OPINION
Goffe, Judge:
The Commissioner determined a deficiency in petitioner’s Federal income tax for the taxable year 1980 in the amount of $2,587,079 and a deficiency in petitioner’s Federal income tax for the short taxable year ended April 24, 1981, in the amount of $7,072,671. Respondent claimed an increased deficiency in an amendment to his answer for the short taxable year ended April 24, 1981, in the amount of $4,487,160. The parties have settled all of the issues framed by the statutory notice of deficiency and the amendment to the answer except one. The sole issue to be decided is whether petitioner must, under the provisions of section 1254 of the Internal Revenue Code, “recapture” intangible drilling and development costs (IDC) as ordinary income when it carved overriding royalties out of the working interests it held in oil and gas leases and transferred them to a trust for the benefit of its shareholders. For convenience, unless otherwise indicated, all section numbers refer to the Internal Revenue Code of 1954 in effect for the taxable years before the Court.
This case was submitted to the Court fully stipulated under Rule 122 of the Court’s Rules of Practice and Procedure. The stipulation of facts and accompanying exhibits are incorporated by this reference.
Petitioner and its subsidiaries are an affiliated group of corporations for Federal income tax purposes, petitioner being the common parent. It was incorporated under the laws of the State of Nevada. When petitioner filed its petition, its principal place of business was Houston, Texas. Petitioner maintained its books and records and filed the consolidated income tax returns using the accrued method of accounting.
The outstanding corporate stock of petitioner, during the years before the Court and for memy prior years, was traded on the Americem Stock Exchemge and was widely held. During the same period, petitioner emd its subsidieiries were engaged primarily in the business of acquiring, developing, emd operating oil and gas properties and selling the production from such properties.
Petitioner, immediately prior to April 24, 1981, was the lessee, either alone or jointly with others, of mineral leases covering various tracts of land throughout the United States and some foreign countries. For simplicity, it is assumed that petitioner was the sole lessee for purposes of this case. Petitioner’s share of the leasehold interest has no bearing upon resolution of the issue presented for our decision. Each lease gave the lessee the right, at its sole cost, to explore for oil and gas, to develop and produce any oil and gas that was discovered, and to own all of the oil and gas produced, exclusive of the interest in the minerals retained by the lessor. The lessor in each lease was entitled to a share of the oil and gas produced or to a share of the proceeds from the sale or production free of all costs.
Petitioner conducted exploration and development activities on the properties covered by the mineral leases from January 1, 1976, through April 24, 1981, incurring substantial IDC that it elected to deduct (rather than to capitalize) on its Federal income tax returns under the provisions of section 263(c). During this period, petitioner discovered oil and gas that was, or was expected to be, capable of being produced in commercial quantities. It likewise conducted little or no successful exploration activities on other portions of the properties covered by the leases and had not determined whether oil or gas in commercial quantities existed.
Tenneco, during the periods of time relevant here, was a publicly traded corporation that was the common parent of a group of corporations which were engaged in a number of different businesses, including oil and gas exploration.
In 1980, petitioner and Tenneco entered into negotiations whereby Tenneco would acquire all of petitioner’s outstanding stock in exchange for stock in Tenneco. In order to reduce the number of shares that Tenneco would be required to issue and to permit the shareholders of petitioner to retain a direct equity interest in petitioner’s oil and gas leases, Tenneco and petitioner agreed to a plan whereby petitioner would create a trust into which it would convey interests in its oil and gas leases and distribute those interests in the trust to its shareholders. Following the distribution, petitioner would become the wholly owned subsidiary of Tenneco in an exchange whereby the shareholders of petitioner would receive .31 shares of the common stock of Tenneco for each share of common stock they held of petitioner.
After the shareholders of petitioner approved the plan, the transactions were completed on April 24, 1981. Petitioner transferred to the trust overriding royalty interests consisting of 75 percent of the net proceeds from productive properties and 5 percent of the gross proceeds from exploratory properties. The overriding royalties were calculated on a property-by-property basis for the productive properties, and on a lease-by-lease basis for the exploratory properties. The units of interest in the trust were distributed pro rata to petitioner’s shareholders.
In addition, the other terms of the agreement between petitioner were carried out by petitioner’s being merged into a subsidiary of Tenneco, thereby becoming the wholly owned subsidiary of Tenneco. The shareholders of petitioner received 10 million shares of common stock of Tenneco which had a fair market value in excess of $400 million. The trust units had a collective fair market value of $900 million.
