerations, the receipt and sufficiency of which are hereby acknowledged, have granted, bargained, sold, and conveyed, and by these presents do grant, bargain, sell, and convey unto Pan American Petroleum Corporation, in its capacity as Operator of the Prentice Northeast Unit, in Terry County, Texas, its successors and assigns, hereinafter referred to as "Grantee", for a term of twenty-five (25) years from the date hereof, with the option of renewal for an additional period of twenty (20) years in the manner hereinafter provided, all of the water and water rights in, to, and under, and that may be produced from the following described land in Terry County, Texas, to-wit:
All of the SE/4 Section 35, Block D-11, SKK Survey, together with the full use of the premises, for the purpose of exploring and drilling for, and producing water therefrom, including the right to install, maintain, operate and remove pumps, pumping equipment, power and other transmission lines, tanks and basins, building pipelines and water ditches, and building roads necessary to the producing, storing, treating, transporting, and using of water.
* * * * * * *
For the same consideration hereinabove recited, Grantors do hereby grant and convey unto Grantee, its successors and assigns, as Operator of the Prentice Northeast Unit, Terry County, Texas, a right of way and easement over, under, through, and across Grantors' lands lying and being situated between the SE/4 of said Section 35 and the Prentice Northeast Unit in said county for the construction, operation, and maintenance of flow lines and water lines necessary for the transportation of water produced by Grantee from a well or wells situated on the SE/4 of said Section 35 to be used in connection with operations conducted on the unit described aforesaid. In lieu of damages to the lands of Grantors used and occupied in the exercise by Grantee of the rights and privileges granted it by this paragraph, Grantee agrees to provide and furnish to Grantors a one-inch water tap or connection from a water well located on the SE/4 of said Section 35, and shall supply Grantors therefrom not to exceed a maximum of one hundred (100) barrels of water per day.
* * * * * * *
In the event any well drilled by Grantee does not meet Grantee's requirements for a water supply well, such well shall be plugged by Grantee, and the land restored to its original contours; provided that, if Grantors desire to assume operation and control of such well, Grantors shall have the right so to do and shall accept such well in its then existing condition and shall assume the responsibility for properly plugging the well upon cessation of production of water therefrom.
Grantors, in consideration of the sums paid hereunder, do hereby give and grant to Grantee, as Operator of the Prentice Northeast Unit, Terry County, Texas, and to its successors and assigns, at its option, the right to renew and extend this agreement for an additional term of twenty (20) years from and after the date of termination hereof, upon the same terms and conditions as in this contract provided and for the rights herein granted. Grantee shall exercise such option by giving written notice prior to the termination date hereof to the Grantors, their heirs or assigns, at the last known address, setting forth Grantee's intention to renew this agreement. Upon such notice and tender of the sum of Eighty Thousand Dollars ($80,000.00), this contract shall be renewed and extended for an additional term of twenty (20) years from the date of the payment of such consideration.
The surface of petitioners' lands is used for farming and for grazing cattle. Section 35 will support a maximum of 30 cows and 25 or 30 calves for 4 months (120 days) per year, during which time they will consume a maximum of 36 barrels of water per day. The maximum per day consumption on an annual basis, therefore, is 12 barrels, and the approximate cost of producing this amount of water would be no greater than 6 mills per barrel or 7 cents per day. Section 5 has substantially the same characteristics as section 35, except that the northeast quarter is under cultivation, and it has never supported more than 25 cows and 25 calves. Water wells sufficient to water petitioners' cattle could be developed on their lands other than the quarter sections subjected to the above agreements.
Prior to negotiating for the acquisition of water from petitioners, Pan American made seismographic tests of section 35. The amount of water under the southeast quarter of section 35, prior to pumping by Pan American, was approximately 1,920 acre-feet (15 million barrels). Another 15 million barrels of water existed under the southeast quarter of section 5 when the contract with Pan American was made.
