22 T.C. 459">*461 The Commissioner determined the following deficiencies and penalties in the three dockets here consolidated:

By amended answers the Commissioner seeks to have us increase the deficiencies and penalties in Docket No. 36218 (Elsie SoRelle) to the following:

Many issues were raised in these proceedings. For convenience 1954 U.S. Tax Ct. LEXIS 190">*197 and clarity, therefore, the opinion has been segregated into captioned portions, each of which contains the findings and opinion applicable to an issue or related group of issues. A number of adjustments made by the Commissioner in the income reported by A. W. SoRelle and Elsie SoRelle for 1946 and 1947 were not contested. These will be given effect in a computation under Rule 50.

Findings of Fact -- General.

Elsie SoRelle, the widow of A. W. SoRelle, resides at Amarillo, Texas. A. W. SoRelle, Jr., Irving SoRelle, Jack SoRelle, and Charles W. SoRelle are the independent executors of the estate of A. W. SoRelle who died January 10, 1949; they reside at Amarillo, Texas. A. W. SoRelle, hereinafter sometimes referred to as SoRelle, was married three times. The first marriage to Laura SoRelle was terminated by divorce on January 17, 1945; SoRelle married Mabel Ruth SoRelle on February 12, 1945, and they were divorced on March 25, 1946; SoRelle married Elsie SoRelle on May 25, 1946, and this marriage was terminated by his death on January 19, 1949.

SoRelle was a farmer and rancher, conducting his business as a sole proprietorship. The income tax returns of A. W. SoRelle, Elsie 1954 U.S. Tax Ct. LEXIS 190">*198 SoRelle, and Mabel Ruth SoRelle were filed with the collector of internal revenue for the second district of Texas.

22 T.C. 459">*462 I. A. W. SoRelle's Accounting Method.

ISSUES.

(a) Whether the correct method of reporting income from SoRelle's farming and ranching business is the cash, the accrual, or a hybrid accounting method.

(b) If the accrual or a hybrid method is correct, then whether the Commissioner erred in his application of the method in valuing cattle and wheat inventories pursuant to the so-called farm-price method.

(c) If the accrual or a hybrid method is correct, then whether the Commissioner erred in failing to take into account 17,000 bushels of wheat allegedly on hand at the beginning of 1946.

FINDINGS OF FACT.

(a) SoRelle maintained a farm and a ranch which were about 42 miles apart. He kept a breeding herd of cows and bulls on the ranch and a herd of ordinary beef cattle on the farm. The calves produced by the breeding herd were weaned when 4 to 6 months old and were placed with the ordinary herd on the farm. The ordinary herd also contained heifers and steers purchased by SoRelle for fattening and resale. Most of SoRelle's income was derived from the sale of 1954 U.S. Tax Ct. LEXIS 190">*199 beef cattle from the ordinary herd. Considerably smaller sums of income were realized from sales of sheep, hogs, rye, wheat, and wool. He also sold cows and bulls culled from the breeding herd when, because of age or infirmity, they had ceased to be satisfactory for breeding purposes.

From 1939 through 1947, SoRelle's books were kept by bookkeepers whom he employed on a part-time basis. The same bookkeepers prepared all his returns for those years, except the original 1947 return and the amended returns for 1946 and 1947, which were prepared by a certified public accountant. The amended returns, which were filed by SoRelle's executors on May 13, 1949, were prepared (along with amended returns for Elsie for those years) primarily to correct alleged errors in SoRelle's inventory counts and because half of the total income from SoRelle's business for 1946 had erroneously been included in the original return filed by Elsie for the period May 25-December 31, 1946. In the original and amended returns filed for 1946 and 1947, SoRelle's net income and tax thereon are reported as follows:

1954 U.S. Tax Ct. LEXIS 190">*200 22 T.C. 459">*463 The following payments were made on his 1946 tax:

On or about July 20, 1951, a claim was filed for a $ 15,837.47 refund of the 1946 taxes paid, which claim was reasserted in the petition filed in this case on August 27, 1951. Subsequently, on April 15, 1952, an additional $ 1,389.74 for 1946 taxes was paid by SoRelle's estate. In its brief the estate now argues that SoRelle's 1946 net income, computed on the cash basis, was $ 29,478.58, and that a tax refund of $ 16,910.25 is therefore due. The brief further asserts that SoRelle's net income for 1947, computed on the cash basis, is $ 47,275.75 and concedes that consequently a deficiency of $ 12,190.89 for that year is owed.

The only books that were kept for SoRelle's business by his part-time bookkeepers were a journal and a ledger. The major source of information for the entries made in the books was bank statements and deposit slips from which income entries were taken and canceled checks which were the source of the expenditure entries, all of which SoRelle furnished monthly. On the deposit slips1954 U.S. Tax Ct. LEXIS 190">*201 and canceled checks there usually were notations regarding the source of the deposit or the purpose of the expenditure. Certain other information, such as explanations of doubtful items and information concerning year-end entries like depreciation, also came directly from SoRelle, neither the bookkeepers nor the certified public accountant having any personal knowledge of the affairs of the business.

In accounting for and reporting income, inventories were used, SoRelle supplying the bookkeepers at each year's end with a sheet and/or verbal information concerning the inventories on hand. For the years 1939 through 1945, inventories of cattle, sheep, hogs, wheat, wool, rye, horses, and mules were used in computing income, but for 1946 and 1947 only cattle was inventoried. The year-end sheets prepared by SoRelle or from information furnished by SoRelle are the only evidence of the size and valuation of the inventories and they contain columns showing only the number of each type (i. e., cows, calves, heifers, steers, etc.) of cattle, the value per head, and the total value for that type. There is no information regarding the weight or grade of the cattle inventoried, nor are there1954 U.S. Tax Ct. LEXIS 190">*202 any underlying records or memoranda prepared by SoRelle or any direct evidence concerning the method used by him to value the inventories. Neither were there any details in the books regarding the number, weight, type, grade, or value of cattle on hand at any particular time during 1946 22 T.C. 459">*464 or 1947, other than at the beginning and end of those years. Moreover, book entries of purchases and sales of cattle during those years often do not disclose the type or weight of cattle involved, merely identifying them as "cattle," and in some cases even failing to state the number of cattle purchased or sold in a particular transaction.

