Accordingly, the TEPCO and WEF coal supply contracts are contracts for the sale of goods under New Mexico law. ³

2006 U.S. Tax Ct. LEXIS 14">*28 Even though coal supply contracts are contracts for the sale of goods covered by article 2 of the Uniform Commercial Code, the obligation of Santa Fe or its successors to sell unsevered coal in the future may also qualify to be treated 126 T.C. 261">*269 as the transfer of an interest in land. See N.M. Stat. Ann. sec. 55-2-107(1). In other words, classification of the two supply contracts as contracts for the sale of goods in the future by N.M. Stat. Ann. section 55-2-107(1), does not preclude those contracts from also effecting a transfer of an interest in real property under New Mexico law. See also 1 Restatement, Contracts 2d, sec. 127, cmt. b & c (1981).

2. Creation of Servitudes

The TEPCO and WEF coal supply contracts created servitudes under New Mexico law. The modern view is that servitudes may be created by contract. See Cafeteria Operators, L.P. v. Coronado-Santa Fe Associates, L.P., 1998 NMCA 5, 124 N.M. 440">124 N.M. 440, 952 P.2d 435">952 P.2d 435, 952 P.2d 435">441 (N.M. Ct. App. 1997); 1 Restatement, Property 3d (Servitudes), sec. 2.1(1)(a), reporter's note (2000).

Although he disputes that the supply contracts created servitudes under2006 U.S. Tax Ct. LEXIS 14">*29 New Mexico law, respondent acknowledges that the servitudes (stemming from the seller's obligation to mine and supply coal from the Lee Ranch mine property to the buyer/utility) involve affirmative covenants. See 1 Restatement, Property 3d (Servitudes), sec. 1.3(1) & (2), cmt. d, illus. 1 & 2. ⁴

2006 U.S. Tax Ct. LEXIS 14">*30 New Mexico law recognizes both "real covenants" and "equitable servitudes".⁵ E.g., Pollock v. Ramirez, 1994- NMCA 011, 117 N.M. 187">117 N.M. 187, 870 P.2d 149">870 P.2d 149, 870 P.2d 149">153 (N.M. Ct. App. 1994). In Pollock, a restrictive covenant was not enforceable because the instrument creating it did not meet the requirements for recordation in real property records. The court in Pollock, however, noted that the restriction could still be enforced as an equitable servitude assuming the requirements for establishing and enforcing such an equitable servitude were met. See 870 P.2d 149">id. at 153.

126 T.C. 261">*270 Under New Mexico law, there are three requirements for a covenant to be an equitable servitude: (1) The covenant must touch and concern the land; (2) the original "covenanting" parties must intend that covenant to run with the land; and (3) any successor against whom enforcement is sought must2006 U.S. Tax Ct. LEXIS 14">*31 have actual, constructive, or inquiry notice of that covenant. Lex Pro Corp. v. Snyder Enters., Inc., 1983 - NMSC 073, 100 N.M. 389">100 N.M. 389, 671 P.2d 637">671 P.2d 637, 671 P.2d 637">639 (N.M. 1983); 870 P.2d 149">Pollock v. Ramirez, supra at 153.

In Lex Pro Corp. v. Snyder Enters., Inc., 100 N.M. 389">100 N.M. at 391, the New Mexico Supreme Court observed that a covenant touches and concerns the land if either (1) the burden of that covenant renders the covenantor's interest in land less valuable or (2) the benefit of that covenant renders the covenantee's interest in land more valuable. The New Mexico courts have also held that a covenant meets the "touch and concern" requirement if it calls for either doing physical things to the land such as building a wall, or refraining from doing physical things to the land. Cypress Gardens, Ltd. v. Platt, 1998 NMCA 7, 124 N.M. 472">124 N.M. 472, 952 P.2d 467">952 P.2d 467, 952 P.2d 467">470 (N.M. Ct. App. 1997). The TEPCO and WEF supply contract obligations of Santa Fe and its successors to mine and supply coal from the Lee Ranch mine property do touch and concern that land. ⁶