Pan American has located two wells on the southeast quarter of section 35 — none has yet been drilled on section 5; one or the other of these wells is operated continuously, producing 15,000 barrels per day (430 gallons per minute). To the date of the trial Pan American had produced 12.5 million barrels of water from section 35.
It is estimated that there were 37.86 million barrels of primary and secondary oil to be recovered from the Prentice Northeast Unit prior to the waterflood. Since at least 3 barrels of water are required to recover 1 barrel of oil, a minimum of 110 million barrels of water will be required to waterflood the Prentice Northeast Unit.
During the negotiations with petitioners, Pan American expressed the intent to extract all of the water under the southeast quarters of sections 5 and 35. The geological and hydrological characteristics of the aquifer under these quarter-sections make it physically possible for Pan American to do so.
On their respective returns for 1965 petitioners reported the amounts received from Pan American as capital gain from the sale of water rights. In the notices of deficiency respondent determined that such amounts were taxable as ordinary income.
OPINION
The parties are in general agreement that the principles developed in the field of oil and gas taxation govern the resolution of the issue presented for decision — whether the lump-sum payments received by petitioners on the execution of their contracts with Pan American are taxable as capital gains or as ordinary income. Defining those principles is not nearly as difficult as applying them to the present facts. One reason, aside from the difficulties inherent in the problem, is that some of the features of the agreements involved herein are foreign to the form of customary oil and gas transactions. Nevertheless, we think that the principles of oil and gas taxation are the most helpful analogies available in deciding the present controversy. Cf. G.C.M. 22730, 1941-1 C.B. 219.
It has long been established that where a mineral interest is assigned for a lump-sum cash consideration (usually described as a "bonus") and the assignor retains a royalty, the transaction is a lease — under which payments are taxable as ordinary income, like rents — rather than a sale of capital assets. Burnet v. Harmel, 287 U.S. 103, 107-108 (1932). Similarly, a lease rather than a sale occurs where the assignor, in addition to receiving a cash bonus, retains a determinate interest such as a production payment plus a continuing interest such as a royalty. Palmer v. Bender, 287 U.S. 551 (1933). In both of these situations the cash consideration is regarded as an advance royalty (thus reducing the assignor's royalty share of future production) and is taxable as ordinary depletable income. See Herring v. Commissioner, 293 U.S. 322, 324 (1934); Murphy Oil Co. v. Burnet, 287 U.S. 299 (1932); Burnet v. Harmel, supra at 111-112. The assignor is deemed to have conveyed to the assignee merely exclusive exploitation privileges and in the initial transaction has not parted with his capital interest in the mineral. G.C.M. 22730, supra at 216.
A royalty is "a right to receive a specified percentage of all oil and gas produced," Anderson v. Helvering, 310 U.S. 404, 409 (1940), which right will last for the entire term of the property interest assigned. Commissioner v. P. G. Lake, Inc., 356 U.S. 260, 262 fn. 1 (1958).
A production, or oil, payment is a "right to a specified sum of money, payable out of a specified percentage of the oil, or the proceeds received from the sale of such oil, if, as and when produced." Anderson v. Helvering, supra at 410.
In contrast, where mineral rights are assigned for a cash consideration, and no interest is reserved, or the only interest reserved is a production payment or a "vertical" fraction, the transaction is a sale of a capital asset (or of section 1231, I.R.C. 1954, property). In such cases the gain included in the cash payment is taxable as capital gain. Commissioner v. Fleming, 82 F.2d 324 (C.A. 5, 1936), affirming 31 B.T.A. 623 (1934); Howard Glenn, 39 T.C. 427, 443 (1962); see Hammonds v. Commissioner, 106 F.2d 420, 425 (C.A. 10, 1939), reversing on another issue 38 B.T.A. 4 (1938); G.C.M. 22730, supra at 217-218. The theory is that the cash payment is unrelated to the production of the mineral, and instead is consideration for the assignor's transfer of all of his interest except the fraction thereof reserved. Commissioner v. Fleming, supra at 327; Howard Glenn, supra at 443. Indeed, since no right to royalties is retained, the cash payment cannot be considered an advance royalty.