Other than inventories, there were no accrual accounts, such as accounts payable and accounts receivable, used in determining SoRelle's income. The great majority of his sales, however, were made through livestock auction companies whose policy it was to pay him on the day of the sale or, at the latest, at the close of the week. Similarly, he made a habit of purchasing on a cash payment rather than credit basis and paid all of his bills promptly, usually by check.

SoRelle used a hybrid system of accounting for and reporting income, to wit, the cash 1954 U.S. Tax Ct. LEXIS 190">*203 receipts and disbursements basis plus the use of inventories. That hybrid system did not clearly reflect SoRelle's net income, and the accrual method of accounting most clearly reflects SoRelle's net income.

SoRelle completed sales of cattle in December 1945 in the following net amounts which, however, were recorded in his books as income for January 1946 and included in his original and amended returns for that year:

(b) The opening cattle inventory used in both SoRelle's original and amended returns for 1946, the first of the two tax years in question, was as follows:

1954 U.S. Tax Ct. LEXIS 190">*204 22 T.C. 459">*465 This inventory has been accepted by the Commissioner as being correctly computed pursuant to the farm-price method of valuation. SoRelle's estate (petitioner) contends, however, that if SoRelle had been using the farm-price method of valuation the January 1, 1946, inventory would be as follows:

Excluding the breeding cattle (cows and bulls) and the milk cows from both calculations we find that the value SoRelle assigned to his ordinary herd is $ 116,647.50, and the value which the estate asserts as proper for that herd pursuant to the farm-price method is $ 116,032.31. The value actually used by SoRelle, therefore, exceeds the estate's asserted farm-price method value by only $ 615.19. We find that SoRelle's values accord with the then current market prices for the ordinary cattle mentioned.

Included in SoRelle's inventories for 1939 through 1945 were wheat, rye, and wool which were raised by him. Upon consideration of the fact that he deducted yearly the costs of those products1954 U.S. Tax Ct. LEXIS 190">*205 in determining net income, and upon examination of the values assigned to them, we find that the farm-price method was used in inventorying them.

Considering the aforementioned facts, i. e., that SoRelle calculated the 1946 opening inventory of his ordinary herd pursuant to the farm-price method, that the farm products he inventoried from 1939 through 1945 were inventoried pursuant to the farm-price method, and that his livestock inventories for 1939 through 1945 (except the breeding herd and milk cows) were probably valued according to that method, we find that SoRelle elected to value all his inventories, other than those of his breeding herd and milk cows, pursuant to the farm-price method.

In inventorying his breeding herd and milk cows for 1946 and 1947, SoRelle assigned the following per head values to that stock:

22 T.C. 459">*466 After studying these figures and the valuations at which such stock was inventoried1954 U.S. Tax Ct. LEXIS 190">*206 for the years 1939 through 1945, we conclude that SoRelle inventoried his breeding herd and milk cows on the basis of his actual total purchase costs for each type and grade of such stock, which total costs he averaged over all the head (both purchased and raised) in that type and grade. He deducted the feeding and maintenance costs of that stock as current expenses rather than adding them to inventory valuation.

We find that the Commissioner in his deficiency notice correctly determined, pursuant to the farm-price method, the value of SoRelle's ordinary herd and wheat inventories for January 1, 1946 (with the one exception noted in subpart (c) below), December 31, 1946-January 1, 1947, and December 31, 1947. We also find to be correct the ordinary herd inventory as of May 25, 1946 (the date of SoRelle's and Elsie's marriage), which was computed by Elsie on the farm-price method. However, we do not consider accurate the breeding herd and milk cow inventories which the Commissioner and Elsie calculated for the aforementioned dates. Therefore, we have analyzed the information contained in the record and have valued the inventories for that stock pursuant to the farm-price method1954 U.S. Tax Ct. LEXIS 190">*207 of valuation. These valuations will be found included in the inventories which appear hereafter at the conclusion of the Findings of Fact under the general heading with which we are now dealing.

(c) On January 11, 1945, just prior to their divorce on January 17, 1945, SoRelle and Laura entered into a separation agreement which provided for the disposition of their separate and community property. The agreement provided, in part, as follows:

FIFTH: It is agreed that the parties own as their common property, to be managed or disposed of as hereinafter provided:

(a) Several thousand bushels of wheat now located in the granary and elevator on the south half (S 1/2) of Section 29, Block 6, I. & G. N. Surveys, Randall County, Texas, being all of the wheat located on said premises, save 3,253 bushels owned by the Harned sisters as rent wheat:

* * * *

SIXTH: The wheat * * * listed as subdivisions (a) * * * of the preceding paragraph * * * shall be subject to the provisions hereinafter contained with respect to the payment of the income tax for the year 1944. Any remaining wheat * * * shall seasonably and within a reasonable time be marketed and the proceeds divided equally between1954 U.S. Tax Ct. LEXIS 190">*208 the parties. Pending such marketing, the said wheat * * * shall remain in its present location and the wife shall not be under any obligation to the husband for any rental or storage charge on her one-half interest therein; neither shall the husband sustain any obligation to the wife save the obligation to use good faith in his dealings with the wife both in the storage and the disposition of said wheat * * *. The husband may use * * * wheat * * * in connection with his operations; but in that event he shall keep accurate account of the wheat * * * so used and shall pay to the wife the one-half part of the market value thereof at the date of use. * * *

22 T.C. 459">*467 On January 1, 1946, 17,000 bushels of that wheat were stored in bins on SoRelle's ranch. One-half of those 17,000 bushels was owned by Laura and the other half by SoRelle. Laura received checks totaling $ 12,408.23 for her share of the wheat on July 26, 1946, and September 9, 1946, indicating that the wheat was finally disposed of sometime after SoRelle married Elsie on May 25, 1946. The market price, less cost of disposition, of the wheat on January 1, 1946, and May 25, 1946, was $ 1.49 a bushel and $ 1.66 a bushel, 1954 U.S. Tax Ct. LEXIS 190">*209 respectively. The inventory value of SoRelle's one-half of the 17,000 bushels, calculated in accordance with the farm-price method, was, therefore, as follows:

The following is a tabulation, pursuant to the farm-price method, of the 1946 and 1947 wheat and cattle inventories heretofore discussed in these findings:

OPINION.