2006 U.S. Tax Ct. LEXIS 14">*32 As to the second requirement that the original covenanting parties intend that the covenant run with the land, the WEF supply contract specifically expresses an intent to effect a dedication of the Lee Ranch mine coal reserves to fulfilling that contract and to establish a servitude upon Santa Fe and its successors running with the Lee Ranch mine property. Although the TEPCO supply contract contains no specific provision, it provides that the agreement is to inure to the benefit of and be binding upon respective successors to and assigns of the original parties to the TEPCO contract. Where the original instrument creating a covenant involving land provided that successors should be bound by the covenant and where only successive owners of the land were capable of performing the obligation pertaining to that covenant, that covenant has been held to run with the land. Murphy v. Kerr, 126 T.C. 261">*271 5 F.2d 908">5 F.2d 908, 5 F.2d 908">910 (8th Cir. 1925); Bolles v. Pecos Irr. Co., 1917- NMSC 049, 23 N.M. 32">23 N.M. 32, 167 P. 280">167 P. 280, 167 P. 280">282-283 (N.M. 1917).⁷

2006 U.S. Tax Ct. LEXIS 14">*33 As to the requirement that the successor against whom enforcement of that covenant is sought have actual, constructive, or inquiry notice, Peabody had actual notice of the TEPCO and WEF coal supply contract obligations, as it assumed those contracts. In addition, a memorandum of dedication concerning the WEF contract was recorded in 1985 with the County Clerk for McKinley County, New Mexico, the county in which the Lee Ranch mine is located.

We hold that the TEPCO and WEF coal supply contracts created servitudes obligating Santa Fe and successive owners of the Lee Ranch mine to mine and supply coal to the buyer/utility and that those servitudes are real property interests under New Mexico law. See 1 Restatement, Property 3d (Servitudes), sec. 2.1 cmt. b, illus. 4.

II. Like-Kind Status of the Supply Contracts Under Section 1031

Petitioner contends that the real property status of the supply contracts under New Mexico law should be determinative of the like- kind issue; i.e., should automatically qualify the contracts as like- kind property to the gold mining property under section 1031(a). In support of this argument, 2006 U.S. Tax Ct. LEXIS 14">*34 petitioner, among other things, relies on this Court's holding in Or. Lumber Co. v. Commissioner, 20 T.C. 192">20 T.C. 192, 20 T.C. 192">196-197 (1953). Petitioner notes that this Court held in Or. Lumber Co. that the rights to harvest standing timber were personal property under Oregon law and therefore were not like-kind property to land (real property) received in exchange.

If the status of the supply contracts as real property is held not in and of itself to be dispositive, petitioner alternatively argues the supply contracts are like-kind property to the gold mining property because the contracts (including potential renewals) could have a duration or term lasting 30 or more years. Petitioner's argument is based on section 1.1031(a)-1(c), 126 T.C. 261">*272 Income Tax Regs., which provides a safe harbor for a 30-year or greater leasehold of a fee to qualify as "like kind" to a fee interest in real property.

Finally, petitioner places reliance in Koch v. Commissioner, 71 T.C. 54">71 T.C. 54, 65-70 (1978), a case which petitioner contends is indistinguishable from the circumstances we consider here. In that case, this Court held that two parcels of fee simple real property were like kind, under section 1031(a), 2006 U.S. Tax Ct. LEXIS 14">*35 even though one parcel was subject to 99-year condominium leases. In Koch, it was reasoned that the leases did not constitute boot because they were not separable from the fee simple real property interest.

