OPINION.
Murdock:
The Commissioner determined a deficiency of $341.55 in the income tax liability of the petitioner for the calendar year 1935. The facts in the case have been stipulated and are hereby found as stipulated. The only issue for decision is whether the Commissioner erred in including $6,779.93 in the petitioner’s income for 1935. He explained his action as follows:
In accordance with the provisions of Article 23 (m)-10 of Regulations 80, there was allowed in the year 1934 a deduction of $11,000.00 as statutory depletion on $40,000.00 cash bonus received during the year as part consideration for the granting of an oil and gas lease on 391.1 acres. During the year 1935, 241 acres of the 391.1 acres were, in accordance with provisions of the lease contract released and restored to taxpayer. Held that the portion of the $11,000.00 depletion allowance for the year 1934 applicable to the 241 acres constitutes taxable income in the year 1935. Article 23 (m)-10 (c) and G. O. M. 14448, O. B. XIV-1.
The petitioner owned as her separate property a piece of land in Texas, containing about 391.1 acres. She leased this entire piece of property on May 8, 1934, to the Southwest Oil Co. to permit the latter to drill for and produce any oil, gas, or other mineral which might be found. The lessee paid to the petitioner in 1934 $40,000 in cash as part consideration for the granting of the lease. The Commissioner, in determining the petitioner’s income tax liability for the year 1934, included the $40,000 in her gross income and allowed a deduction for depletion of 27% percent thereof, or $11,000. The parties agree that the Commissioner made no error in his determination for the year 1934. Herring v. Commissioner, 293 U. S. 322.
The lease was to continue for a term of years and the lessor was to receive additional payments out of production. However, the lease was to terminate at the end of the first year unless drilling had been commenced prior to that time or unless the lessee had paid to the lessor a rental fixed at $1,955.50 for the entire acreage. The lessee could deliver a release covering any portion of the premises, relieving itself of all obligations as to the acreage surrendered, and thereafter the rentals payable should be reduced in proportion to the reduction in acreage affected by the release.
The lessee did not commence any drilling operations and nothing was extracted from the acreage during the first year. The lessee “failed to pay the petitioner the sum provided * * * to cover the privilege of deferring for 12 months from May 8, 1935, the com[866]*866mencement of drilling operations on 241 of the 391.1 acres covered by the lease, and as of May 8, 1935, the lease terminated and expired as to said 241 acres without any oil or gas or other mineral substances having been extracted or produced.”
The parties have agreed “that $6,779.93 of the depletion of $11,000 allowed as a deduction on the $40,000 lease bonus in computing petitioner’s net income for [1934] is applicable to the 241 acres as to which the lease expired in 1935.”
The petitioner does not argue that percentage depletion allowed for 1934 on account of the bonus should not be restored to income of the year in which the lease terminates where no oil or gas is ever extracted from the leased premises, but contends that there should be no restoration in 1935 because the lease did not terminate in that year as to all of the land covered by the lease. The respondent points to the stipulation that the lease terminated on May 8, 1935, as to 241 of the 391.1 acres covered by the lease, no oil or gas was extracted from the 241 acres, and $6,779.93 of the percentage depletion allowecl as a deduction in 1934 was applicable to the 241 acres. The respondent then argues that it is entirely immaterial in the light of this stipulation whether or not the lessee forfeited the lease in 1935 as to the remaining acreage. The only argument advanced by the petitioner is not supported by the facts. We perceive no flaw in the respondent’s contention.
Furthermore, there appears to be no sound reason for reversing the determination of the Commissioner. All of the regulations, beginning with Regulations 45, covering the Revenue Act of 1918, have provided that if depletion is allowed with respect to an advance royalty or bonus and no production occurs during the life of the lease, the lessor must restore to his capital account and report as income in the year the lease terminates the amount which he has been allowed to deduct as depletion in connection with the advance payment. See Regulations 45, art. 215, as amended by T. D. 3938, C. B. V-2, p. 117, and corresponding provisions in later regulations. Percentage depletion was first allowed by the Revenue Act of 1926, and the method above described was continued. See Regulations 69, art. 215. The regulations continued the method under the Revenue Act of 1934. See Regulations 86, art. 23 (m)-10. The Supreme Court, in Murphy Oil Co. v. Burnet, 287 U. S. 299, considered and approved this method of allowing and adjusting deductions for depletion, as is shown by the following quotation from the opinion :
We think the Commissioner’s method “reasonable” within the meaning of the statute. The deduction for depletion from the bonus payments, which the statute requires, must either be made after the process of extracting the oil is complete, to the extent that the royalties received have been insufficient to replace invested capital, with the attendant inconvenience of indefinite post[867]*867ponement of the allocation of the bonus to income and return of capital, or a formula must be adopted by which the appropriate allocation may be made as the two classes of gross income, bonus and royalties, are received.