(a) The basic rule is that taxable net income must be computed in accordance with the method of accounting which the taxpayer regularly employs in keeping his books, but if that method does not clearly reflect income the computation is to be made in accordance with1954 U.S. Tax Ct. LEXIS 190">*211 such method as in the opinion of the Commissioner does clearly reflect income. I. R. C., sec. 41. ² Two methods of accounting are generally recognized for income tax purposes -- cash receipts and disbursements method and accrual method. It is well settled that hybrid methods of accounting which do not clearly reflect the taxpayer's income are improper. Massachusetts Mut. Life Ins. Co. v.22 T.C. 459">*469 , 288 U.S. 269">288 U.S. 269; United States v. Anderson, 269 U.S. 422">269 U.S. 422; Security Flour Mills Co. v. Commissioner, 321 U.S. 281">321 U.S. 281; Estate of Julius I. Byrne, 16 T.C. 1234; Regs. 111, sec. 29.41-2. ³ If, therefore, a taxpayer has used a hybrid method which does not clearly reflect income, adjustment must be made to make it conform to that method, cash or accrual, which it most closely resembles, Niles Bement Pond Co. v. United States, 281 U.S. 357">281 U.S. 357, Estate of Julius I. Byrne, supra, and the Commissioner, in the exercise of his discretion under section 41, may not (as his contentions in this1954 U.S. Tax Ct. LEXIS 190">*212 case indicate he is apparently attempting to do) compel the taxpayer to remain on such a hybrid basis. Farmers and livestock raisers have the option of reporting their income on either a cash or accrual basis. Regs. 111, secs. 29.22 (a)-7, 29.22 (c)-6. If they use inventories, however, the accrual method of accounting is mandatory. Regs. 111, sec. 29.41-2.

1954 U.S. Tax Ct. LEXIS 190">*213 We have found that SoRelle computed his income, for the tax years in question and for prior years back as far as 1939, on a hybrid basis which did not clearly reflect that income; he inventoried his cattle and, prior to 1946, all of his livestock and farm products, but recorded all other items on the cash basis. By electing to use inventories at least as far back as 1939 for sales of all of his livestock and farm products, SoRelle thereby made it mandatory for himself to use the accrual method until permission for change to another method was secured from the Commissioner. Regs. 111, secs. 29.22 (c)-6, 29.41-2. There is no evidence that such permission was ever secured either by SoRelle or his executors, who now argue that the cash basis of accounting for SoRelle's income for 1946 and 1947 is the proper one. ⁴

1954 U.S. Tax Ct. LEXIS 190">*214 We note that even though the only item inventoried in 1946 and 1947 was cattle, by far the major portion of SoRelle's business came from the sale of ordinary herd cattle, the receipts from which accounted for 64.55 per cent of his total operating receipts in 1946 and 22 T.C. 459">*470 86.67 per cent of total operating receipts in 1947. Moreover, although SoRelle did not accrue his sales receipts or his expenses, it was found that he usually received the proceeds of a cattle sale on the day of the sale and that he always paid his expenses promptly. Examination of the record also indicates that a good portion of the remaining receipts for 1946 and 1947 can be identified as originating in cash transactions. Therefore, even as regards 1946 and 1947, petitioners have failed to show at least that in the majority of the most substantial items of income and deductions SoRelle's accounting method is not an accrual method. In Diamond A Cattle Co., 21 T.C. 1, we said:

This is not a case in which the Commissioner has attempted to change a long established and consistently used method of accounting on the ground that it does not clearly reflect income or on any other1954 U.S. Tax Ct. LEXIS 190">*215 ground. Instead he has merely insisted, as the law and regulations require, that the petitioner consistently follow the method of its choice, i. e., an accrual method, with respect to several substantial items which would have to be accrued under any proper accrual method. * * *

In other words, even though SoRelle's book entries, other than the aforementioned inventories from 1939 through 1947, were made on a cash basis his method of doing business was such that the income which those books indicate was realized from his major business activity, buying and selling cattle, is, with one important exception, substantially that which the books would show for that activity had they been kept entirely on an accrual basis. That one exception involves cattle sales totaling $ 28,732.83 which we have found were made at the end of December 1945, but were entered in SoRelle's books as income for January 1946. Those sales must be excluded in computing SoRelle's 1946 income; on the accrual basis they are properly a part of his 1945 income. David W. Hughes, 22 T.C. 1.

It is, of course, true that there are other less important items which would be recorded differently1954 U.S. Tax Ct. LEXIS 190">*216 in SoRelle's books had he used a strict accrual basis and for which, because of lack of information, we cannot make appropriate adjustment. For example, there is not sufficient information upon which to reconstruct inventories of those less important products which SoRelle sold in the years in issue. Although this produces some distortion in the determination of income, it is the result of SoRelle's own failure to take inventories in a proper manner and to maintain proper records. Petitioners therefore, cannot be heard to complain. Moreover, we are of the opinion that those items have no substantial effect on the end result. Diamond A Cattle Co., supra.

(b) Petitioners contend that, even though the accrual method of accounting be held the proper one for SoRelle, the Commissioner erred in valuing SoRelle's inventories of cattle and wheat for 1946 and 22 T.C. 459">*471 1947 pursuant to the so-called farm-price method rather than at cost. The farm-price method provides for the valuation of inventories at market price less direct cost of disposition. Regs. 111, sec. 29.22 (c)-6. No change in the method of valuing inventories can be made without first securing1954 U.S. Tax Ct. LEXIS 190">*217 the Commissioner's approval. Regs. 111, sec. 29.41-2. Petitioners have failed to convince us that the Commissioner erred in valuing SoRelle's inventories (other than those of his breeding herd and milk cows) pursuant to the farm-price method. It was SoRelle's duty to keep accurate and complete inventory records, Regs. 111, sec. 29.22 (c)-2, and by failing to do so he has prevented petitioners from successfully carrying their burden of proof. That SoRelle is now dead and it consequently may be impossible to sustain that burden is unfortunate but does not alter the situation. Burnet v. Houston, 283 U.S. 223">283 U.S. 223.

