21 T.C. 678">*679 These consolidated proceedings involve deficiencies in income tax and penalties asserted against Vern W. Bailey and his wife, June L. Bailey, as follows:

The issues to be determined are: (1) Whether the sale of undivided leasehold interests by Vern W. Bailey resulted in ordinary income or capital gains; (2) whether petitioners are subject to penalties under section 291 (a) of the Internal Revenue Code for 1954 U.S. Tax Ct. LEXIS 297">*300 delinquency in filing their returns for 1946 and 1947; and (3) whether petitioners are subject to penalties under section 293 (a) of the Internal Revenue Code for negligence in preparing their returns.

The parties have agreed by oral stipulation, made during their 21 T.C. 678">*680 opening arguments at the trial, on other issues raised by the pleadings which will be taken into account under a Rule 50 computation.

FINDINGS OF FACT.

Vern W. Bailey (hereinafter referred to as Bailey) and his wife, June L. Bailey, resided in Portland, Oregon, in 1946 and 1947. In April of 1948, Bailey moved to Texas although his wife and family continued to live in Portland, Oregon. Their income tax returns for the years here involved, 1946, 1947, and 1948, were filed with the collector of internal revenue for the district of Oregon.

Bailey was an officer and manager of a corporation manufacturing truck bodies when he met one Harry Stebinger (hereinafter referred to as Stebinger) in 1945. During a discussion of Stebinger's experiences in the oil fields, the possibility of securing a certain oil and gas lease in Texas was broached. The two men thereupon devised a plan for exploiting this lease with a minimum1954 U.S. Tax Ct. LEXIS 297">*301 investment on their part. It was estimated that the cost of acquiring the lease and drilling a well would be approximately $ 12,000. This entire sum was to be raised by the sale of undivided interests in one-half of the lease. The remaining half of the lease was to be jointly owned by Bailey, Stebinger, and two others who were taken into the venture, namely, one Forrest Wallace and one Al Stebinger, a nephew of Stebinger. Wells could be drilled anywhere on the lease under this arrangement since each individual's interest was to be an undivided one. Bailey was to be responsible for the financing, and Stebinger was to conduct the operations in Texas.

On April 23, 1945, a trust agreement was executed naming Bailey and Stebinger as trustees. It was signed by 20 individuals who contributed a total of $ 12,000, each receiving a trust receipt specifying the amount of the contribution. The terms of the trust instrument state, in part:

WHEREAS all the parties are interested in exploring and developing a tract of land in Callahan County, Texas, comprising approximately 1200 acres on what is known as the Kennard Ranch in sections 9, 10 and 25 E. T. R. R. Co., Survey, and desire to accumulate1954 U.S. Tax Ct. LEXIS 297">*302 a fund for the purpose of obtaining a one half interest in a lease upon said premises and conducting exploration work upon the same towards the production of petroleum and gas, and have agreed upon a plan under which said funds shall be held and used for the benefit and convenience of all concerned,

* * * *

Each depositor executing this agreement agrees that he will deliver over to the trustees such sum in multiples of $ 500.00 as each depositor may determine, each $ 500.00 representing an undivided interest equal to 25 acres or a one forty eighth (1/48) in the 1200 acres, as the case may be. The trustees shall execute and deliver to each respective depositor a receipt for said funds. The trustees shall take and hold said funds including any amounts which may be deposited 21 T.C. 678">*681 by the trustees themselves in said fund upon such receipt, in a bank selected by them. Said funds shall be used and dispersed by the Trustees for the purpose of obtaining the lease hold [sic] interest hereinabove referred to and for the purpose of drilling a discovery well upon said property to a depth of approximately 2000 feet. Said funds shall be dispersed by the trustees and no part thereof 1954 U.S. Tax Ct. LEXIS 297">*303 shall be used as or comingled with the individual funds of either trustee or of any other member of the group of depositors.

* * * *

In the event the "discovery well" should prove to be a producer, if the trustees elect to drill an additional well or wells, the profits from the operation of the first well or following wells shall be used by the trustees in additional development to such extent as the trustees may determine.