The distinction between a sale and a lease, therefore, turns principally on the type of interest retained by the assignor. See Dingman v. United States, 303 F. Supp. 110, 111 (D. Minn. 1969). The type of retained interest involved in the first two situations described above is generally referred to as an "economic interest" in the mineral in place. As defined by the Supreme Court in Palmer v. Bender, supra at 557, an economic interest exists in —
every case in which the taxpayer has acquired, by investment, any interest in the oil in place, and secures, by any form of legal relationship, income derived from the extraction of the oil, to which he must look for a return of his capital.
Accord, sec. 1.611-1(b), Income Tax Regs. This definition was amplified in Commissioner v. Southwest Expl. Co., 350 U.S. 308, 314 (1956), where the Court stated that the second prong of the economic interest test is satisfied only if "the taxpayer must look solely to the extraction of oil or gas for a return of his capital." (Emphasis in original.)
We have concluded that the lump-sum cash consideration received by petitioners on the execution of the Pan American contracts represents the proceeds of the sale of capital assets rather than ordinary income. Under these contracts Pan American acquired the right to all of the water underlying petitioners' lands; it intended to withdraw that water, and, under the peculiar facts, could do so within the stated 25- or 45-year periods. The amount of the consideration, paid at the time the contracts were signed, was fixed by the terms thereof and was in no way dependent on the fact or amount of the future production or extraction of the water. Neither by the terms of those contracts nor by virtue of any collateral fact did petitioners retain an economic interest in the water in place which disqualifies the lump-sum payment from treatment as capital gain.
Respondent contends that petitioners retained an economic interest in the water in place because (1) they reserved rights to receive up to 100 barrels of water per day and (2) they retained a reversionary interest in the water. This latter contention is grounded on respondent's assertions that Pan American cannot withdraw all of the water within the 25- or 45-year periods because the subterranean movement of water beneath adjoining properties will replenish the underground reservoir, and that petitioners have not shown that all of the water will, in fact, be withdrawn. We disagree.
Petitioners' reservation of rights to 100 barrels of water per day is quite obviously insufficient to determine the character of the entire transaction. Pan American's wells on section 35 were producing 15,000 barrels per day compared with Don's right to receive 100 barrels daily. And the evidence shows that Don was drawing a maximum of 36 barrels per day for 120 days each year, or 12 barrels per day on an annual basis. Since no wells had been drilled on Dan's property at the time of the trial, his reserved water rights had not yet ripened, but they will not exceed those of Don. The reserved rights are obviously de minimis when compared with the rights conveyed to Pan American.
As noted above, moreover, under the principles of oil and gas taxation, the disposition of a "vertical" fraction of a mineral interest may produce capital gain even though the remaining fraction is reserved for the productive life of the property. See Commissioner v. Fleming, supra; Howard Glenn, supra. But even more pertinent to the present case, Rev. Rul. 55-295, 1955-1 C.B. 373, holds that capital gain may be realized on the disposition of water rights even though the grantor —
reserves the right to use only so much of the water in, under and upon the premises as may be necessary to drill for and produce oil, gas and other minerals, and further reserves the right to use such water for the purpose of normal farming and ranching operations and domestic use but not for irrigation purposes.
Petitioners' reserved water rights were much less extensive than those reserved by the taxpayer in that revenue ruling and certainly do not rise to the dignity of the "paramount rights" referred to in Puckett v. Commissioner, 355 F.2d 551 (C.A. 5, 1966), affirming per curiam a Memorandum Opinion of this Court, discussed infra.
