DocketNumber: Docket No. 18123-80
Judges: Shields
Filed Date: 1/9/1984
Status: Precedential
Modified Date: 11/14/2024
*124
In 1966, petitioners executed a contract covering a period of 62 years for the sale of timber to a timber cutting company. The agreement provided for quarterly fixed payments to petitioners for the sale of 640 cords of wood per year, with payments to be made whether or not any timber was cut. Petitioners retained title to the timber, paid taxes on it, and bore the risk of loss until it was cut. A cord credit account was maintained by the purchaser under which petitioners were credited with a minimum of 640 cords per year and debited as the timber was cut. Petitioners were compensated for any overcut in addition to the fixed annual payments. At the termination of the contract, petitioners were entitled to retain as liquidated damages all payments received whether or not any timber had been cut.
From 1966 through 1979, petitioners reported all amounts received under the contract as capital gains. For 1978 and 1979, respondent determined that the payments were taxable as ordinary income.
*74 Respondent determined deficiencies in petitioners' income tax for 1978 and 1979 in the respective amounts of $ 16,086.83 and $ 1,488.37. After concessions by the parties, the issue remaining for decision is whether certain payments received by petitioners under a long-term contract for the sale of timber must be treated as ordinary income as contended by the respondent, or as income from capital gains under
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by reference.
Petitioners Percy E. Godbold, Jr., and Grace F. Godbold, husband and wife, resided in Anniston, Ala., when the petition was filed in this case. They filed joint income tax returns for 1978 and 1979 with the Internal Revenue Service Center*127 in Chamblee, Ga.
Mr. Godbold is a banker and certified public accountant. Mrs. Godbold is a housewife. On April 8, 1966, Mrs. Godbold had owned for several years a tract of land containing 652 acres of which 640 acres constituted timberland. Neither Mr. *75 Godbold nor Mrs. Godbold was in the business of selling or harvesting timber, and the timber standing on the property was not used by them in a trade or business or held for sale in the course of any business.
On April 8, 1966, petitioners, as owners, executed a Timber Sale and Purchase Contract with Harmac Alabama, Inc., as purchaser. The name of the purchaser was later changed to MacMillan Bloedel Products, Inc., and will be referred to herein as MacMillan Bloedel, the purchaser or the corporation. The contract covered timber standing on, or to be grown on, the aforesaid 640 acres of timberland. The contract was effective through December 31, 2028, a period of 62 years.
Under the contract, MacMillan Bloedel received the exclusive right to cut and remove all timber standing and growing at the time of the contract and all future timber standing and growing during the term of the contract, except for the equivalent of*128 1,280 cords of pulpwood timber which the petitioners reserved the right to cut and remove on or before January 1, 1968. MacMillan Bloedel was obligated to pay the petitioners for pulpwood timber, and certain hardwood timber at a specified rate of $ 6 per cord as adjusted in each year in which there was a fluctuation of 5 percent or more in the annual average of the Wholesale Price Index for All Commodities over the annual average of such index for 1964. MacMillan Bloedel was also obligated to pay the petitioners for any removal of merchantable saw, pole, piling, crosstie, or veneer block timber according to the stumpage price prevailing from time to time in the vicinity.
The contract required MacMillan Bloedel to maintain a "cord credit account" which was to be credited each year for 640 cords of merchantable pine pulpwood timber. The account was to be debited for each cord of merchantable pine pulpwood timber, or its equivalent, as it was cut and removed from the land. The corporation, however, was under no obligation to cut any quantity of timber in any year, but was required to pay the petitioners in equal quarterly installments an amount equal to the purchase price of 640 *129 cords of merchantable pine pulpwood timber, whether or not any timber was cut during that year.
If MacMillan Bloedel cut timber in any one year in excess of the total cord credit, resulting in a debit balance in the cord *76 credit account, the corporation was to pay the petitioners the purchase price for the overcut of timber in the following year. Any credit balance in the account was to be carried forward each year as a credit against any timber cut during subsequent years, but any such credit would not reduce the corporation's obligation to pay the petitioners the minimum amount each year equal to the purchase price of 640 cords.
Upon termination of the contract, the petitioners were entitled to retain as liquidated damages all minimum payments they had received, whether or not MacMillan Bloedel ever cut the timber for which such payments were made.
On May 23, 1966, the petitioners sold to MacMillan Bloedel the 1,280 cords of pulpwood timber that had been reserved in the original contract between the parties. The petitioners received $ 7,680 for this timber, payable in two equal amounts of $ 3,840 in 1966 and 1967. By agreement, these 1,280 cords of pine pulpwood timber*130 were credited to the cord credit account, but the payments did not eliminate the corporation's obligation to make the minimum quarterly installments for 1966 and 1967 as prescribed in the agreement of April 8, 1966.
The entries made in the cord credit account maintained by MacMillan Bloedel for the years 1966 through 1979 pursuant to the timber sale and purchase contract were as shown on page 77.
MacMillan Bloedel cut no timber under the contract in 1966 through 1971, or in 1974, 1978, and 1979. Timber was cut in 1972 and 1973, and in 1975 through 1977. Until 1977, the cut timber did not exceed the credit balance in the cord account. In 1977, MacMillan Bloedel overcut the timber by 6,437 cords, and, pursuant to the contract, paid petitioners $ 71,197.53 in 1978 for the overcut.
The fair market value on April 8, 1966, of the timber on the land covered by the contract was $ 68,817.34. From and after their receipt of the payment in 1978 for the overcut in 1977, the petitioners had completely recovered the value of the timber on the date of the contract.