We have found, as aforementioned, that SoRelle's practice was to value all his inventories, other than those of his breeding herd and milk cows, pursuant to the farm-price method. The latter he appears to have valued on the basis of average purchase cost, unadjusted for feeding and maintenance costs which were deducted annually. Since the record contains no evidence that either SoRelle or his executors ever obtained permission from the Commissioner to change the inventory valuation method, it is manifest that all of SoRelle's inventories1954 U.S. Tax Ct. LEXIS 190">*218 for 1946 and 1947 must be valued pursuant to the farm-price method. This mandate extends to the breeding herd and milk cow inventories, which are required to be valued pursuant to the farm-price method by section 29.22 (c)-6 of the regulations, providing that: "If this [farm-price] method of valuing inventories is used, it must be applied to the entire inventory except as to livestock inventoried, at the taxpayer's election, under the 'unit-livestock-price method'." Petitioners do not make any contention that SoRelle used the "unit-livestock-price method." Our findings contain the proper computation of SoRelle's inventories pursuant to the farm-price method for all the critical dates involved in this case.

(c) We have found that 17,000 bushels of wheat were in SoRelle's bins as of January 1, 1946, and were owned in equal shares by SoRelle and his divorced first wife, Laura. This wheat was not sold until sometime after SoRelle married Elsie on May 25, 1946. The value of SoRelle's share of the wheat, calculated pursuant to the farm-price method, was $ 12,665 on January 1, 1946, and $ 14,110 on May 25, 1946. It must be included, at those respective values, in SoRelle's January 1, 1954 U.S. Tax Ct. LEXIS 190">*219 1946, inventory and Elsie's May 25, 1946, inventory for the purpose of computing her share of the community income.

It is true that the wheat was SoRelle's separate property and did not belong to the community of SoRelle and Elsie. However, the 22 T.C. 459">*472 proceeds realized from sale of the wheat (subsequent to SoRelle's and Elsie's marriage) were commingled with proceeds realized from the sale of their community property and were included in determining Elsie's income. It is not possible to segregate those proceeds now, since there is no evidence indicating the amount thereof. Therefore, under the law of Texas, the proceeds are gross income of the community. W. D. Johnson, 1 T.C. 1041, 1056. As such they are taxable in equal shares to SoRelle and Elsie. Poe v. Seaborn, 282 U.S. 101">282 U.S. 101. It naturally follows that the wheat is properly includible in Elsie's opening inventory as of May 25, 1946, which is to be used for the purpose of computing her share of the community income from May 25, 1946, to the end of the year.

II. Breeding Herd.

ISSUES.

(a) Whether the Commissioner failed to properly give capital gains treatment, 1954 U.S. Tax Ct. LEXIS 190">*220 under section 117 (j) of the Code, to income derived from the sale of livestock from SoRelle's breeding herd.

(b) Whether depreciation deductions, under section 23 (l), may be taken on the breeding herd.

FINDINGS OF FACT.

SoRelle's breeding herd was kept on his ranch 42 miles away from the farm on which the ordinary herd was pastured. None of the breeding herd cows were registered and, although there was testimony to the effect that SoRelle might buy either registered or unregistered bulls, there is no evidence indicating that any of the bulls in inventory during 1946 and 1947 were registered. When any cows outlived their usefulness as breeders, either because of poor health or of reaching an age usually in excess of 7 years, they were sold for beef. Similarly the bulls were sold for beef when they outlived their usefulness as breeders. When necessary SoRelle would replenish his herd of bulls through purchases and his herd of cows both through purchases and selection of promising heifers from his ordinary herd. He included his cows and bulls in inventory at average purchase cost, but deducted as current expenses the costs of food and maintenance for the herd. SoRelle did not1954 U.S. Tax Ct. LEXIS 190">*221 buy cows or bulls, nor utilize heifers raised by him and once transferred to the breeding herd, for any purpose other than as breeders; he did not buy or raise such cows or bulls for beef purposes.

In the tax years in issue SoRelle sold the following breeding herd stock, which stock was held by him for at least 6 months prior to the dates of sale and had the bases noted: 22 T.C. 459">*473

SoRelle never claimed any deductions for depreciation of his breeding herd in his returns for 1939 through 1945, nor in his original returns for 1946 and 1947. Neither did his executors claim such deductions in the amended returns filed for 1946 and 1947. At the hearing petitioners contended that deductions for breeding herd depreciation should be allowed in the amounts of $ 4,633.92 for 1946 and $ 5,740.40 for 1947.

OPINION.

(a) In his brief the Commissioner concedes, as petitioners contend, that, 1954 U.S. Tax Ct. LEXIS 190">*222 despite the fact that SoRelle inventoried his breeding herd, he is entitled to capital gain treatment on sales of the stock culled from that herd if such stock was held by him for more than 6 months. I. R. C., sec. 117 (j); ⁵Albright v. United States, (C. A. 8) 173 F.2d 339; Mim. 6660, 1951-2 C. B. 60. It is clear from the language of the statute, the Commissioner's regulations and rulings, and the applicable 22 T.C. 459">*474 case law that this result follows even though the taxpayer elects to include the breeding stock in his inventory and forego depreciation thereon, rather than to capitalize such stock and take depreciation deductions. Regs. 111, secs. 29.117-7 (a)-1, 3, 29.117-7 (c); I. T. 3666, 1944 C. B. 270; Fawn Lake Ranch Co., 12 T.C. 1139.

1954 U.S. Tax Ct. LEXIS 190">*223 The only questions remaining, therefore, are factual ones involving the numbers of breeding herd cattle sold which qualify for section 117 (j) treatment, the amounts received therefor, and the proper bases for sale. Our findings in this respect reveal that, in 1946, SoRelle sold 32 breeding herd cows for a total of $ 4,283.21 and that his basis therefor (i. e., their value in the last inventory prior to sale), I. R. C., sec. 113 (a) (2), was $ 2,560 ($ 80 each). During 1947, SoRelle sold 380 breeding herd cows for a total of $ 58,117.60, and their basis under section 113 (a) (2) was $ 33,440 ($ 88 each).

