Comm'r of Internal Revenue

Tax Court of the United States.Nov 10, 1948
11 T.C. 826 (U.S.T.C. 1948)

Docket No. 15973.



T. F. Ryan, Esq., for the petitioner. H. H. McCall, Esq., for the respondent.

Petitioner is engaged in the business of digging plastic loam, excavating and processing molding sand, and marketing both products. In 1940 he purchased 3 tracts of land aggregating approximately 15 acres in order to continue his operations. He claimed depletion on 2 tracts, based on discovery value. Held, petitioner failed to sustain his burden of proof of showing that the tracts were not proved before purchase; held, further, that he failed to show a proper and adequate basis for computing the probable content of molding said in such tracts. T. F. Ryan, Esq., for the petitioner. H. H. McCall, Esq., for the respondent.

The respondent determined a deficiency of $4,979.59 in the petitioner's income and victory tax liability for the year 1943.

The major issue now in controversy is whether or not the petitioner is entitled to discovery value depletion on molding sand allegedly discovered by the petitioner.

A collateral issue is the allowance of a deduction for medical expenses. This issue is contingent upon the amount of the petitioner's income resulting from the determination of the first issue.


The petitioner is an individual, residing in Pittsburgh, Pennsylvania. He filed his income tax and victory tax return for the taxable year with the collector of internal revenue for the twenty-third district of Pennsylvania.

Certain facts were stipulated. In so far as they are material to the issue, they are as follows:

By deed dated August 30, 1940, Margaret C. Snyder, widow, conveyed to the petitioner for a consideration of $5,500 a tract of land situated in the township of Harmar, Allegheny County, Pennsylvania, containing 10.137 acres and fronting on its eastern side 400.83 feet on Little Deer Creek Valley Road. By deed dated November 26, 1940, Philip H. Hodel and wife conveyed to the petitioner for a consideration of $1,875 a tract of land situated in the same township, containing 2 1/2 acres and adjoining the Snyder tract on the north. By deed dated October 30, 1940, John D. Nixon and wife conveyed to the petitioner for a consideration of $1,073 a tract of land situated in the same township, containing 3.904 acres and adjoining the western border of the Snyder tract.

On the Nixon tract the petitioner erected a plant and installed machinery and equipment for processing molding sand and shipping it, as well as plastic loam. The construction work therefor progressed throughout the year 1941.

On the Snyder and Hodel tracts, in early March 1942, the petitioner commenced to remove loam and to dig molding sand, which was processed through the plant erected on the Nixon tract, and those products were sold and shipped therefrom.

The operation of the petitioner on the Snyder, Hodel, and Nixon tracts is known as the Larry plant, as distinguished from a then lessee operation for molding sand and plastic loam by the petitioner known as the Murray plant, which was situated in Springdale Township, Allegheny County, Pennsylvania, about three air miles distant from the Larry plant, with hills and valleys intervening. The petitioner was the lessee of the Murray plant.

The record discloses the following additional facts:

The petitioner is engaged in the business of digging plastic loam and extracting and processing molding sand. Plastic loam or yellow clay is used in its natural state by steel mills for lining ladles, sealing fire doors, as troughs for hot metal, etc. Molding sand is a mixture of clay and gravel consisting usually of approximately 20 per cent clay and 80 per cent gravel, processed by crushing into small particles less than three-eighths of an inch in diameter, and is used in molding steel ingots.

The petitioner began the business in 1933 as lessee of an established operation called the Murray Plant. He paid a royalty of 25 cents a ton on both the plastic loam and the unprocessed molding sand. He also was required to restore, replace, and maintain the machinery, equipment, and buildings composing the plant.

In the spring of 1939 the supply of plastic loam at the Murray Plant was becoming exhausted. The petitioner then secured loam from an adjoining tract. In the spring of 1940 he began to look elsewhere for a possible source of supply of both loam and molding sand. He was assisted in the search by William S. Slifer, a graduate engineer, who is now dead. Slifer located a commercial deposit of loam on the Snyder tract. The petitioner found plastic loam therein.

The petitioner then talked with Mrs. Snyder, who fixed a price of $550 per acre for her land. Hazel Carnahan, Mrs. Snyder's daughter, was present at the conference. The possible presence of ‘loam sand‘ on the tract was discussed. Mrs. Snyder gave the petitioner a 60-day option on her land, with the privilege of drilling test holes.

The option contained the following paragraph:

IT IS FURTHER AGREED that the party of the second part shall, during the term of this option, have the right to go upon said premises and drill test holes thereon, which test holes shall be re-filled by him at his own expense, before the expiration date of this option, in case that he does not exercise said option before its expiration date.

The petitioner thereupon drilled test holes at least 10 feet deep, and sometimes as much as 40 feet deep. The soil removed therefrom contained sand and gravel. The test holes were about 200 feet from the Little Deer Creek Valley Road.

On the Snyder tract, as well as on the Hodel tract, there was a surface soil of about 8 inches in thickness; under that a stratum of ‘plastic loam‘ (a substance which becomes slippery and plastic when wet) varying in thickness from one to four feet, and under that a stratum of clay mixed with gravel or pebbles and larger stones. When there is an excess of clay over the 20 per cent required to produce molding sand, it is not sent to the crushing plant, but is piled at the excavation. The deposit of gravel or pebbles was very irregular in thickness, or ‘spotty‘. At the petitioner's plant the clay and gravel, or ‘molding sand‘ (so termed when processed), are removed together. The petitioner knew that there was molding sand (or the raw material from which it was produced) under the Hodel tract before he bought it. After the test holes had been bored on the Snyder tract, the petitioner exercised the option to purchase the land from Mrs. Snyder on August 30, 1940, as above set forth. The petitioner also had in mind the possible use of the tract as a home-building project.