* * * *

H. A. Stebinger, Co-Trustee, shall have and take personal charge of the work of arranging for the lease, drilling the well or wells and generally conducting this operation hereinabove referred to, limited however, to the conditions and provisions hereof. He shall select and assemble the drilling equipment, negotiate for the sale of all products and shall be entitled to his actual and reasonable travel and maintenance expenses incurred while so doing. He shall not be entitled to any wages or salary until the venture shall be put upon a profitable, productive basis, after which he shall be entitled to resonable [sic] compensation.

It is specifically agreed and understood that none of the parties hereto is or shall be a co-partner with any of the other1954 U.S. Tax Ct. LEXIS 297">*304 parties interested, and no such representation shall be made by any of the parties hereto, and that none of the parties shall be obligated to any of the parties or to any third party to any amounts whatsoever over and above the amount deposited, or any additional deposits which the parties may hereafter see fit to make. It is further understood and declared that the arrangement herein outlined has been made upon a purely voluntary basis on the part of each party hereto, and that no person or persons have solicited, urged or requested any of the parties to join in said venture or made any representations or inducements to any party or parties joining herein, and as said venture is being entered into by each of the parties hereto with the full knowledge and understanding of the risk involved, and not upon any promises or undertakings of any nature on the part of the other contracting parties.

Stebinger proceeded to Texas and, on May 15, 1945, acquired a lease on the Callahan County tract, which proved to contain 1,310 acres instead of 1,200. The lease was issued in the names of Bailey and Stebinger as trustees. The rental was $ 1 an acre for the first year. For subsequent years 1954 U.S. Tax Ct. LEXIS 297">*305 it was 50 cents an acre for part of the leasehold and $ 1 for the remainder. Stebinger supervised the drilling of a well on the property, expending the $ 12,000 which had been raised. Oil was struck in December 1945. It was decided to deepen the well immediately; but in the process, a water-bearing formation was reached and the well was abandoned. In January 1946, Bailey went to Texas to investigate the situation. After discussions with Stebinger, it was decided to drill another well on the same property and to raise the necessary funds by the sale of interests in the one-half portion of the lease which had been retained by the four associates. 21 T.C. 678">*682 However, Forrest Wallace and Al Stebinger objected to this plan. Suit was filed to compel them to either participate in this plan or to step out. This disagreement was settled out of court by the allocation of a specific 80 acres to these two in exchange for their interests in the lease. Bailey returned to Oregon and proceeded to raise new capital for the drilling of a second well. He devoted his entire time to this and discontinued drawing an income from the equipment business in which he was then a partner. In 1946, his1954 U.S. Tax Ct. LEXIS 297">*306 total drawings from the equipment business were $ 1,200, and it was disbanded in October 1946. As a result, he was compelled to sell portions of his interest in the lease in order to support himself and also to defray the traveling and entertainment expenses which he incurred in order to sell these leasehold interests.

It was impossible to know in advance the final cost of drilling a well. Liberal estimates had to be made in order to avoid the risk of running out of funds while the drilling operations were in progress. During 1946, Bailey raised $ 47,900 by the sale of portions of his interest in the lease. The second well was begun in August 1946. Bailey forwarded approximately $ 30,000 to Stebinger which was used by him in the drilling of the well and for his living expenses. The balance of the $ 47,900 was retained by Bailey, and he invested about $ 5,000 of it in a mountain resort. Bailey would turn down would-be purchasers of interests in the lease after he thought sufficient money had been raised to complete the drilling of a well.

This second well was abandoned in December 1946 after it was decided that it had been ruined by mud used in the drilling operation. However, 1954 U.S. Tax Ct. LEXIS 297">*307 Bailey and Stebinger still retained hope of drilling successfully on this lease, and during 1947 two more wells were drilled. These were financed by the sale of additional undivided interests in the remainder of the lease. Bailey raised $ 43,815.46 in this manner, forwarding most of this money to Stebinger to be used by him for operating and living expenses.