(b) In Regulations 111, section 29.22 (a)-7, farmers reporting income on the accrual basis are given the option of either treating their breeding stock as "capital assets subject to depreciation" or including such stock in inventory. If the latter course is adopted, however, the taking of depreciation deductions on the breeding stock is expressly prohibited by section 29.23 (l)-10 of the regulations, which provides as follows:

A reasonable allowance for depreciation may also be claimed on live stock acquired for work, breeding, or dairy purposes, unless they are included in an1954 U.S. Tax Ct. LEXIS 190">*224 inventory used to determine profits in accordance with section 29.22 (a)-7. Such depreciation should be based on the cost or other basis and the estimated life of the live stock. If such live stock be included in an inventory no depreciation thereof will be allowed, as the corresponding reduction in their value will be reflected in the inventory. * * *

We think that the denial of depreciation deductions for inventoried breeding stock accords with sound accounting practices for the precise reason stated in section 29.23 (l)-10, to wit, "the corresponding reduction in their value will be reflected in the inventory." Moreover the aforementioned regulatory provisions have been contained in the regulations since 1934, ⁶1954 U.S. Tax Ct. LEXIS 190">*225 and the statutory provisions which they interpret have been repeatedly reenacted, without changes here pertinent, since then. ⁷ Consequently, this long continued executive construction must be deemed to have received legislative sanction. Oil Shares, Inc., 29 B. T. A. 664.

In view of the regulations petitioners must fail in their claim that depreciation deductions on SoRelle's breeding herd for 1946 and 1947 22 T.C. 459">*475 are allowable. Since at least as far back as 1939 SoRelle, whose proper accounting method we have heretofore determined to be the accrual method, had been inventorying his livestock and including his breeding herd in that inventory. He had never in any of his tax returns claimed depreciation deductions for his breeding herd. Obviously, therefore, he had elected not to capitalize the breeding herd and take depreciation deductions thereon but, rather, to include it in inventory and forego depreciation deductions. By including the breeding herd in SoRelle's inventories for 1946 and 1947, we have accorded with this election by SoRelle.

III. Gifts of Wheat.

ISSUES.

(a) Whether gifts of land and the matured crops of wheat thereon, which SoRelle made to his children on June 23, 1947, immediately prior to harvest, resulted in the realization of taxable income equal1954 U.S. Tax Ct. LEXIS 190">*226 to the fair market value of the wheat at the date of the gift.

(b) If taxable income was realized, whether it was the separate income of SoRelle or community income of him and his then wife, Elsie.

FINDINGS OF FACT.

SoRelle had four children: Arthur W. SoRelle, Jr., Charles W. SoRelle, Emily SoRelle Upshaw, and Florence SoRelle Bohannon. In May 1946, before his marriage to Elsie on the 25th thereof, SoRelle first discussed with his accountant gifts of land which he contemplated making to each of his four children. By the fall of the year he had decided upon the parcel of land which each child would be given and inquired of his accountant whether the conveyance of the land would carry with it the transfer of any wheat growing thereon. The accountant replied that it would. In December 1946, SoRelle told Florence SoRelle Bohannon that he was going to give her a certain identified parcel of land, which he had that fall seeded in wheat and that the wheat crop would also be hers. He further said that he would harvest the wheat for her, store it, let her know when it was wise to sell, sell it for her, and turn over the proceeds to her, less his harvesting and sales expenses. SoRelle1954 U.S. Tax Ct. LEXIS 190">*227 also told his other children about the specific parcels of land he intended to give them along with the wheat crops thereon.

Time passed but SoRelle failed to make the intended gifts. His accountant therefore warned him that unless he completed the gifts prior to the harvesting of the wheat he would be subject to income tax on the crop. Consequently, on June 23, 1947, just prior to the harvesting (which terminated on July 4 or 5 of that year) SoRelle 22 T.C. 459">*476 executed four warranty deeds conveying the four parcels of land, upon which there were matured wheat crops, to his four children. The fair market value of the matured wheat crops at the date of the gifts totaled $ 53,259.50 The land conveyed was SoRelle's separate property, not the community property of him and his then wife, Elsie. Elsie had no control over the giving or withholding of the land itself, she did not sign the deeds, nor did she in any way join in or oppose the gift of the land or of the wheat thereon. There were no restrictions or conditions placed by SoRelle upon the children's ownership of the land, the wheat, or the proceeds to be received from the sale of the wheat, but it was understood that the children1954 U.S. Tax Ct. LEXIS 190">*228 would lend SoRelle the proceeds of sale.

A. W. SoRelle, Jr., supervised the harvesting of the wheat on his gift parcel of land and Florence SoRelle Bohannon's husband supervised the harvesting of the wheat on her land. It appears that the harvesting of the crops on the other two parcels was supervised generally by SoRelle. SoRelle's employees and equipment were used in all the aforementioned harvesting. At the time the gifts were made, no contract or arrangement for the wheat's sale had been made and no immediate sale was contemplated. The wheat was placed in SoRelle's storage bins, was held without charge to the children until SoRelle deemed it advantageous to sell, and was then sold with the children's consent sometime subsequent to the end of 1947. The proceeds of the sale (less an amount retained by SoRelle as reimbursement for harvesting and selling expenses) were subsequently loaned to SoRelle by his children. The children received notes evidencing the loans, which were paid in full by SoRelle's executors following his death on January 10, 1949.

SoRelle filed a gift tax return for 1947, covering the aforementioned four gifts of land and wheat, and the four donees paid 1954 U.S. Tax Ct. LEXIS 190">*229 income tax on the profit realized from the subsequent sale of the wheat. The cost of planting, raising, and harvesting the wheat was deducted from the income reported on SoRelle's 1946 and 1947 original and amended returns.

OPINION.

(a) The Commissioner, in Docket No. 36411, contends that SoRelle realized, and is taxable on, income in 1947 equal to the fair market value of the wheat at the date of the gifts. Alternatively, by amended answer in Docket No. 36218, the Commissioner contends that income realized from the gifts is community income, half of which is taxable to Elsie.