Upon the merger petitioner became a member of the Tenneco affiliated group of corporations, and it has continued to carry on the business which it carried on prior to the merger and it has continued to operate substantially all of the leasehold interests from which it carved out the overriding royalties.
After petitioner carved out the overriding royalties, it continued to have the exclusive right and obligation to explore, develop, and operate the properties covered by the leases. Both before and after the creation of the overriding royalties, each of petitioner’s leasehold interests was an “operating mineral interest” as that term is used in section 614(d) and section 1.614-2(b), Income Tax Regs. Each of the overriding royalty interests which petitioner conveyed to the trust was a nonoperating mineral interest within the meaning of section 614(e) and section 1.614-5(g), Income Tax Regs.
The Commissioner, in the statutory notice of deficiency mailed to petitioner, determined that when petitioner transferred the overriding royalties to the trust, it disposed of property pursuant to section 1254, and petitioner, therefore, must recognize ordinary income in the amount of $89,889,786.
Section 1254, in general, provides that if a taxpayer disposes of “oil, gas, or geothermal property” the taxpayer must treat as ordinary income the aggregate of expenditures it has deducted under section 263 (or other sections not applicable here). In effect, section 1254 amounts to a “recapture” of IDC previously deducted upon disposition of certain property.
The only disagreement between the parties is whether the property which petitioner disposed of is “oil, gas, or geothermal property” as that term is defined in section 1254(a)(3).
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OPINION
Goffe, Judge:
The Commissioner determined a deficiency in petitioner’s Federal income tax for the taxable year 1980 in the amount of $2,587,079 and a deficiency in petitioner’s Federal income tax for the short taxable year ended April 24, 1981, in the amount of $7,072,671. Respondent claimed an increased deficiency in an amendment to his answer for the short taxable year ended April 24, 1981, in the amount of $4,487,160. The parties have settled all of the issues framed by the statutory notice of deficiency and the amendment to the answer except one. The sole issue to be decided is whether petitioner must, under the provisions of section 1254 of the Internal Revenue Code, “recapture” intangible drilling and development costs (IDC) as ordinary income when it carved overriding royalties out of the working interests it held in oil and gas leases and transferred them to a trust for the benefit of its shareholders. For convenience, unless otherwise indicated, all section numbers refer to the Internal Revenue Code of 1954 in effect for the taxable years before the Court.
This case was submitted to the Court fully stipulated under Rule 122 of the Court’s Rules of Practice and Procedure. The stipulation of facts and accompanying exhibits are incorporated by this reference.
Petitioner and its subsidiaries are an affiliated group of corporations for Federal income tax purposes, petitioner being the common parent. It was incorporated under the laws of the State of Nevada. When petitioner filed its petition, its principal place of business was Houston, Texas. Petitioner maintained its books and records and filed the consolidated income tax returns using the accrued method of accounting.
The outstanding corporate stock of petitioner, during the years before the Court and for memy prior years, was traded on the Americem Stock Exchemge and was widely held. During the same period, petitioner emd its subsidieiries were engaged primarily in the business of acquiring, developing, emd operating oil and gas properties and selling the production from such properties.
Petitioner, immediately prior to April 24, 1981, was the lessee, either alone or jointly with others, of mineral leases covering various tracts of land throughout the United States and some foreign countries. For simplicity, it is assumed that petitioner was the sole lessee for purposes of this case. Petitioner’s share of the leasehold interest has no bearing upon resolution of the issue presented for our decision. Each lease gave the lessee the right, at its sole cost, to explore for oil and gas, to develop and produce any oil and gas that was discovered, and to own all of the oil and gas produced, exclusive of the interest in the minerals retained by the lessor. The lessor in each lease was entitled to a share of the oil and gas produced or to a share of the proceeds from the sale or production free of all costs.
Petitioner conducted exploration and development activities on the properties covered by the mineral leases from January 1, 1976, through April 24, 1981, incurring substantial IDC that it elected to deduct (rather than to capitalize) on its Federal income tax returns under the provisions of section 263(c). During this period, petitioner discovered oil and gas that was, or was expected to be, capable of being produced in commercial quantities. It likewise conducted little or no successful exploration activities on other portions of the properties covered by the leases and had not determined whether oil or gas in commercial quantities existed.