Conversely, respondent contends that the fact that the supply contracts are treated as real property interests under New Mexico law does not conclusively establish that they are like kind to the gold mining property Peabody transferred. Respondent argues that like kind status of the supply contracts, for purposes of section 1031, is a question of Federal tax law. Respondent also notes that section 1031 case precedent does not support the axiom that exchanges of real property are ipso facto like kind. On this point, see 71 T.C. 54">Koch v. Commissioner, supra at 64-65 (citing Fleming v. Commissioner, 24 T.C. 818">24 T.C. 818, 24 T.C. 818">823-824 (1955), affd. in part and revd. in part 241 F.2d 78">241 F.2d 78 (5th Cir. 1957), affd. sub nom. Commissioner v. P.G. Lake, Inc., 356 U.S. 260">356 U.S. 260, 78 S. Ct. 691">78 S. Ct. 691, 2 L. Ed. 2d 743">2 L. Ed. 2d 743, 1958-1 C.B. 516 (1958)). Respondent contends that the supply contracts constitute property of a different kind and class and are not like-kind property to the gold mining property Peabody transferred, 2006 U.S. Tax Ct. LEXIS 14">*36 because the contracts are of an intrinsically different nature and character from gold mining property. See sec. 1.1031(a)-1(b), Income Tax Regs.

Finally, respondent argues that Koch is distinguishable from and inapplicable to this case because the condominium leases in Koch were 99-year (long-term) land leases, whereas the coal supply contracts we consider are only interests in coal to be removed from the ground. ⁸ Respondent also attempts to distinguish Koch, where condominium leaseholders 126 T.C. 261">*273 had the primary right directly to use the land, from this case, where the coal buyers have no direct and substantially similar right to use the Lee Ranch mine land.

We agree with respondent that exchanges of real property interests are not, ipso facto, like-kind exchanges2006 U.S. Tax Ct. LEXIS 14">*37 under section 1031. 71 T.C. 54">Koch v. Commissioner, supra at 64-65; see also Smalley v. Commissioner, 116 T.C. 450">116 T.C. 450, 116 T.C. 450">463-464 (2001). For example, carved-out oil payments, although characterized as real property under State law, were found not to be like kind to a fee interest in real estate. 24 T.C. 818">Fleming v. Commissioner, supra at 823-824. See also Wiechens v. United States, 228 F. Supp. 2d 1080">228 F. Supp. 2d 1080, 228 F. Supp. 2d 1080">1085 (D. Ariz. 2002), where 50-year water rights were not like kind to a fee interest in real estate, and Clemente, Inc. v. Commissioner, T.C. Memo. 1985-367, where an 8-acre parcel of land was not like kind to gravel extraction rights in another parcel of land.

To decide whether an exchange is like kind within the meaning of section 1031(a), we must compare the exchanged properties to ascertain whether the nature and character of the transferred rights in and to the respective properties are substantially alike. 71 T.C. 54">Koch v. Commissioner, supra at 64-65; sec. 1.1031(a)-1(b), Income Tax Regs. See generally the discussion in 116 T.C. 450">Smalley v. Commissioner, supra at 461-464. We conclude that the real2006 U.S. Tax Ct. LEXIS 14">*38 property interest status under New Mexico law of the TEPCO and WEF supply contracts is not determinative of whether those supply contracts constitute like- kind property as opposed to boot under section 1031. See 71 T.C. 54">Koch v. Commissioner, supra at 64-65. In making this comparison, consideration is to be given to the respective interests in the physical properties, the nature of the title conveyed, the rights of the parties, the duration of the interests, and any other factor bearing on the nature or character of the properties as distinguished from their grade or quality. Id.; sec. 1.1031(a)-1(b), Income Tax Regs.

In Commissioner v. Crichton, 122 F.2d 181">122 F.2d 181, 122 F.2d 181">182 (5th Cir. 1941), affg. 42 B.T.A. 490">42 B.T.A. 490 (1940), the Court of Appeals for the Fifth Circuit held that the exchange of an overriding royalty interest in minerals for a city lot qualified as a like-kind exchange. See also Rev. Rul 68-331, 1968-1 C.B. 352, in 126 T.C. 261">*274 which it was ruled that the exchange of an oil producing lease for a fee simple title to a ranch qualified as a like-kind exchange.