As for respondent's argument that the reservoir beneath petitioners' properties will be replenished by water underlying adjoining properties, its oil and gas analog was first made, and rejected, in United States v. Ludey, 274 U.S. 295, 303 (1927):
It is argued that, because oil is a fugacious mineral, it cannot be known that the reserve has been diminished by the operation of wells. Perhaps some land may be discovered which, like the Widow's cruse, will afford an inexhaustible supply of oil. But the common experience of man has been that oil wells, and the territory in which they are sunk, become exhausted in time. Congress in providing for the deduction for depletion of oil wells acted on that experience. * * *
More pertinent, this same argument was made in United States v. Shurbet, 347 F.2d 103 (C.A. 5, 1965), affirming 242 F. Supp. 736 (N.D. Tex. 1961), where the issue was whether deductions for cost depletion in respect of ground water extracted from the Ogallala formation were allowable. The District Court had found that the ground water was being "mined," that it was a nonrenewable resource, and that it was being exhausted. 242 F. Supp. at 744. The Government attacked these findings, insisting that the taxpayers did not have an ownership interest in the water which was being pro tanto exhausted as the water was pumped and had not shown that their capital investment was being diminished by pumping water from beneath the land. The Court of Appeals rejected the Government's arguments, saying:
In Texas the common law rule prevails that the owner of the land owns the soil and the percolating water which is a part of the soil. [Citation omitted.] More specifically, a Texas statute has recognized that the ownership of underground water in the Ogallala formation is vested in the owners of the land. [Citation omitted.] The careful and thorough evidentiary development of the taxpayers' case furnished ample support for each of the findings of the district court. [ 347 F.2d at 106.]
The facts regarding the geological and hydrological characteristics of the Ogallala formation, recited in our findings, were stipulated by the parties and are essentially identical to the findings of the District Court in Shurbet.
While Ludley and Shurbet involved depletion, we think their reasoning is apposite. We see no reason why the possibility that water underlying other properties may flow into the reservoir under petitioners' lands should alter the character of the transaction any more than the possibility that an underground oil reserve will be replenished by the subterranean movement of oil.
See Wood v. United States, 377 F.2d 300, 305 (C.A. 5, 1967), certiorari denied 389 U.S. 977 (1967): "the test for determination of whether proceeds are taxable as capital gains or ordinary income is the same as that for determining whether proceeds are subject to depletion.12" (Footnote omitted.) See also Anderson v. Helvering, supra at 407-408.
The present contracts are not analogous to conveyances carving production payments out of larger interests, such as those in Commissioner v. P. G. Lake, Inc., 356 U.S. 260, (1958), and United States v. Foster, 324 F.2d 702 (C.A. 5, 1963). Each of the cited cases involved a production payment in a specified amount payable over a period less than the life of the property interest from which it was carved. The courts found that the substance and effect of such transactions was a substitute of a lump-sum payment for future income rather than a conversion of a capital asset.
In contrast, the present contracts conveyed to Pan American the rights to all of the water underlying the subject properties and reserved none of it to petitioners. It was for all of the water — nothing less, nothing more — that Pan American paid, and petitioners received, the lump sums of $56,000 each. We have the uncontradicted testimony of petitioners' expert witness that Pan American will require at least 110 million barrels of water to waterflood its oil field; the reservoir underlying the southeast quarters of sections 5 and 35 contained only 30 million barrels of water at the time the contracts were made. And Pan American expressed the intent to extract all of the water. Therefore, no substantial rights to the water were reserved by petitioners.
That all of the water under petitioners' properties can be extracted is clear. It has been stipulated that that water is a nonrenewable resource and that there has been a substantial decline in the water table in the Ogallala formation. And we have found as a fact that under present conditions the Ogallala reservoir will be exhausted. See United States v. Shurbet, 347 F.2d 103 (C.A. 5, 1965), affirming 242 F. Supp. 736 (N.D. Tex. 1961); cf. subpars. (A) and (B) of sec. 613(b)(6), I.R.C. 1954, classifying water and "inexhaustible resources" in separate categories.