Tenneco, during the periods of time relevant here, was a publicly traded corporation that was the common parent of a group of corporations which were engaged in a number of different businesses, including oil and gas exploration.
In 1980, petitioner and Tenneco entered into negotiations whereby Tenneco would acquire all of petitioner’s outstanding stock in exchange for stock in Tenneco. In order to reduce the number of shares that Tenneco would be required to issue and to permit the shareholders of petitioner to retain a direct equity interest in petitioner’s oil and gas leases, Tenneco and petitioner agreed to a plan whereby petitioner would create a trust into which it would convey interests in its oil and gas leases and distribute those interests in the trust to its shareholders. Following the distribution, petitioner would become the wholly owned subsidiary of Tenneco in an exchange whereby the shareholders of petitioner would receive .31 shares of the common stock of Tenneco for each share of common stock they held of petitioner.
After the shareholders of petitioner approved the plan, the transactions were completed on April 24, 1981. Petitioner transferred to the trust overriding royalty interests consisting of 75 percent of the net proceeds from productive properties and 5 percent of the gross proceeds from exploratory properties. The overriding royalties were calculated on a property-by-property basis for the productive properties, and on a lease-by-lease basis for the exploratory properties. The units of interest in the trust were distributed pro rata to petitioner’s shareholders.
In addition, the other terms of the agreement between petitioner were carried out by petitioner’s being merged into a subsidiary of Tenneco, thereby becoming the wholly owned subsidiary of Tenneco. The shareholders of petitioner received 10 million shares of common stock of Tenneco which had a fair market value in excess of $400 million. The trust units had a collective fair market value of $900 million.
Upon the merger petitioner became a member of the Tenneco affiliated group of corporations, and it has continued to carry on the business which it carried on prior to the merger and it has continued to operate substantially all of the leasehold interests from which it carved out the overriding royalties.
After petitioner carved out the overriding royalties, it continued to have the exclusive right and obligation to explore, develop, and operate the properties covered by the leases. Both before and after the creation of the overriding royalties, each of petitioner’s leasehold interests was an “operating mineral interest” as that term is used in section 614(d) and section 1.614-2(b), Income Tax Regs. Each of the overriding royalty interests which petitioner conveyed to the trust was a nonoperating mineral interest within the meaning of section 614(e) and section 1.614-5(g), Income Tax Regs.
The Commissioner, in the statutory notice of deficiency mailed to petitioner, determined that when petitioner transferred the overriding royalties to the trust, it disposed of property pursuant to section 1254, and petitioner, therefore, must recognize ordinary income in the amount of $89,889,786.
Section 1254, in general, provides that if a taxpayer disposes of “oil, gas, or geothermal property” the taxpayer must treat as ordinary income the aggregate of expenditures it has deducted under section 263 (or other sections not applicable here). In effect, section 1254 amounts to a “recapture” of IDC previously deducted upon disposition of certain property.
The only disagreement between the parties is whether the property which petitioner disposed of is “oil, gas, or geothermal property” as that term is defined in section 1254(a)(3). If the property is not “oil, gas, or geothermal property,” petitioner need not recognize ordinary income. If the property is such property, petitioner must recognize ordinary income.
“Oil, gas, or geothermal property” is defined, insofar as the definition applies to this case, as follows in section 1254(a)(3):
(3) Oil, gas, or geothermal property — The term “oil, gas, or geothermal property” means any property (within the meaning of section 614) with respect to which any expenditures described in paragraph (1)(A) are properly chargeable.
It is readily apparent that section 614 must be considered in the interpretation of section 1254(a)(3). In addition, it must be kept in mind that the definition is applied only to the disposition of “oil, gas, or geothermal property.” Sec. 1254(a)(1).
“Oil, gas, or geothermal property,” by the definition in section 1254(a)(3), is only property to which any expenditure described in section 1254(a)(1)(A) is properly chargeable. Section 1254(a)(1)(A) covers the IDC election under section 263. Section 614 (which is incorporated by reference parenthetically in the definition) defines “property” very broadly. The parties agree that the working interests in each mineral lease are each separate properties and the overriding royalty interests in each of the mineral leases are each separate properties under section 614(a). Their conclusion is confirmed by section 1.614-l(a), Income Tax Regs.