Title to the timber covered by the contract remained in petitioners until the timber was cut. Until such time, they were also responsible*131 for all taxes levied against the property including the standing timber, and they bore the risk of any *77
Price | Price | Payments | ||||
Cord | per cord | Cord | per cord | Cord | received by | |
Year | credit | for credit | (debit) | for debit | balance | petitioners |
1966 | 640.00 | $ 6.00 | 640.00 | $ 3,840.00 | ||
1967 | 640.00 | 6.00 | 1,280.00 | 3,840.00 | ||
1968 | 640.00 | 6.17 | 1,920.00 | 3,945.60 | ||
1969 | 640.00 | 6.33 | 2,560.00 | 4,051.20 | ||
1970 | 640.00 | 6.54 | 3,200.00 | 4,182.40 | ||
1971 | 640.00 | 6.95 | 3,840.00 | 4,444.80 | ||
1972 | 640.00 | 7.21 | (1,490.86) | $ 7.21 | 2,989.14 | 4,614.40 |
1973 | 640.00 | 7.21 | (1,688.35) | 7.21 | 1,940.79 | 4,614.40 |
1974 | 640.00 | 8.52 | 2,580.79 | 5,452.80 | ||
1975 | 640.00 | 10.12 | (2,033.14) | 10.12 | 1,187.65 | 6,476.80 |
1976 | 640.00 | 11.06 | (285.45) | 11.06 | 1,542.20 | 7,078.40 |
1977 | 640.00 | 11.06 | (8,619.59) | 11.06 | (6,437.39) | 7,078.40 |
6,437.39 | 11.06 | (additional payment | 0 | 71,197.53 | ||
for debit balance) | ||||||
1978 | 640.00 | 12.28 | 640.00 | 7,859.20 | ||
1979 | 640.00 | 13.24 | 1,280.00 | 8,473.60 | ||
147,149.53 |
*78 damage to the timber caused by fire, weather, disease, or insects.
On their returns for 1966 through 1979, *132 the petitioners reported all payments received under the timber contract as income from capital gains. The respondent did not question this treatment on any of the returns for 1966 through 1977, but in the deficiency notice for 1978 and 1979, he determined that $ 69,858.59 of the $ 79,056.73 received by the petitioners from MacMillan Bloedel in 1978 and all of the $ 8,473.60 they received from the corporation in 1979 were ordinary income and not income from capital gains.
The respondent has subsequently conceded that all of the $ 71,197.53 received by the petitioners in 1978 for the overcut made in 1977 was properly reported by them as capital gain income. He continues to insist, however, that the minimum payments totaling $ 7,859.20 in 1978 and $ 8,473.60 in 1979 are ordinary income.
On their part, the petitioners concede that 75 percent of the minimum payments for 1978 and 1979 do not qualify for capital gain treatment under
They continue to insist, however, that the other 25 percent of *133 such payments qualifies for capital gain treatment under either
OPINION
Under
The applicable regulation describes an economic interest as one "in which the taxpayer has acquired by investment any interest in * * * standing timber and secures, by any form of legal relationship, income derived from the * * * severance of the timber, to which he must look for a return of his capital."
It is essential that the consideration for the transaction, whether*135 payable in cash or in kind, be contingent upon the severance of the timber, and payable to the owner solely out of the proceeds from the natural resource itself.
The Court concluded that capital gains treatment under
Again, in
Finally, in
The taxpayers in
The contract at issue in the
Petitioners argue, however, that under
*139 In view of the foregoing, we conclude that petitioners are not entitled to the benefits of
Even though petitioners did not retain an economic interest in the timber which would entitle them to capital gains treatment under
Therefore, all payments received under the contract by the petitioners for the timber which was in existence on April 8, 1966, qualify for capital gains treatment under
*143
1. All section references are to the Internal Revenue Code of 1954 as amended, unless otherwise indicated.↩
2. At the time of the execution of the contract,
"In the case of the disposal of timber held for more than six months before such disposal, by the owner thereof under any form or type of contract by virtue of which such owner retains an economic interest in such timber, the difference between the amount realized from the disposal of such timber and the adjusted depletion basis thereof, shall be considered as though it were a gain or loss, as the case may be, on the sale of such timber."
In 1976, this section was amended to require that the timber be held for more than 1 year. Pub. L. 94-455, 90 Stat. 1732.↩
3.
(1) Where the conditions of paragraph (a) of this section are met [the timber is held for more than 1 year and the taxpayer retains an economic interest], amounts received or accrued prior to cutting (such as advance royalty payments or minimum royalty payments) shall be treated under
(2) However, if the right to cut timber under the contract expires, terminates, or is abandoned before the timber which has been paid for is cut, the taxpayer shall treat payments attributable to the uncut timber as ordinary income and not as received from the sale of timber under
4. See also
5. An appeal from the decision in this case would be to the newly created Eleventh Circuit. However, the case law of the former Fifth Circuit has been adopted by the Eleventh Circuit as binding precedent unless or until overruled by the Eleventh Circuit Court of Appeals sitting en banc.
6. Petitioners' reliance on
Crosby v. United States ( 1968 )
Milton Dyal v. United States ( 1965 )
Ah Pah Redwood Company, a Corporation v. Commissioner of ... ( 1957 )
W. H. Plant, Jr., and Doris D. Plant v. United States ( 1982 )
L. O. Crosby, Jr., and Dorothy H. Crosby v. United States ( 1969 )