Respondent's reliance upon Puckett v. Commissioner, supra, is misplaced. The agreement involved in that case bore the following characteristics of a lease, none of which are present here: The consideration was payable in fixed annual sums — having no relation either to the amount of water produced or to the value of the water available for extraction — much like rental payments under a lease of realty; the assignee could terminate the agreement at the end of any year without further obligation to the assignor; and "there was no substantial initial payment, a common characteristic of a sale." Indeed, the only consideration received by the present petitioners was a single "substantial initial payment."
See M. C. Puckett, T.C. Memo. 1964-40.
Nor is this case similar to Wood v. United States, 377 F.2d 300 (C.A. 5, 1967), certiorari denied 389 U.S. 977 (1967). There the taxpayer assigned an exclusive right to mine sand, gravel, and rock on his land for an indefinite period; the consideration for such assignment was a royalty interest, including a provision for a guaranteed minimum annual royalty. The court held that the agreement was a lease and that the royalty receipts were taxable as ordinary income rather than capital gains. In so holding, the court concluded that the taxpayer had to look solely to production for a return on his investment — the existence of minimum royalties did not alter that conclusion, id. at 307 and fn. 18 — and he therefore had clearly retained an economic interest. Accord, Standard Oil Co. ( Ind.), 54 T.C. 1099 (1970). The same was true of the taxpayers in the other "hard mineral" cases relied on by the court in Wood: Rabiner v. Bacon, 373 F.2d 537 (C.A. 8, 1967); Freund v. United States, 367 F.2d 776 (C.A. 7, 1966); Laudenslager v. Commissioner, 305 F.2d 686 (C.A. 3, 1962), affirming a Memorandum Opinion of this Court, certiorari denied 371 U.S. 947 (1963); Albritton v. Commissioner, 248 F.2d 49 (C.A. 5, 1957), modifying 24 T.C. 903 (1955). Here, by contrast, petitioners received lump-sum cash payments upon execution of their contracts with Pan American; the payments were unrelated to production; and petitioners will receive no additional payments during the initial term of the contract.
The possibilities that petitioners will receive an additional payment at the end of 25 years, or that Pan American may not exercise its option to extend the agreement for an additional 20 years, do not prevent the transaction from constituting a sale. Cf. Helvering v. Elbe Oil Land Co., 303 U.S. 372 (1938) (facts that payments of installments of purchase price were contingent upon purchaser's nonabandonment of the transaction and that taxpayer shared in the net profits of production did not prevent the transaction from being a sale); Ima Mines Corporation, 32 T.C. 1360, 1367 (1959), acq. 1960-1 C.B. 4 (consideration was a fixed sum, payable in annual installments, against which "excess royalties" were to be offset; held — taxpayer did not retain any economic interest, and the transaction was a sale); Maude W. Olinger, 27 T.C. 93, 97-98 (1956).
We hold that petitioners are entitled to long-term capital gain treatment of the receipts from Pan American. The purpose of the capital gains provisions was "to relieve the taxpayer from these excessive tax burdens on gains resulting from a conversion of capital investments, and to remove the deterrent effect of those burdens on such conversions." See Burnet v. Harmel, supra at 106. We are aware that this is an exception to the general rule as to the taxation of gains and has "always been narrowly construed so as to protect the revenue against artful devices." Commissioner v. P. G. Lake, Inc., supra at 265; see Commissioner v. Gillette Motor Co., 364 U.S. 130, 134-135 (1960); Corn Products Co. v. Commissioner, 350 U.S. 46, 52 (1955); Comment, "Treatment of Gain from Disposition of Rental Property," 68 Col.L.Rev. 1174, 1187-1191 (1968). Nevertheless, we are convinced that petitioners' gain from the disposition of their water rights falls within the exception. When petitioners made their capital investments they acquired rights to the underlying water which very substantially affected the value of their land. In a single transaction they converted their valuable capital investments to cash, all taxable in a single year. In no real sense can it be said that the $56,000 received by each of the petitioners was a substitute for future income.
Decisions will be entered for the petitioners.