The IDC costs which petitioner previously deducted and which respondent has determined must be recaptured are chargeable only against working (operating) interests and not against royalty interests. This conclusion is not in dispute. Sec. 1.612-4(a), Income Tax Regs.; Cottingham v. Commissioner, 63 T.C. 695 (1975).
Petitioner contends that because the IDC are chargeable only against the working interests and petitioner did not dispose of the working interests that the overriding royalties which petitioner carved out of the working interests and transferred to the trust were not “oil, gas, or geothermal property.” Respondent counters with the argument that petitioner carved the overriding royalties out of the working interests and because the IDC had been charged against the working interests the properties transferred to the trust were, therefore, “oil, gas, or geothermal property.” But respondent has stipulated that both before and after the transfers, petitioner owned all of the working interests.
It is true that petitioner has less than it did before the transfers, but the lesser quantum of petitioner’s interest is only in petitioner’s right to the oil and gas produced from the leases. When petitioner transferred the overriding royalties to the trust, it created new property interests under section 614(a). It carved out overriding royalties which had previously been in solution in its working interests. But the interests which it carved out and transferred were not working interests. It has been generally accepted by the courts for many years that nonoperating mineral interests may be separated from operating mineral interests, and, when that occurs, the new mineral interests which are created take on only the character and rights of nonoperat-ing mineral interests, e.g., Commissioner v. Southwest Exploration Co., 350 U.S. 308 (1956); Burton-Sutton Oil Co. v. Commissioner, 328 U.S. 25 (1946); and Kirby Petroleum Co. v. Commissioner, 326 U.S. 599 (1946). The mineral interests transferred to the trust were nonoperating mineral interests and were not properties against which IDC was chargeable as required by the definition in section 1254.
After the carveout, petitioner continued to own the working interests and could exclusively continue to elect to deduct 100 percent of the IDC. The trust, as holder of the overriding royalty interests for the benefit of the shareholders, could not pass on to the shareholders any deductions for IDC because the overriding royalty interests were not operating mineral interests.
In a series of cases involving the IDC election with respect to offshore drilling platforms we have consistently pointed out the relationship between risk-taking and IDC. The Commissioner apparently now recognizes the relationship to constitute a type of analysis which he recently described as “risk analysis.” Rev. Rul. 89-56, 1989-16 I.R.B. 4. We summarized some of the rationale which connected risk-taking with IDC in Standard Oil Co. (Indiana) v. Commissioner, 77 T.C. 349, 397 (1981), as follows:
The argumentative justification for liberality in taxation of oil and gas is that such liberality encourages and emboldens the fiscally timid to exploit the hidden resource. It rewards the risk-taker. * * * [United States v. Cocke, 399 F.2d 433, 452 (5th Cir. 1968).]
The regulations do not contemplate that investors * * * [can be] allowed a deduction for intangible drilling costs without assuming the risk of the unknown result of the drilling. * * * [Haass v. Commissioner, 55 T.C. 43, 50 (1970).]
Thus, it is clear that risk and IDC are inextricably related. [Standard Oil Co. (Indiana) v. Commissioner, 68 T.C. at 350.]
The taking of risks has always been inextricably related to the availability of the IDC option. [Gates Rubber Co. v. Commissioner, 74 T.C. at 1477; Sun Co. v. Commissioner, 74 T.C. at 1510.]
More recently, we reiterated the importance of risk-taking with respect to the exploration for hydrocarbons as follows in Gulf Oil Corp. v. Commissioner, 87 T.C. 324, 345 (1986):
We have consistently held that IDC and risk are inextricably related. Standard Oil Co. (Indiana) v. Commissioner, 68 T.C. at 350. The risk referred to, however, is the general risk of exploration for, drilling, and producing hydrocarbons and that risk does not cease at an arbitrary time prior to the end of the use of the platform in the taxpayer’s trade or business. * * *
Our risk analysis has been followed in Texaco, Inc. v. United States, 598 F. Supp. 1165, 1174 (S.D. Tex. 1984), and by the U.S. Court of Appeals for the Third Circuit in affirming our decision in Sun Co. v. Commissioner, 74 T.C. 1481 (1980), affd. 677 F.2d 294 (3d Cir. 1982).