Conversely, in Fleming v. Commissioner, 24 T.C. 818">24 T.C. 823- 824,2006 U.S. Tax Ct. LEXIS 14">*39 we held that the exchange of an assignment of carved-out oil payment rights for a fee interest in real estate failed to qualify because they were not like-kind properties, even though applicable State law characterized the oil payment rights as an interest in real estate.

In Koch v. Commissioner, 71 T.C. 54">71 T.C. 65, we reconciled the difference in the holdings of Crichton and Fleming as follows:

The main distinction between the two transactions is the duration of the interests -- an overriding royalty interest continues until the mineral deposit is exhausted whereas a carved-out oil payment right terminates usually when a specified quantity of minerals has been produced or a stated amount of proceeds from the sale of minerals has been received.

Petitioner attempts to distinguish the coal supply contracts here from the carved-out production payment rights in Fleming, on the basis that the supply contracts are more extensive in scope and duration. Petitioner argues that the contracts involve "essentially perpetual and unlimited rights" and meet the 30-year- leasehold safe harbor of section 1.1031(a)-1(c), Income Tax Regs., because each2006 U.S. Tax Ct. LEXIS 14">*40 contract, with renewals, had 30 or more years to run at the time of the exchange.

Peabody's right to mine and extract coal from the Lee Ranch mine land derives solely from its ownership of the land in fee and the coal leases making up that coal mine property, not from the TEPCO and WEF contracts. As previously discussed, the supply contracts created servitudes obligating Peabody to mine and supply coal from the Lee Ranch mine to the utility/buyers pursuant to those contracts. Those contracts themselves, however, did not give Peabody the right to mine coal from the Lee Ranch land.

The supply contracts obligate each utility/buyer to pay a specified price for Lee Ranch mine coal. In other words, the contracts afford Peabody specified payment rights with respect to the coal supplied. In that respect, Peabody's supply contract payment rights are incident to, derive almost exclusively from, and cannot be separated from its ownership of the Lee Ranch mine land. It is Peabody's ownership of that 126 T.C. 261">*275 mine's coal reserves that gives Peabody the right to mine and extract coal from the Lee Ranch mine land. ⁹2006 U.S. Tax Ct. LEXIS 14">*42 In addition, unlike the overriding royalty interests in 122 F.2d 181">Crichton, Peabody's supply contract2006 U.S. Tax Ct. LEXIS 14">*41 payment rights do not necessarily last until coal on the Lee Ranch mine land has been exhausted. Without optional renewals, the TEPCO supply contract lasts until December 31, 2009, and the WEF supply contract lasts until December 31, 2004. See, e.g., Clemente v. Commissioner, T.C. Memo. 1985-367, where exchanged properties were held not to be like kind because the gravel extraction right the taxpayer received did not give that taxpayer the right to an unlimited quantity of gravel. By contrast, in Rev. Rul. 55-749, 1955-2 C.B. 295, the exchange of fee land for perpetual water rights was ruled to be qualified as like kind. ¹⁰

However, Peabody seeks to come within the safe harbor of section 1.1031(a)-1(c), Income Tax Regs., by relying on the renewal terms of the supply contract that might cause the contracts to last 30 years or more. ¹¹ In Century Elec. Co. v. Commissioner, 15 T.C. 581">15 T.C. 581, 15 T.C. 581">591-592 (1950), affd. 192 F.2d 155">192 F.2d 155 (8th Cir. 1951), we indicated that subsequent 10-year periods were added to the initial term of a 25-year lease to meet the requirements of a leasehold for 30 years or more 126 T.C. 261">*276 under the Treasury regulation safe harbor. See also Rev. Rul. 78-72, 1978-1 C.B. 258 (1978), which2006 U.S. Tax Ct. LEXIS 14">*43 would allow the addition of optional renewal periods to determine if a leasehold interest was for 30 years or more.