That formula the regulation purports to furnish. Where the estimates are reasonable, the formula affords a fair and convenient method of avoiding the present taxation of the bonus, when received, as income, in the face of the probability that it will ultimately prove not to be such. It will not fail to provide, with reasonable certainty, for the restoration of capital to which the taxpayer is entitled, if the oil extracted equals or exceeds the amount originally estimated. If less than that amount, it does not preclude revision and necessary adjustments, as errors appear probable. In addition, provision is made by subdivisions (c) and (<?,) of the regulation, as amended, for such necessary capital readjustments as may be occasioned by the termination, abandonment or expiration of the lease before all the oil is extracted.
The reasonableness and desirability of such a regulation, whether applied to deductions based upon cost or upon percentage, is adequately shown by the discussion of the Supreme Court in the Murphy Oil Co. case already quoted. The following quotation from Herring v. Commissioner, supra, seems unimportant in view of the statements contained in the Murphy Oil Co. case:
As to income tax liability in the year of termination of the lease, on account of bonus paid at the execution of the lease, if no mineral has then been extracted, we express no opinion.
Likewise unimportant now is the decision in Kittie A. Knapp, 7 B. T. A. 790.
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OPINION.
Murdock:
The Commissioner determined a deficiency of $341.55 in the income tax liability of the petitioner for the calendar year 1935. The facts in the case have been stipulated and are hereby found as stipulated. The only issue for decision is whether the Commissioner erred in including $6,779.93 in the petitioner’s income for 1935. He explained his action as follows:
In accordance with the provisions of Article 23 (m)-10 of Regulations 80, there was allowed in the year 1934 a deduction of $11,000.00 as statutory depletion on $40,000.00 cash bonus received during the year as part consideration for the granting of an oil and gas lease on 391.1 acres. During the year 1935, 241 acres of the 391.1 acres were, in accordance with provisions of the lease contract released and restored to taxpayer. Held that the portion of the $11,000.00 depletion allowance for the year 1934 applicable to the 241 acres constitutes taxable income in the year 1935. Article 23 (m)-10 (c) and G. O. M. 14448, O. B. XIV-1.
The petitioner owned as her separate property a piece of land in Texas, containing about 391.1 acres. She leased this entire piece of property on May 8, 1934, to the Southwest Oil Co. to permit the latter to drill for and produce any oil, gas, or other mineral which might be found. The lessee paid to the petitioner in 1934 $40,000 in cash as part consideration for the granting of the lease. The Commissioner, in determining the petitioner’s income tax liability for the year 1934, included the $40,000 in her gross income and allowed a deduction for depletion of 27% percent thereof, or $11,000. The parties agree that the Commissioner made no error in his determination for the year 1934. Herring v. Commissioner, 293 U. S. 322.
The lease was to continue for a term of years and the lessor was to receive additional payments out of production. However, the lease was to terminate at the end of the first year unless drilling had been commenced prior to that time or unless the lessee had paid to the lessor a rental fixed at $1,955.50 for the entire acreage. The lessee could deliver a release covering any portion of the premises, relieving itself of all obligations as to the acreage surrendered, and thereafter the rentals payable should be reduced in proportion to the reduction in acreage affected by the release.
The lessee did not commence any drilling operations and nothing was extracted from the acreage during the first year. The lessee “failed to pay the petitioner the sum provided * * * to cover the privilege of deferring for 12 months from May 8, 1935, the com[866]*866mencement of drilling operations on 241 of the 391.1 acres covered by the lease, and as of May 8, 1935, the lease terminated and expired as to said 241 acres without any oil or gas or other mineral substances having been extracted or produced.”
The parties have agreed “that $6,779.93 of the depletion of $11,000 allowed as a deduction on the $40,000 lease bonus in computing petitioner’s net income for [1934] is applicable to the 241 acres as to which the lease expired in 1935.”
