Commissioner of Internal Revenue v. Gracey, 159 F.2d 324 (5th Cir. 1947)

Louise Foster, Sewall Key, J. Louis Monarch, and Newton K. Fox, Sp. Assts. to the Atty. Gen., Douglas W. McGregor, Asst. Atty. Gen., and J. P. Wenchel, Chief Counsel, Bur. Int. Rev., and Bernard D. Daniels, Sp. Atty., Bur. Int. Rev., both of Washington, D. C., for Commissioner of Internal Revenue.

James H. Yeatman, of Houston, Tex., for taxpayers.

Before HOLMES, McCORD, and WALLER, Circuit Judges.

McCORD, Circuit Judge.

The Commissioner and the taxpayers have filed petitions for review of a decision of the Tax Court redetermining income tax deficiencies for the year 1940. The findings and opinion of the Tax Court are reported, 5 T.C. 296.

During the taxable year, taxpayers were husband and wife residing in Texas, a community property State. Their income tax returns were filed on a community basis, and for the taxable year all their income and deductions represented community income and community deductions.

Euleon Jock Gracey owned an oil well drilling rig which had been used in his business since 1935. The drilling rig had been subject to a depreciation allowance, and the parties agree that it could not be considered a "capital asset" under Section 117(a) (1) of the Internal Revenue Code, 26 U.S.C.A. Int.Rev.Code, § 117(a) (1). In February, 1940, Gracey exchanged his drilling rig for 500 shares of stock in the C. I. Drilling Co., Inc. It was stipulated, and the Tax Court found, that the exchange of the drilling rig for the stock was a taxfree exchange under Section 112(b) (3) of the Internal Revenue Code, 26 U.S.C.A. Int.Rev.Code, § 112(b) (3), "and that the basis for gain or loss to petitioner of the 500 shares of stock of C. I. Drilling Co., *325 Inc., which he received in exchange for the drilling rig is $29,658.18, the undepreciated cost of the rig."

In March, 1940, Gracey sold 250 shares of the stock for $25,000.00. Since these 250 shares of stock had a substituted basis of $14,829.09, one-half of the undepreciated cost of the rig, a profit of $10,170.91 was realized. Taxpayers treated the profit as a long-term capital gain and included only one-half of the gain in their net community income. The Commissioner determined that the profit was derived from the sale of capital assets held not more than one month, and that, therefore, under Section 117(b) one hundred percentum of the gain was includible in taxpayers' net community income. Applying Section 117(h) (1) of the Internal Revenue Code^[1], the Tax Court overturned the Commissioner's determination and held that the holding period for the stock should include the period for which taxpayers held the oil well drilling rig.

The Commissioner contends here, as he did before the Tax Court, that Section 117 (h) (1) does not permit the tacking on of a previous holding period where the property exchanged for a capital asset was not itself a capital asset. In substance, Commissioner's argument is that Congress did not intend for the holding period of a non-capital asset to be added to the holding period of a capital asset received in a tax-free exchange.^[2]

We agree that for practical tax purposes, in determining gains and losses includible in income under Section 117(b), it ought not to be possible to add the holding period of a non-capital asset such as a drilling rig to the short holding period of a capital asset received in exchange. Congress may not have contemplated that Section 117(h) (1) could be availed of to bring a situation such as is here presented within the long-term capital gains benefits of the statute. However, we may not speculate as to what Congress might have contemplated or intended. We must construe and apply the law as it is written. Sabine Transportation Co. v. Commissioner, 5 Cir., 128 F.2d 945, affirmed 318 U.S. 306, 63 S. Ct. 569, 87 L. Ed. 773; Helvering v. Credit Alliance Corporation, 316 U.S. 107, 62 S. Ct. 989, 86 L. Ed. 1307.

Section 117(h) (1), in clear and unambiguous language, provides for the inclusion in the holding period of a capital asset received on an exchange, if the basis does not change, of the "period for which the taxpayer held * * * the property exchanged * * *." The statute makes no distinction based on whether the prior held property was a capital or a non-capital asset. We may not write such a distinction into the law.

The decision of the Tax Court holding that taxpayers were entitled to report the profit from the sale of the shares of stock as a long-term capital gain is in accord with Section 117(h) (1) and is, therefore, Affirmed.

On the second issue in the case, the Tax Court sustained the Commissioner's determination and overruled taxpayers' contentions that they were entitled to deduct, in computing community net income, or exclude from their gross income, a sum representing one-fourth of the net profits from the operation of an oil and gas lease, which sum they had paid to the assignor of the lease during the taxable year. The Tax *326 Court held the amount paid to assignor to be a capital expenditure, recoverable through depletion allowance. Cf. Quintana Petroleum Co. v. Commissioner, 5 Cir., 143 F.2d 588; Burton-Sutton Oil Co. v. Commissioner, 5 Cir., 150 F.2d 621.

Subsequent to the decision of the Tax Court and pending this appeal, the Supreme Court reversed the Burton-Sutton Case. Burton-Sutton Oil Co. v. Commissioner, 328 U.S. 25, 66 S. Ct. 861, 90 L. Ed. 1062, 162 A.L.R. 827. The Supreme Court decision changes the complexion of principles applicable in cases of this kind. Accordingly, the decision of the Tax Court on this issue, "Issue 2", is Reversed and the cause is Remanded with direction to reopen the case as to this issue and make a redetermination in accordance with the Supreme Court's decision in the Burton-Sutton Case, making proper adjustment for depletion previously allowed on the questioned payment.

[1] Sec. 117(h) "Determination of period for which held. * * *

"(1) In determining the period for which the taxpayer has held property received on an exchange there shall be included the period for which he held the property exchanged, if under the provisions of section 113, the property rereceived has, for the purpose of determining gain or loss from the sale or exchange, the same basis in whole or in part in his hands as the property exchanged."

[2] The Tax Court observed that "The precise question presented has not been brought to issue before any court * * *. The Commissioner has not incorporated into his Regulations * * * the interpretation of subsection (h) (1) which is advanced here. Respondent cites G.C.M. 621, (1926) * * * and G.C.M. 11557, (1933) * * *. Consideration has been given to those rulings but, under the facts of this proceeding, we must reach the conclusion stated above [upholding taxpayers' contention]."