There is no doubt in our mind as to the bona fides of SoRelle's gifts of land and wheat crops to his four children. A genuine intent to make the gifts was first manifested by SoRelle in May 1946, over a 22 T.C. 459">*477 year before the gifts were actually consummated, and no "strings" were attached to the gifts or to the proceeds derived from the contemplated sales of the wheat. Although there was an understanding that the proceeds of sale would be loaned to SoRelle by the donees, the gifts were not conditioned thereon and no compulsion in that respect was exercised. Such loans were conducted on a business basis, 1954 U.S. Tax Ct. LEXIS 190">*230 evidenced by notes which were subsequently paid. In other words, the gifts were not mere shams and the Commissioner, in fact, has not urged that point. See Richardson v. Smith, (C. A. 2) 102 F.2d 697.

Moreover, it has not been contended, nor does it appear, that SoRelle retained such control over the wheat as to be regarded as its owner for purposes of income taxation. See Helvering v. Clifford, 309 U.S. 331">309 U.S. 331. His supervision of the harvesting of some of the wheat, the storage of it all in his bins, and the arrangement whereby he was to determine the time for its sale were simply managerial functions performed with the donees' consent. They were such as any father might well be expected to perform for his children.

Respondent argues, however, that under Helvering v. Horst, 311 U.S. 112">311 U.S. 112, SoRelle "realized" taxable income equal to the fair market value of the wheat at the date of the gifts. In that case, the Supreme Court held that the owner of bonds who continued to retain ownership of the bonds but made a gift to his son of negotiable1954 U.S. Tax Ct. LEXIS 190">*231 interest coupons thereon, which matured and were cashed by the son later in the taxable year, realized income in the amount of such interest coupons.

Petitioners contend that 311 U.S. 112">Helvering v. Horst, supra, is not controlling here and that the courts have consistently declined to extend the principle of the Horst case to a gift of the property itself as distinguished from an assignment of the income. Petitioners rely on the following facts as sufficient to show that the Horst case is not applicable in the instant case: (1) The gifts in question were actually completed gifts, designed to vest in SoRelle's children the entire ownership of the lands in question, with no character of interest or control reserved by SoRelle in either the land itself or the crop growing on the land at the time of the gifts; (2) they were an actuality, that is to say, they were not devices designed to anticipate income or simply to reallocate it within the family without change of control, but were instead unqualified conveyances of real estate; and (3) they represented merely the completion of that which SoRelle had fully1954 U.S. Tax Ct. LEXIS 190">*232 determined to do a good many months back and were not prompted by the existence of a crop on the land. We think that petitioners must be sustained in their contention that the Horst case is not controlling here.

22 T.C. 459">*478 Pearce v. Commissioner, 315 U.S. 543">315 U.S. 543, dealt with an annuity contract purchased by the divorced husband for the divorced wife pursuant to their agreement made prior to the divorce, the question being whether the income produced by the annuity subsequent to the divorce decree was taxable to the wife, who received it, or to the husband, who provided it. In holding the income taxable to the wife and not to the husband, the Court said:

Such cases as Helvering v. Horst, 311 U.S. 112">311 U.S. 112, 61 S. Ct. 144">61 S. Ct. 144, 85 L. Ed. 75">85 L. Ed. 75, 131 A. L. R. 655, Helvering v. Eubank, 311 U.S. 122">311 U.S. 122, 61 S. Ct. 149">61 S. Ct. 149, 85 L. Ed. 81">85 L. Ed. 81, and Harrison v. Schaffner, supra, are not opposed to this result. Those cases dealt with situations where the taxpayer had made assignments of income from 1954 U.S. Tax Ct. LEXIS 190">*233 property. He was held taxable on the income assigned by reason of the principle "that the power to dispose of income is the equivalent of ownership of it and that the exercise of the power to procure its payment to another, whether to pay a debt or to make a gift, is within the reach" of the federal income tax law. Harrison v. Schaffner, supra, 312 U.S. page 580, 61 S. Ct. page 760, 85 L. Ed. 1055">85 L. Ed. 1055. But in those cases the donor or grantor had "parted with no substantial interest in property other than the specified payments of income." Id., 312 U.S. page 583, 61 S. Ct. page 762, 85 L. Ed. 1055">85 L. Ed. 1055. Here he has parted with the corpus. And "the tax is upon income as to which, in the general application of the revenue acts, the tax liability attaches to ownership." Blair v. Commissioner, 300 U.S. 5">300 U.S. 5, 300 U.S. 5">12, 57 S. Ct. 330">57 S. Ct. 330, 57 S. Ct. 330">333, 81 L. Ed. 456">81 L. Ed. 456. * * * [Emphasis supplied.]

It is the settled law of Texas that the conveyance of the land carries with it the ownership of the growing crops, so that when the crops were harvested 1954 U.S. Tax Ct. LEXIS 190">*234 they actually belonged to the SoRelle children because they actually owned the land. 13 Tex. Jur. p. 19; Roberts v. Armstrong, (Tex. Com. App.) 231 S.W. 371; Hollomand v. Bishop, (Tex. Civ. App.) 197 S.W. 1000; Ray v. Foutch, (Tex. Civ. App.) 50 S.W.2d 380; Dimmitt Elevator Co. v. Carter, (Tex. Civ. App.) 70 S.W.2d 615.

We are not here concerned with a mere assignment of the right to receive income. We do not here have an "anticipatory arrangement devised to prevent income from vesting in the donor." We are not here concerned with a mere reallocation of business income within the family group. We have instead an actually completed and admittedly bona fide gift of income producing property, and the gift of that property carried with it the unharvested wheat crop which was still on the land. This wheat became the property of the four children to whom the land was given and when the wheat was harvested and later sold the income resulting therefrom belonged to the children and was taxable to them and not to petitioner. See Estate of W. G. Farrier, 15 T.C. 277.1954 U.S. Tax Ct. LEXIS 190">*235 This case involved a gift by Mamie F. Farrier, widow of decedent, to her daughter of a herd of cattle consisting of old cows, which decedent had owned at the time of his death, and 80 head of heifers and calves which had been raised by the estate. 22 T.C. 459">*479 Respondent sought to tax to Mamie F. Farrier, as income, the value of the heifers and calves which he alleged was realized by reason of the gift under the doctrine of 311 U.S. 112">Helvering v. Horst, supra.We held, in favor of the taxpayer, that the Horst case was not applicable and that there was no income realized by Mamie F. Farrier by reason of the gift.