The petitioner does not argue that percentage depletion allowed for 1934 on account of the bonus should not be restored to income of the year in which the lease terminates where no oil or gas is ever extracted from the leased premises, but contends that there should be no restoration in 1935 because the lease did not terminate in that year as to all of the land covered by the lease. The respondent points to the stipulation that the lease terminated on May 8, 1935, as to 241 of the 391.1 acres covered by the lease, no oil or gas was extracted from the 241 acres, and $6,779.93 of the percentage depletion allowecl as a deduction in 1934 was applicable to the 241 acres. The respondent then argues that it is entirely immaterial in the light of this stipulation whether or not the lessee forfeited the lease in 1935 as to the remaining acreage. The only argument advanced by the petitioner is not supported by the facts. We perceive no flaw in the respondent’s contention.
Furthermore, there appears to be no sound reason for reversing the determination of the Commissioner. All of the regulations, beginning with Regulations 45, covering the Revenue Act of 1918, have provided that if depletion is allowed with respect to an advance royalty or bonus and no production occurs during the life of the lease, the lessor must restore to his capital account and report as income in the year the lease terminates the amount which he has been allowed to deduct as depletion in connection with the advance payment. See Regulations 45, art. 215, as amended by T. D. 3938, C. B. V-2, p. 117, and corresponding provisions in later regulations. Percentage depletion was first allowed by the Revenue Act of 1926, and the method above described was continued. See Regulations 69, art. 215. The regulations continued the method under the Revenue Act of 1934. See Regulations 86, art. 23 (m)-10. The Supreme Court, in Murphy Oil Co. v. Burnet, 287 U. S. 299, considered and approved this method of allowing and adjusting deductions for depletion, as is shown by the following quotation from the opinion :
We think the Commissioner’s method “reasonable” within the meaning of the statute. The deduction for depletion from the bonus payments, which the statute requires, must either be made after the process of extracting the oil is complete, to the extent that the royalties received have been insufficient to replace invested capital, with the attendant inconvenience of indefinite post[867]*867ponement of the allocation of the bonus to income and return of capital, or a formula must be adopted by which the appropriate allocation may be made as the two classes of gross income, bonus and royalties, are received.
That formula the regulation purports to furnish. Where the estimates are reasonable, the formula affords a fair and convenient method of avoiding the present taxation of the bonus, when received, as income, in the face of the probability that it will ultimately prove not to be such. It will not fail to provide, with reasonable certainty, for the restoration of capital to which the taxpayer is entitled, if the oil extracted equals or exceeds the amount originally estimated. If less than that amount, it does not preclude revision and necessary adjustments, as errors appear probable. In addition, provision is made by subdivisions (c) and (<?,) of the regulation, as amended, for such necessary capital readjustments as may be occasioned by the termination, abandonment or expiration of the lease before all the oil is extracted.
The reasonableness and desirability of such a regulation, whether applied to deductions based upon cost or upon percentage, is adequately shown by the discussion of the Supreme Court in the Murphy Oil Co. case already quoted. The following quotation from Herring v. Commissioner, supra, seems unimportant in view of the statements contained in the Murphy Oil Co. case:
As to income tax liability in the year of termination of the lease, on account of bonus paid at the execution of the lease, if no mineral has then been extracted, we express no opinion.
Likewise unimportant now is the decision in Kittie A. Knapp, 7 B. T. A. 790. The repeated reenactment by Congress of the provisions relating to depletion would seem to give to the long established and uniform regulations of the Commissioner the force and effect of law. Helvering v. Reynolds Tobacco Co., 306 U. S. 110.
Finally, the present case is analogous to a number of others, where, with or without a supporting regulation, an adjustment has been made during the taxable year in which actually no income was received. See Estate of William H. Block, 39 B. T. A. 338, and many cases there cited. See also Houbigant, Inc., 31 B. T. A. 954; aff'd. per curiam, 80 Fed. (2d) 1012. Income tax liability must be determined for annual periods on the basis of facts as they existed in each period. Burnet v. Sanford & Brooks Co., 282 U. S. 359. When some event occurs which is inconsistent with a deduction taken in a prior year, adjustment may have to be made by reporting a balancing item in income for the year in which the change occurs. This petitioner was able to offset a portion of the payment received in 1934 by a deduction for depletion and thus escape income tax on that portion of the payment. The deduction allowed for 1934 was proper but was granted conditionally. The petitioner by accepting the reduction also accepted the condition provided in the regulations. Depletion is an allowance made for exhaustion of the property. The [868]*868lease was terminated in 1935 without any exhaustion ever haying-taken place. The petitioner thereupon became required under the regulations to restore to income the amount previously allowed as a deduction in respect to the 241 acres. There was no error in the determination of the Commissioner.
Reviewed by the Board.
Decision will he entered for the respondent.