In 1935 James H. McCrady, Jr., owned a 90-acre tract of land adjoining the Snyder tract. His tract had been operated as a gravel extraction enterprise since about 1919. McCrady had been interested in the sand and gravel business for 52 years. He produced molding sand by substantially the same method as that employed by the petitioner. The gravel deposits in the McCrady and petitioner's operations are of approximately the same thickness and are continuations of the same alluvial deposits. The faces of their respective workings are about 700 feet apart. The deposits on the McCrady tract continued through to the petitioner's land. In 1940 the petitioner knew of McCrady's operation and was familiar with the topography of the land in the vicinity of the Snyder tract.

In various banks on the Snyder land outcroppings of sand and grave and plastic loam were visible. On the western portion of the Snyder tract were slopes and gullies, caused by erosion, which exhibited similar outcroppings.



The primary issue in the case at bar is whether or not the petitioner is entitled to discovery value depletion as provided in section 23(m) and 114(b)(2) of the Internal Revenue Code.

SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(m) DEPLETION.— In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. In any case in which it is ascertained as a result of operations or of development work that the recoverable units are greater or less than the prior estimate thereof, then such prior estimate (but not the basis for depletion) shall be revised and the allowance under this subsection for subsequent taxable years shall be based upon such revised estimate. * * *For percentage depletion allowable under this subsection, see section 114(b)(3) and (4).SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.(b) BASIS FOR DEPLETION.—(2) DISCOVERY VALUE IN CASE OF MINES.— In the case of mines (other than metal, coal, fluorspar, ball and sagger clay, rock asphalt, or sulphur mines) discovered by the taxpayer after February 28, 1913, the basis for depletion shall be the fair market value of the property at the date of discovery or within thirty days thereafter, if such mines were not acquired as the result of purchase of a proven tract or lease, and if the fair market value of the property is materially disproportionate to the cost. The depletion allowance under section 23(m) based on discovery value provided in this paragraph shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property upon which the discovery was made, except that in no case shall the depletion allowance under section 23(m) be less than it would be if computed without reference to discovery value. Discoveries shall include minerals in commercial quantities contained within a vein, or deposit discovered in an existing mine or mining tract by the taxpayer after February 28, 1913, if the vein or deposit thus discovered was not merely the uninterrupted extension of a continuing commercial vein or deposit already known to exist, and if the discovered minerals are of sufficient value and quantity that they could be separately mined and marketed at a profit.

The latter section establishes the basis for depletion as the fair market value of the property at the date of discovery, or within 30 days thereafter, if such mines were not acquired as a result of the purchase of a proved tract or lease. Thus, assuming, without deciding, that petitioner's operation is a ‘mine‘ (but see Evangeline Gravel Co., 13 B.T.A. 101; Parker Gravel Co., 21 B.T.A. 51; Grand River Gravel Co., 22 B.T.A. 1124; Dunn & Baker, Inc., 30 B.T.A. 663), if petitioner is to prevail we must find that the petitioner conformed to the requirement of the statute, that the land in controversy was not a proved tract at the time of purchase. (See Melville G. Thompson, 10 B.T.A. 25.)

The record is convincing that prior to his purchase of the Snyder tract the petitioner knew of the existence therein of the type of gravel from which he produced molding sand. He stated freely that he had bored extensive test holes on the land varying from 10 to 40 feet in depth. It would be difficult to believe that at that time he did not encounter the stratum of gravel which he later worked so successfully and the profits from which induced him to seek a deduction for depletion based on discovery value.

In the light of the petitioner's previous experience in extracting and processing molding sand, his familiarity with operations of that character (including the neighboring McCrady plant), his realization of the necessity of securing new lands suited to his needs, and his examination and knowledge of the Snyder tract and contours, it is unmistakably apparent to us that he was conversant with the character and probable extent of the ‘molding sand‘ deposit at the time of purchase of the land.

We hold that the petitioner is not entitled to a deduction for depletion based on discovery value.

There are further reasons why petitioner can not prevail.

The evidence, though not conclusive, tends to show that the gravel deposits under the Snyder and Hodel tracts were uninterrupted extensions of a continuing commercial deposit already known to exist. The land adjacent to the Snyder tract and the land across the Little Deer Creek Valley Road (33 feet wide) showed the evidence of the same gravel stratum as that demonstrated by the test holes to underlie the Snyder land. The respondent's expert witness and McCrady both testified that the petitioner's operation was in the same gravel bed as that exposed on the McCrady property. In any event, the petitioner has failed to sustain his burden of proof that his stratum of molding sand is not such a continuation.

Further, petitioner has not adequately proved that the fair market value of the tracts was disproportionate to their cost.

The petitioner has not presented adequate proof of the basis for his calculations of the tonnage of molding sand in place. He estimated it to be 180,000 tons in the Snyder land and 20,000 tons in the Hodel land. The petitioner insists that the stratum was very irregular and spotty. Under such circumstances and in the absence of more precise and accurate support of that estimate, we can not accept it. The petitioner stated that he paid 25 cents a ton royalty at the Murray plant, but he did not show that it was the prevailing or market price at the Larry location. Moreover, as we said in Dunn & Baker, supra:

* * * But even assuming a determinable content and a fixed-price, the multiplication of the two figures does not give fair market value. Reinecke v. Spalding, 280 U.S. 227.

In Reinecke v. Spalding, supra, the Court said:

* * * Manifestly, the fair market value of this interest in 1913 was much less than 25 cents per ton of the estimated contents of the mines, but respondent introduced no evidence which tended to show such value.

The lack of proof on this point would require a holding against petitioner were there no other defect in the record.

The second issue, relating to medical expenses, requires no consideration by us.

Decision will be entered under Rule 50.