In the instant case, some of the leases involved are producing leases and others are not. The owner of the working interests bears the costs of exploration and operating the leases and continues to bear all of the duties and responsibilities inherent in the ownership of the working interest. Petitioner bears all of the risk of exploration and development of the leases. Petitioner, as lessee, continues to be responsible for a host of duties, whether specified in the mineral leases or by virtue of the considerable body of State case law of implied covenants in oil and gas. M. Merrill, The Law Relating to Covenants Implied in Oil and Gas Leases (2d ed. 1940); 5 E. Kuntz, A Treatise on the Law of Oil and Gas (1987). These include the duty to prevent drainage from the reservoir on the leased premises by drilling wells if it appears that wells from adjoining properties may be draining the reservoir on the leased premises. Petitioner has the duty to produce from the wells as long as such production is profitable; to market the hydrocarbon with due diligence; to seek such administrative action in aid of the other obligations under the leases; and to use reasonable care in the operations of the lease, including use of proven modern methods of development and operations. These are but a few of the duties and obligations which fall upon petitioner by virtue of its ownership of the working interests in the mineral leases.
When petitioner carved out the overriding royalty interests and transferred them to the trust, it was not relieved of any of the myriad duties and obligations which it held. Absent any Congressional intent to recapture IDC upon the carveout and transfer of nonoperating mineral interests, we conclude that it is more consistent to hold that recapture does not occur because the transferor of the nonoperating mineral interests will continue to incur IDC and the transferee of those nonoperating mineral interests will not commence to incur IDC. We recognize that recapture involves IDC previously incurred; nevertheless, it is undisputed that the only operating mineral interests, both before and after the creation of the overriding royalties, are held by petitioner.
There are no final regulations which are of assistance in deciding whether petitioner disposed of “oil, gas, or geothermal property.” Regulations which were proposed were somewhat more favorable to the interpretation contended by petitioner, but the regulations were never adopted and, of course, do not represent competent authority. Eller v. Commissioner, 77 T.C. 934, 946 (1981).
Both parties cite one committee report to demonstrate the purpose of section 1254 and the statutory scheme which Congress enacted to bring about recapture of IDC. H. Rept. 94-658 (1975), 1976-3 C.B. (Vol. 2) 695, 780.
The report proposes a change in the law because an oil and gas tax shelter investor could deduct IDC currently, thus deferring tax to a later time. If the oil investment became profitable, the investor could sell his interest at capital gain rates and, thus, avoid offsetting the IDC deductions by realizing ordinary income from the sale of hydrocarbons. The report also points out an abuse in the case of dry holes which is not applicable here. Respondent does not contend that the actions of petitioner in carving out the overriding royalties and transferring them to a trust for its shareholders falls within the abuse which Congress pointed out in the committee report and, indeed, we cannot see how petitioner’s actions fall within such perceived abuse. The IDC incurred and deducted by petitioner occurred during the period from January 1, 1976, through April 24, 1981, and petitioner did not dispose of any mineral interests which were taxable as capital gains.
Section 1254 closely tracks the committee report by incorporating by reference section 614. The report uses the term “oil and gas property” and defines such a property on page 90 of the report as follows:
A property is to be considered an oil or gas property only if intangible drilling and development costs are properly chargeable to that property (either in the hands of the taxpayer or his predecessor in interest). Thus, an interest in a tract or parcel of land which is not an operating interest does not constitute an oil or gas property. [H. Rept. 94-658, supra, 1976-3 C.B. (Vol. 2) at 782.]
The property transferred by petitioner to the trust is not “oil, gas, or geothermal property.” Petitioner did not dispose of any such property. It disposed of nonoperating mineral interests which, under the terms of sections 1254 and 263 are not “oil, gas, or geothermal property.”
Respondent argues that if recapture is not required the door will be opened to substantial abuse. We are convinced that our interpretation of section 1254 is correct. If the question were closer we might be inclined to interpret the section to prevent possible abuse. The opportunity for abuse is, however, slight. An innovative tax practitioner would be unable to use our opinion to avoid the application of section 1254 because Congress changed the law in the Tax Reform Act of 1986, Pub. L. 99-514, sec. 413, 100 Stat. 2085, 2227. After 1986, nonoperating mineral interests come within section 1254; therefore, IDC would be recaptured under the facts of the instant case if the disposition occurred in 1986 or later.
As to cases which are still pending, we are confident that there sire adequate means available to prevent abuse if it is perceived. In order to reflect the settlement agreement of the parties, as well as the foregoing,
Decision will be entered under Rule 155.