24 T.C. 935">*936 The Commissioner determined deficiencies in income tax for 1947 and 1948 as follows:

1955 U.S. Tax Ct. LEXIS 112">*113 In Docket No. 54592, the petitioner does not contest the deficiency for 1947 and claims an overpayment of income tax for 1948 in the amount of $ 27,838.42.

The only issue to be decided is whether the gain from the sale of an oil payment in 1948 is taxable as ordinary income or as capital gain.

FINDINGS OF FACT.

The facts which have been stipulated are found as facts. The stipulation, together with the attached exhibits, is incorporated herein by this reference.

A. J. and Lora May Slagter, husband and wife, are residents of Milwaukee, Wisconsin. They filed a joint income tax return for 1948 with the collector of internal revenue for the district of Wisconsin.

Earl B. Paulson died testate on March 21, 1952, a resident of Milwaukee, Wisconsin. Ethelle Paulson Bushman, formerly known as Ethelle Paulson, is the duly appointed and acting executrix of his estate. The decedent filed an individual income tax return and an amended return for 1948 with the collector of internal revenue for the district of Wisconsin.

Prior to and during 1948, A. J. Slagter, Jr., and Earl B. Paulson were the only members of a partnership doing business under the firm name of "A. J. Slagter, Jr." Each had a1955 U.S. Tax Ct. LEXIS 112">*114 50 per cent interest in the partnership. The partnership was engaged in the business of developing and operating oil and gas leases in the Illinois Basin. The partnership acquired undeveloped leases and, in most instances, sold a fractional interest in the leases in order to finance development costs. In each of the years 1946, 1947, and 1948, the partnership drilled an average of from 25 to 35 wells. In 1948, the partnership was operating about 72 oil leases on which were located approximately 125 to 130 producing wells.

24 T.C. 935">*937 The partnership owned leasehold interests in 45 of the 72 leases which were operated by it in 1948. The Slagter Oil and Grease Company, a corporation, owned leasehold interests in 3 of the 72 leases.

On August 16, 1948, Slagter and Paulson, as partners, and the Slagter Oil and Grease Company assigned to Ashland Oil & Refining Company, hereinafter referred to as Ashland, an oil payment in the face amount of $ 513,500 payable out of 60 per cent of the assignors' leasehold interest in the aforementioned 48 oil and gas leases. In addition, Ashland was granted an irrevocable option or "call" to purchase at the prevailing market price the assignors' shares, 1955 U.S. Tax Ct. LEXIS 112">*115 and the shares of others controlled by the assignors, of all oil produced from the lands covered by the 48 leases with certain exceptions. The option or call was for a period of 6 years from June 1, 1948, or for the life of the oil payment whichever period was longer. Ashland paid $ 501,000 in cash for the oil payment. The oil payment assignment was made effective as of June 1, 1948, and provided, in part, that the assignors --

do hereby grant, bargain, sell, transfer and convey unto said ASHLAND OIL & REFINING COMPANY, ASSIGNEE, an undivided sixty per cent (60%) of all of the oil, gas and casinghead gas in and under and which may be produced, saved and marketed from and after June 1, 1948 at 7:00 a. m. from the hereinafter described interest in and to the following oil and gas leases; * * *

To Have and To Hold the above described interest in said leases and in and to said oil, gas and casinghead gas, together with all of the rights, tenements and hereditaments thereunto and in any wise appertaining unto said Ashland Oil & Refining Company, its successors, and assigns, until said ASSIGNEE has received from the net proceeds from the sale of such oil, free and clear of all costs1955 U.S. Tax Ct. LEXIS 112">*116 and expenses of every kind and character, including all ad valorem, gross production and severance taxes (but not income taxes), in the aggregate, the sum of FIVE HUNDRED THIRTEEN THOUSAND FIVE HUNDRED AND NO/100 DOLLARS ($ 513,500.00), based on the prevailing posted market price regularly paid by principal purchasers of crude oil in the general area of said leases for oil of like kind and quality.

The assignment also provided that as soon as Ashland received $ 513,500 from the production under the leases, the conveyance would expire and Ashland's interest in the leases and in the oil and gas under the lands would revert to and vest in the assignors.

Under the terms of the oil payment assignment, the partnership and Slagter Oil and Grease Company were required to pay the costs of producing the oil attributable to Ashland's assigned interest. As of June 1, 1948, the estimated cost of producing the oil attributable to Ashland's assigned interest was $ 220,096.63.

The pay-out date of the oil payment was estimated to be March 31, 1956, or a pay-out period of 7 years and 10 months. Ashland realized $ 513,500 from the oil payment assignment by November 30, 1953. The pay-out was accelerated1955 U.S. Tax Ct. LEXIS 112">*117 by an increase in the price of crude oil, the drilling by the partnership of 9 additional wells, and water-flooding 24 T.C. 935">*938 operations which were carried out on adjacent leases. Of the 48 leases covered by the oil payment assignment, 20 were abandoned prior to November 30, 1953.

The oil and gas lease interests which were assigned in part by the partnership to Ashland had been owned by the partnership for varying periods in excess of 6 months prior to the effective date of the oil payment assignment.

During the period from 1942 to 1948, inclusive, the partnership sold only one producing lease. The lease was sold to the Magnolia Petroleum Company which wanted to water flood the area in which the lease was located. The partnership sold the lease because it did not have sufficient funds to participate in the project. During the same period, the partnership sold only one oil payment which is the one involved in these proceedings.