Approximately 60 people invested money in the drilling of these 4 wells through the purchase of undivided interests. Most of them resided in Oregon, Washington, and Idaho. The last sales of interests in the lease were made in July and August of 1947. The price at which sales were made fluctuated according to the state of operations in Texas. Thus, 600 acres were sold to the original investors under the trust agreement for $ 12,000, or $ 20 per acre. After some oil was discovered during the drilling of the first well, undivided interests were sold for $ 200 per acre, and then even for $ 1,000 per acre. Bailey subsequently realized that $ 1,000 per acre would be unjustified even if a successful well were drilled, and told those who had paid this price that their interests were being doubled.

Delayed rentals were paid on 1954 U.S. Tax Ct. LEXIS 297">*308 this lease through 1950.

21 T.C. 678">*683 On December 16, 1946, Bailey entered into a partnership with Stebinger, one Stanley Stinsman, and one Robert Griffin for the exploitation of various other oil leases. Bailey obtained the money for his share of this venture from the sale of his equipment business and also from proceeds of the sale of undivided interests in his original oil venture. Three leases were acquired in Callahan County, Texas, but no wells were drilled on these leases nor were any interests sold in them. A lease was acquired north of Putnam, Texas, and a well was drilled on this property. However, it had to be abandoned when water was struck. In October 1947, the partnership acquired a lease in Eastland County, Texas, and a successful well was completed on it on February 16, 1948. The drilling of this well was financed by the sale of interests in the particular lease being developed. The amount of $ 83,500 was raised by such sales in 1948. Bailey, Stinsman, and Griffin retained $ 5,000 of this for their personal use, dividing it equally. Upon the successful completion of this well, a second well was immediately begun and was successfully completed on July 5, 1948. 1954 U.S. Tax Ct. LEXIS 297">*309 This second well was financed, in part, by a loan of $ 40,000 from the Baptist Foundation. After the 2 wells had been completed, 1 sale of an interest in the lease was made by the partnership amounting to $ 5,000.

Bailey thought he had no taxable income during the years 1946 and 1947; and although he realized that a return had to be filed, he delayed such filing. When he took it to an accountant in the latter part of 1948, he was advised that he had earned taxable income during those years. He thereupon filed a joint return for 1946 and separate returns for himself and his wife for 1947. These were received by the deputy collector of internal revenue for the district of Oregon on November 29, 1948. He attached the following statement to his 1946 and 1947 returns:

I have been absent from my residence developing an oil well in Texas and have unintentionally neglected to file these returns. Also I have not had the funds with which to pay the tax. There was no intent to evade the law.

The following statement was attached to the 1947 return of June L. Bailey:

My husband has been away from home and I was not aware of my liability until he returned. There was no intent to evade1954 U.S. Tax Ct. LEXIS 297">*310 the law.

Pursuant to the advice of the accountant who prepared their returns for 1946 and 1947, the total sales of undivided interests in the Callahan lease were reported as resulting in ordinary income to Bailey and his wife, less deductions for the costs of development. The respondent determined that the amounts of such sales had been understated and that certain casing costs in the amount of $ 6,212.29 had been expensed in 1946 but should have been capitalized. The petitioner agrees to the 21 T.C. 678">*684 amounts of sales understated and to the amount of such casing costs, but assigns as error in his petition the treatment accorded to such items by the respondent.

In the preparation of the 1948 return for the Bailey Griffin Oil Co. partnership, the accountant omitted $ 83,500 attributable to the sale of undivided interests by the partnership in the Eastland County lease. Bailey informed him of this item; but though he signed this partnership return, he failed to read it to ascertain whether this item had been included. The respondent determined that this amount was ordinary income to the partnership, and adjusted the petitioners' distributive share of the partnership income accordingly.

1954 U.S. Tax Ct. LEXIS 297">*311 Bailey's interests in the Callahan and Eastland leases were real property interests held for development of their oil and gas resources, and not primarily for sale to customers in the ordinary course of his trade or business.