As to this issue, we sustain petitioners.

(b) In view of our above decision it is unnecessary to discuss the second issue posed at the beginning of this part of our Opinion.

IV. Elsie SoRelle.

ISSUES.

(a) Whether Elsie SoRelle, who reported her income on the cash basis prior to her marriage to A. W. SoRelle on May 25, 1946, may properly be required to report her share of the community income from SoRelle's business on the accrual basis used by SoRelle.

(b) Whether $ 58.60 was erroneously allowed by1954 U.S. Tax Ct. LEXIS 190">*236 the Commissioner as a credit against tax in computing Elsie SoRelle's deficiency for 1946 and should, therefore, be added to that deficiency.

FINDINGS OF FACT.

Elsie married SoRelle on May 25, 1946. Prior to that she earned her income as a school teacher and stenographer and always reported it for tax purposes on the cash receipts and disbursements basis, maintaining no books or records. From January 1 to May 25, 1946, Elsie earned $ 735 in wages teaching at the Hartley Independent School, Hartley, Texas. From these earnings $ 89.60 in income taxes was withheld. On January 15, 1947, she filed a separate return, under her maiden name of Elsie M. Wheeler, covering those earnings. In an amended answer the Commissioner states that, in computing Elsie's deficiency for 1946, he gave her full credit against tax for the $ 89.60 withheld from her wages but that, in fact, $ 58.60 of that sum had previously been refunded to her. Respondent, therefore, claims that the deficiency for 1946 determined against Elsie in the statutory notice should be increased by $ 58.60 and the negligence penalty by $ 2.93. There is no evidence in the record that any taxes withheld from Elsie's wages in 19461954 U.S. Tax Ct. LEXIS 190">*237 were, as claimed by respondent, ever refunded to her.

Elsie filed returns covering her share of the income earned by the community of herself and SoRelle from May 25 to December 31, 1946, and for 1947. These were separate returns filed under the name of Mrs. A. W. SoRelle on March 15, 1947, and March 4, 1948, respectively. The 1946 return was prepared by SoRelle's bookkeeper, and the 1947 return by his accountant. On May 13, 1949, subsequent to SoRelle's 22 T.C. 459">*480 death, Elsie filed amended returns prepared by the accountant covering her community income for 1946 and 1947.

Elsie did not acquire any of SoRelle's separate property subsequent to her marriage to him. She did not enter into any sort of business arrangement or partnership with him, did not participate in the business, and his books contained no income or disbursement accounts pertaining to her. She neither kept books of her own after the marriage nor maintained any record of the earnings of the community, and there is no evidence of those earnings other than the books and records of SoRelle himself. Elsie had no accounting or bookkeeping experience and she was not familiar with SoRelle's books, which were kept during1954 U.S. Tax Ct. LEXIS 190">*238 1946 and 1947 by his bookkeepers. She went to the bookkeepers' and to the accountant's offices to sign the original and amended tax returns prepared by them for 1946 and 1947, but never discussed those returns with them and did not know the reason for filing the amended returns. Elsie never requested permission from the Commissioner to change her method of reporting income from the cash to the accrual basis nor did she follow the adjustment procedure or file the adjustment sheets prescribed in Treasury Regulations 111, section 29.22 (c)-6, as a step in changing such basis.

The computation, on the accrual basis from SoRelle's books, of Elsie's community share of the income from SoRelle's business is a computation which clearly reflects her income therefrom.

In her original and amended returns for the period May 25-December 31, 1946, and for 1947, Elsie reported the following as her net income and tax thereon:

Elsie made the following payments on her 1946 tax:

1954 U.S. Tax Ct. LEXIS 190">*239 On July 26, 1951, Elsie filed a claim for a $ 6,463.52 refund of the 1946 taxes paid by her, which claim was reasserted in the petition filed by her in this case. In her brief she now argues that her net income for 1946, computed on the cash basis, is $ 7,349.74, and that a refund of $ 5,574.86 is therefore due. Her brief further asserts that 22 T.C. 459">*481 her net income for 1947, computed on the cash basis, is $ 47,275.74, and concedes that consequently a deficiency of $ 12,190.89 for that year is owed.

OPINION.

(a) Petitioner Elsie SoRelle contends that she reported her income on the cash basis prior to her marriage to SoRelle, that the marriage did not make her a new taxpaying personality, that she therefore remained under the duty to report her community share of the income from SoRelle's business for 1946 and 1947 on the cash basis, and that the Commissioner may not require her to use the accrual basis. In support of this position, Elsie relies primarily on Irene Nunnery Theriot, 15 T.C. 912, affd. (C. A. 5) 197 F.2d 13, certiorari denied 344 U.S. 874">344 U.S. 874. In the Theriot case, the taxpayer and1954 U.S. Tax Ct. LEXIS 190">*240 her husband were domiciled in Louisiana, a community property State. Prior to her marriage, the taxpayer reported her income on the calendar year basis, using the cash receipts and disbursements accounting method. She kept no books or records either before or after her marriage. Her husband kept books for his business, an individual proprietorship, and he reported his income on a fiscal year basis using the accrual method of accounting. The issue was whether the taxpayer could report her share of the community income on a fiscal year basis. This Court held, with the Court of Appeals for the Fifth Circuit affirming, that the taxpayer could not report her community income on the fiscal year basis because (1) section 41 of the Code makes it mandatory for income to be computed on the calendar year basis when the taxpayer does not keep books and the books of her husband's business were not her books as an individual, and (2) taxpayer failed to comply with section 46 of the Code and Regulations 111, section 29.46-1, which require the Commissioner's approval for a change from the calendar year to fiscal year basis. It was further held that the taxpayer did not, by her marriage, become1954 U.S. Tax Ct. LEXIS 190">*241 a new taxpaying personality and was therefore bound by her prior returns on the calendar year basis.