The partnership sold the oil payment to Ashland in order to obtain funds with which to pay partnership debts incurred in the development and operation of its leases. The partnership owed between $ 500,000 and $ 600,000 when it sold the oil payment to Ashland.

1955 U.S. Tax Ct. LEXIS 112">*118 Ashland purchased the oil payment in order to obtain, in addition to the oil covered by the assignment, the option or call on all of the oil controlled by the partnership and produced from the 48 leases. There was a shortage of crude oil in the Illinois Basin in 1948, and independent refiners were engaged in intense competition for the available supply.

The 45 oil and gas leases assigned in part to Ashland were held by the partnership for the development and production of oil and gas. The leases were not property of a kind which would properly be includible in inventory by the partnership, and the leases were not held by the partnership primarily for sale to customers in the ordinary course of its trade or business.

The amount paid by Ashland for the oil payment, $ 501,000, was apportioned among the assignors as follows:

Slagter and Paulson, in their respective income tax returns for 1948, each reported a long-term capital gain in the amount of $ 240,026.50 from the sale by the partnership of the oil payment to Ashland. The partners, in reporting1955 U.S. Tax Ct. LEXIS 112">*119 their respective shares of the gain, did not deduct from the proceeds of the sale their pro rata shares of the estimated cost, as of June 1, 1948, of producing the oil attributable to Ashland's assigned interest. The respondent, in his notices of deficiencies, 24 T.C. 935">*939 determined that the gain from the sale of the oil payment is taxable as ordinary income subject to an allowance for depletion.

The parties have stipulated that, if the Court determines that the gain from the sale of the oil payment is taxable as capital gain, the estimated cost to the partnership on June 1, 1948, of producing the oil assigned to Ashland, as hereinabove set forth, is to be deducted from the proceeds of the sale in determining the amount of the gain.

OPINION.

The only issue presented is whether the gain realized by the partnership in 1948 upon the sale of the oil payment to Ashland is taxable as capital gain, as petitioners contend, or as ordinary income subject to an allowance for depletion, as respondent has determined. The amount of the gain is not in dispute. It has been stipulated that, if the Court determines that the gain is taxable as capital gain, the estimated cost on June 1, 1948, of producing1955 U.S. Tax Ct. LEXIS 112">*120 the oil assigned to Ashland is to be deducted from the proceeds of the sale in determining the amount of the gain.

Petitioners contend that the oil payment assignment conveyed an interest in real property which was used by the partnership in its trade or business and held by it for more than 6 months and that, consequently, they are entitled to treat the gain from the sale of the oil payment as long-term capital gain under the provisions of section 117 (j) of the 1939 Code. ¹ Petitioners rely, principally, upon Lester A. Nordan, 22 T.C. 1132; John David Hawn, 23 T.C. 516 (on appeal C. A. 5); and Caldwell v. Campbell, (C. A. 5) 218 F.2d 567.

1955 U.S. Tax Ct. LEXIS 112">*121 Respondent seeks to distinguish this case from the authorities cited on the ground that here the grantee of the oil payment was a refining company which normally purchased oil from the grantor. He argues that since the partnership was engaged in the business of developing and operating producing properties and since Ashland24 T.C. 935">*940 would normally purchase the oil produced by the partnership, the oil payment assignment should be regarded as a contract by the partnership to sell oil to its regular customer in advance of production. Upon this basis, respondent urges that the transaction merely accelerated the receipt of ordinary income by the partnership. The respondent cites no authority in support of his argument.

The basic fallacy in the respondent's argument is that it fails to give effect to the agreement entered into by the parties. The parties executed an oil payment assignment and not a contract for the sale of oil, if, as, and when produced. In this respect, it is interesting to note that the sale by the partnership of the oil payment was motivated by business necessity and not primarily by tax considerations. Cf. John David Hawn, supra,1955 U.S. Tax Ct. LEXIS 112">*122 and Caldwell v. Campbell, supra.The partnership sold the oil payment in order to obtain funds with which to pay partnership debts incurred in the development and operation of its leases.

In our opinion, this case is not distinguishable in principle from the authorities relied upon by the petitioners. Respondent recognizes that the interest of a lessee in oil and gas is a real property interest, and he has so ruled in I. T. 3693, 1944 C. B. 272, which was quoted with approval by this Court in Vern W. Bailey, 21 T.C. 678, and Walter A. Henshaw, 23 T.C. 176. The conveyance of an oil payment constitutes a transfer of the grantor's interest in the oil in place. See Palmer v. Bender, 287 U.S. 551">287 U.S. 551; Anderson v. Helvering, 310 U.S. 404">310 U.S. 404; Ortiz Oil Co., 37 B. T. A. 656, affd. 102 F.2d 508, certiorari denied 308 U.S. 566">308 U.S. 566; T. W. Lee, 42 B. T. A. 1217, affd. 126 F.2d 825.1955 U.S. Tax Ct. LEXIS 112">*123 It is a transfer of the income-producing property itself and not merely an assignment of income. Lester A. Nordan, supra;John David Hawn, supra;Caldwell v. Campbell, supra.Consequently, the partnership under the oil payment assignment conveyed an interest in real property.

There is no dispute that the leases out of which the oil payment was carved were used by the partnership in its trade or business, and that they were held by it for more than 6 months prior to the effective date of the assignment. Accordingly, it is held that the petitioners are entitled to treat the gain from the sale of the oil payment as gain from the sale of a capital asset under the provisions of section 117 (j) of the 1939 Code.

The respondent's determination is reversed.

Decision in Docket No. 43274 will be entered for the petitioners.

Decision in Docket No. 54592 will be entered under Rule 50.