Contrary to petitioner's argument, the supply contract payment rights are not a leasehold interest in a fee property. As previously held, Peabody's right2006 U.S. Tax Ct. LEXIS 14">*44 to mine and extract coal from that land comes solely from ownership of the coal mine. We therefore conclude that the 30-year safe harbor provisions of section 1.1031(a)-1(c), Income Tax Regs., do not apply. See Wiechens v. United States, 228 F. Supp. 2d 1080">228 F. Supp. 2d at 1085 (where it was held that a taxpayer's 50-year water rights were not equivalent to a leasehold of a fee for 30 years or more so as to qualify for the regulation safe harbor).

The underlying rationale for allowing nonrecognition of gain or loss under section 1031 is the concept that a taxpayer's economic situation following the exchange is essentially the same as it had been before the transaction. This is expressed in the following quote from the committee report underlying the predecessor statute to section 1031: "if the taxpayer's money is still tied up in the same kind of property as that in which it was originally invested, he is not allowed to compute and deduct his theoretical loss on the exchange, nor is he charged with a tax upon his theoretical profit". H. Rept. 704, 73d Cong., 2d Sess. (1934), 1939-1 C.B. (Part 2) 554, 564; see also Biggs v. Commissioner, 69 T.C. 905">69 T.C. 905, 69 T.C. 905">913 (1978),2006 U.S. Tax Ct. LEXIS 14">*45 affd. 632 F.2d 1171">632 F.2d 1171 (5th Cir. 1980). The underpinning supporting section 1031(a) is that the new property is substantially a continuation of the old investment which remains unliquidated. Commissioner v. P.G. Lake, Inc., 356 U.S. 260">356 U.S. at 268.

In determining whether the like-kind requirement of section 1031 had been met, we found it significant in Koch v. Commissioner, 71 T.C. 54">71 T.C. 65, that section 1031(a) refers to property of a like, not an identical, kind. The required comparison of the old and new exchanged properties, we reasoned, should be directed to whether the taxpayer, in making the exchange, has used its property to acquire a new kind of asset or has merely exchanged its property for an asset of like nature or character. Id. Examining the exchanged properties in Koch with those principles in mind, we held the taxpayer's exchange of fee simple land for other fee simple land 126 T.C. 261">*277 subject to 99-year condominium leases qualified for nonrecognition treatment under section 1031(a) because those exchanged properties were property of a like kind. 71 T.C. 54">Id. at 65-70.

In Koch, we rejected the Commissioner's contention that the taxpayer/lessor's interests2006 U.S. Tax Ct. LEXIS 14">*46 (primarily the right to condominium rental payments) could be separated from the taxpayer's fee simple interest in that land. We observed that: (1) The taxpayer's right to rent was not a separate and distinct item of property but part of the bundle of rights incident to ownership of the fee; (2) the bundle of rights and its related obligations were inextricably bound up with the fee simple interest; (3) the condominium leases contained numerous provisions (some of which we briefly summarized in our findings in Koch) not only securing the payment of rent but also protecting the value of the taxpayer's reversionary interest; and (4) the right to rent was merely an incident of ownership of the fee simple interest. 71 T.C. 54">Id. at 66-68. We also acknowledged that the 99-year condominium leases prevented the taxpayer from taking physical possession of the land received and using it for other purposes. We viewed that leasehold restriction on the taxpayer's use of the new land as a distinction in the grade or quality of the exchanged old and new properties as opposed to a difference in their kind or class. We observed that section 1031(a) "'was not intended to draw any distinction between2006 U.S. Tax Ct. LEXIS 14">*47 parcels of real property however dissimilar they may be in location, in attributes, and in capacities for profitable use.'" Koch v. Commissioner, 71 T.C. 54">71 T.C. 68 (quoting Commissioner v. Crichton, 122 F.2d 181">122 F.2d at 182).¹² Finally, in 71 T.C. 54">Koch v. Commissioner, supra at 70, we held that the value of the taxpayer's condominium lease interests did not constitute taxable other property or boot under section 1031(b), because the "lessor's fee simple interest cannot be so fragmented."