There are obvious distinctions between Theriot, supra, and the instant case. However, we need not discuss those distinctions nor determine their validity since the Fifth Circuit's opinion directly dealt with the question at hand. Although the taxpayer had, prior to her marriage, reported her income on the cash basis, her community income was reported on the accrual basis, having been computed from her husband's business books which were kept on that basis. She did not first secure the Commissioner's approval to change her accounting method from cash to accrual, as required by section 29.41-2 of the regulations. Nevertheless, the court stated at 197 F.2d 15:

There is no fatal inconsistency in the Tax Court's decision in holding that the taxpayer's income could not be reported on the basis of the community fiscal 22 T.C. 459">*482 year, and yet sustaining the computation of her income from the business books kept on the accrual basis, even though the taxpayer had formerly reported her income on the cash basis. To attempt to state1954 U.S. Tax Ct. LEXIS 190">*242 her income otherwise than according to her husband's books would lead to a chaotic situation. In sustaining the computation therefrom, the Tax Court did not treat the books of the husband as the wife's books, but rather, we think, sustained the Commissioner in the exercise of the discretion vested in him by Section 41 of the Internal Revenue Code, 26 U.S. C. A. § 41, to approve a method which would clearly reflect the income of the taxpayer.

In view of our finding that the computation of Elsie's community income on the accrual basis from SoRelle's books clearly reflects income, we are of the opinion that the above quoted excerpt is dispositive of this issue.

(b) In an amended answer the Commissioner contends that he erroneously gave Elsie credit for $ 58.60 in computing her deficiency for 1946. He therefore prays that Elsie's 1946 deficiency be increased by that amount and that her 1946 negligence penalty be increased by $ 2.93 (5 per cent of the additional deficiency). The facts relative to this claim are stated in our Findings. In brief the claim rests upon the allegation that the Commissioner, in determining Elsie's deficiency for 1946, 1954 U.S. Tax Ct. LEXIS 190">*243 gave her a credit against tax for $ 89.60 withheld from wages she earned in that year prior to marrying SoRelle when, in fact, $ 58.60 of that sum had been refunded to her. The burden of proving this claim rests upon the Commissioner. Tax Court's Rules of Practice, Rule 32. Since there is no evidence in the record that the $ 58.60 was ever refunded to Elsie, the Commissioner has not carried that burden and must, therefore, fail in his contention.

V. Mabel Ruth SoRelle.

ISSUE.

Whether income earned by A. W. SoRelle's business between January 1, 1946, and March 25, 1946, was community income taxable in equal proportions to SoRelle and his then wife, Mabel Ruth SoRelle, or was SoRelle's separate income. If it was community income, whether the Commissioner has successfully carried his burden of proving that the 5-year statute of limitations prescribed in section 275 (c) of the Code is applicable to Mabel Ruth SoRelle.

FINDINGS OF FACT.

SoRelle married Mabel on February 12, 1945. On January 24, 1946, Mabel and SoRelle intended to and did separate permanently. They entered into a separation agreement in contemplation of divorce on February 19, 1946 (acknowledged February 20, 1946), 1954 U.S. Tax Ct. LEXIS 190">*244 disposing of their separate and community property as of that date. The agreement was subsequently incorporated into their divorce decree handed 22 T.C. 459">*483 down on March 25, 1946, by the District Court, Potter County, Texas, 108th Judicial District. In pertinent part the agreement states:

2.

Whereas disputes and unhappy differences have arisen between the parties hereto, for which reason they have consented and agreed to live separate and apart from each other during their natural lives, and they contemplate securing a divorce, they having separated from each other on January 24, 1946 and have not lived together as man and wife since said date, and hereby wish to fully and completely settle all property rights as between them.

3.

The parties hereto own certain real and personal property as will be hereinafter set forth; that first party [SoRelle] owned as his separate estate at the time of his marriage to second party [Mabel] the following described real estate, to-wit:

* * * *

that in addition to said real property first party owned considerable personal property in the nature of cattle, horses, farm equipment and machinery, automobiles, trucks and pickups at the time of his marriage1954 U.S. Tax Ct. LEXIS 190">*245 to second party. Second party owned certain personal property, the exact nature and extent of which she cannot determine at this time. There having been certain community property acquired by said parties since their marriage in the nature of rents and revenues from the operation of first party's estate, and the enhancement and value of said first party's estate.

4.

The parties hereto have given due consideration to the differences arising between them and have come to the mutual conclusion that their further living together as man and wife has become insupportable, and the parties hereto have further given due consideration of all the property rights and interest by them owned, and are each entirely familiar with all the various kinds and character of property so owned and the respective values thereof. Said parties have agreed to fully settle and compromise, adjust and partition all property, real, personal and mixed owned by them at this time to the end that each shall henceforth own in his or her separate name, and as his or her separate property and estate the entire interests in portion of said property, and so that there shall be no jointly owned properties or property rights1954 U.S. Tax Ct. LEXIS 190">*246 existing between them.

5.

In consideration of the premises and of the desire of the parties to partition and divide all properties owned by them, and fully settle and adjust all community property and property rights as between the parties, the parties hereto have mutually agreed to so partition, divide and settle such properties as follows:

A. From and after the date hereof, the said A. W. SoRelle shall take, have, hold and own as his sole and separate property and estate, free and clear of any interest therein or lien, claim or demand of any nature whatsoever on the part of the said Mabel Ruth SoRelle all of the following described property, and the said Mabel Ruth SoRelle does, by the execution of this instrument, hereby sell, assign, transfer and convey to the said A. W. SoRelle all of her 22 T.C. 459">*484 right, title and interest in and to said following described property, for which she hereby binds herself, her heirs, executors, administrators and assigns to the said A. W. SoRelle, his heirs, executors, administrators and assigns forever, to-wit:

(1) [Certain described real estate.]

(2) All cattle of every description now owned by said parties; all horses, hogs, sheep, and all1954 U.S. Tax Ct. LEXIS 190">*247 livestock of every description now owned by said parties.

(3) All automobiles, trucks, trailers, pickups, and all farm machinery of every kind or character now owned by said parties.