Petitioners were delinquent in filing their Federal income tax returns for the years 1946 and 1947.

Petitioners were negligent in filing their Federal income tax returns for 1946, 1947, and 1948.

OPINION.

The principal issue to be determined is whether the petitioners realized ordinary income or capital gains ¹ from the sale of undivided interests in two Texas oil and gas leases. The "interest of a lessee in oil and gas constitutes an interest in 'real property.' * * * [And] if such interests were held for more than six months, except with respect to a dealer therein, they will qualify as 'property 21 T.C. 678">*685 used in the trade or business,' as defined by section 117 (j) of the Code, and they are subject to the treatment provided by that section." I. T. 3693, 1944 C. B. 272.

1954 U.S. Tax Ct. LEXIS 297">*312 It is respondent's contention that Bailey became a dealer in leases and made these sales in the "course of his trade or business," thus realizing ordinary income. Numerous tests have been employed to aid in the determination of whether property has been held by a taxpayer "primarily for sale to customers in the ordinary course of his trade or business." The factor which must be given greatest weight is the purpose for which the property was held during the period in question. Walter R. Crabtree, 20 T.C. 841; Carl Marks & Co., 12 T.C. 1196 (1949). This purpose must be determined from the evidence as to the intention of the taxpayer at the time of acquisition and his conduct during the holding period. The record shows that the 1,310-acre Callahan County lease was acquired for the purpose of exploitation of its oil and gas resources. It appears that the trust owned an undivided 600 acres of the lease and that the balance was retained by the original four associates. They had hopes of becoming wealthy oil producers with the technical skill of Stebinger, the financing efforts of Bailey, and the funds for drilling an initial1954 U.S. Tax Ct. LEXIS 297">*313 well provided by the trust. Although the first well proved to be a failure, Bailey and Stebinger still retained faith in the oil-bearing properties of their lease. Their two associates, Wallace and Al Stebinger, were bought out; and they decided to proceed with the development. The only way in which Bailey could raise funds for the drilling of a second well was by the sale of part of his undivided interest in the lease. Unfortunately, the second well was also a failure; and the process had to be repeated for the financing of a third and fourth well, both of which were also unsuccessful. But it is significant that Bailey at all times tried to retain as great an interest in the lease as possible. Of course, since it was impossible to know in advance what the cost of drilling a well would be, Bailey found it necessary to raise more than the amounts actually spent in this manner. He was compelled to do this because it would be uneconomical to stop operations while raising additional capital. Bailey was also forced to make additional sales in order to help support himself and his family. He was risking everything on the successful completion of the wells; and rather than abandon1954 U.S. Tax Ct. LEXIS 297">*314 the lease and lose everything that he had already put in, he gave up his business in order to devote his entire time to the raising of the necessary funds for the drilling of a "successful" well. Although Bailey gave up his business in 1946 in order to devote his entire time to raising money for these oil ventures, he did not thereby become a dealer in leases. He was an oil operator trying to induce others to invest capital in the lease which he hoped would make him, and them, wealthy individuals.

21 T.C. 678">*686 The record shows that the Eastland lease was acquired for the same purpose as the Callahan lease, and that sales of interests in it were made in the same manner and for the same purpose as in the Callahan tract. However, we may dismiss from our consideration the issue as to whether the proceeds of the sale of interests in the Eastland County lease amounting to $ 83,500 are entitled to the favorable treatment afforded by section 117 since it does not appear that this lease was held for the required 6 months before these particular sales were made. This lease was acquired in October 1947, and a well was completed thereon on February 16, 1948, with $ 83,500 acquired by the sale1954 U.S. Tax Ct. LEXIS 297">*315 of interests in that particular lease. Although a part of the $ 83,500 in interests sold in that lease may have been sold after the required 6-month holding period, and may have been used to finance the drilling of a second well on the Eastland County lease, petitioner has failed to introduce any evidence to this effect. It, therefore, follows that the $ 83,500 resulted in ordinary income.