In return2006 U.S. Tax Ct. LEXIS 14">*48 for the gold mining property Peabody, among other things, received the Lee Ranch coal mine, which was subject to two coal supply contracts. Respondent acknowledges 126 T.C. 261">*278 that the Lee Ranch mine (consisting of fee simple land and coal leases) is like kind to the gold mining property and qualifies for nonrecognition treatment under section 1031(a). ¹³ Respondent, however, contends this case is distinguishable from 71 T.C. 54">Koch. Respondent argues that the coal supply contracts are separable from the Lee Ranch mine and constitute taxable other property or boot under section 1031(b). In other words, respondent argues those two supply contracts can be fragmented and are not inextricably bound up with Peabody's ownership of the Lee Ranch mine's coal reserves. We disagree.

2006 U.S. Tax Ct. LEXIS 14">*49 Although each supply contract is also a contract for the sale of goods under New Mexico law and does not give the utility/buyer a right to extract coal from the Lee Ranch mine land, in the context of this case we do not find those distinctions to be significant nor to sufficiently distinguish this case from 71 T.C. 54">Koch. Peabody's right to mine and extract coal from the Lee Ranch mine land and its supply contracts payment rights for the coal cannot be separated from its ownership of the Lee Ranch mine coal reserves. Those rights are part of the bundle of rights incident to Peabody's ownership of the Lee Ranch mine land coal reserves. Indeed, those supply contracts give Peabody no right to mine and extract coal from that land. Instead, Peabody's right to mine and extract coal from that land comes solely from its ownership of that land and coal reserves.

As to the right to payment under the contracts for coal furnished, those rights are ancillary to Peabody's ownership of the coal reserves. Accordingly, the question of whether the supply contracts afford an advantageous or detrimental coal price to Peabody is immaterial in that setting. See Koch v. Commissioner, 71 T.C. 54">71 T.C. 68.2006 U.S. Tax Ct. LEXIS 14">*50 Because we hold that the right to receive income from the tenant is part of the bundle of rights ancillary to and inherent in the ownership of the realty, the question of whether the lease was advantageous or detrimental to the fee owner is immaterial.

It is true Peabody is obligated to mine and supply coal to meet the operating needs of power stations and that Peabody is prohibited from impairing the contracted-for supply by 126 T.C. 261">*279 selling coal to other buyers. In our view those contract obligations and restrictions constitute a distinction in the grade or quality of the old and new mining properties rather than a difference in their kind or class. The new coal mine property is of a like nature or character to the gold mining property Peabody exchanged. By exchanging the gold mining property for the coal mining property subject to the supply contracts, Peabody is essentially continuing the original investment which remains fully unliquidated. See Commissioner v. P.G. Lake, Inc., 356 U.S. 260">356 U.S. at 268. Respondent, contrary to our holding in Koch, is attempting to fragment and currently tax Peabody on the supply contracts before their actual realization.

We hold that the coal mine2006 U.S. Tax Ct. LEXIS 14">*51 subject to the TEPCO and WEF supply contracts Peabody received is like kind to the gold mining property transferred and that Peabody's exchange qualifies for nonrecognition treatment under section 1031(a). See Koch v. Commissioner, 71 T.C. 54">71 T.C. 54 (1978). In the light of that holding and because the supply contracts cannot be separated from Peabody's ownership of the Lee Ranch mine coal reserves, it follows that those contracts are not taxable as other property or boot under section 1031(b). See id.

On the basis of the forgoing, we conclude, as a matter of law, that petitioner is entitled to summary judgment and respondent is not so entitled.

An appropriate order and decision will be entered for petitioner at docket No. 20328-04, and decision will be entered for petitioner at docket No.6899-05.