The respondent argues that the frequency and continuity of sales indicates that they were made in the course of business. Snell v. Commissioner, 97 F.2d 891 (C. A. 5, 1938). However, the sale of interests was not a continuous process. When additional funds were required for the drilling of a new well, Bailey would sell part of his remaining interest in the lease. Although sales may have been frequent at these periods when new capital was required, he would discontinue his fund-raising activities while the well was being drilled. The record shows that it was a general practice to turn down would-be purchasers when it was believed that sufficient funds had been raised for the drilling of the particular well being financed.

Bailey sold no interests in leases1954 U.S. Tax Ct. LEXIS 297">*316 in which the production of oil was not the immediate objective. He and his associates held several leases which they never developed, but they sold no interests in these leases. Nor were sales made to hedge or minimize the risk. It is clear that the dominant motives for such sales were the need for new capital for development costs and for current living expenses. Any gains realized on the sale of portions of their investment merit capital gains treatment under section 117.

Petitioners argue that the proceeds of the various sales must be considered contributions to capital to the extent that they were actually used in the development of the wells. They cite our decisions in Rawco, Inc., Ltd., 37 B. T. A. 128 (1938), and Transcalifornia Oil Co., Ltd., 37 B. T. A. 119 (1938). These cases are not in point. In each, the drilling of specific wells was financed by the sale of production certificates entitling purchasers to percentage interests in proceeds to be derived from the wells' production. Vital to the decision in each case is the finding that the seller was required, by the terms of the sale, to use the proceeds1954 U.S. Tax Ct. LEXIS 297">*317 of the sale in the development of the well whose 21 T.C. 678">*687 future production was being assigned. No evidence of any such agreement has been brought to our attention in the instant case. Although it may have been implicit in the various selling arrangements that a well was to be developed by Bailey and Stebinger, we have no basis for assuming that the proceeds of the various sales were required to be earmarked for that purpose rather than being at the unconditional disposal of the sellers.

Petitioners now contend that a portion of the gain from the sales of interests in the Callahan County lease is allocable to Stebinger, even though they had included the entire amount as their own on their 1946 and 1947 tax returns. No assignment of error is made in the petitions as to the proportion of the gain from these sales properly allocable to the petitioners. We, therefore, hold that the entire gain from the sale of these interests is taxable to the petitioners. They also contend that any income earned or capital gain realized on the sale of interests in the Callahan County lease in 1946 and 1947 and the Eastland County lease in 1948 are not taxable to them according to their distributive1954 U.S. Tax Ct. LEXIS 297">*318 share on the theory that both the Callahan and Eastland arrangements were, in reality, associations taxable as corporations. Having failed to raise these issues in their petitions, they cannot now be considered.

Petitioners have not shown that failure to file timely returns for 1946 and 1947 was due to reasonable cause and not to willful neglect. The respondent's assessment of a 25 per cent delinquency penalty under section 291 (a) is, therefore, sustained.

Petitioners have failed to offer any explanation for the stipulated understatement of their income in their 1946 and 1947 returns, by $ 7,337.40 and $ 7,165.46, respectively. Respondent's determination of 5 per cent negligence penalties under section 293 (a) must, therefore, be upheld. The negligence penalty for 1948 must be sustained. The duty of filing accurate returns cannot be avoided by placing responsibility upon an agent. The fact that petitioner told the person who made up the partnership return about the sale of leasehold interests totaling $ 83,500 cannot excuse his failure to read the return and ascertain the inclusion of this item. Milton A. Mackay, 11 B. T. A. 569 (1928). There1954 U.S. Tax Ct. LEXIS 297">*319 is no evidence that this amount was omitted due to an honest misunderstanding of the law.

There remains one last item, amounting to $ 6,212.29, which petitioners deducted as prospecting and drilling expense in their return for 1946. Respondent determined that this was for the purchase of casing which should have been capitalized. Petitioners offered no evidence with respect to this adjustment, and did not argue it on brief. We, therefore, deem the allegation of error in the petition with respect to this item to have been abandoned.

Decisions will be entered under Rule 50.