BACKGROUND This document provides temporary income tax regulations under section 191 of the Internal Revenue Code of 1954, as added by section 2124(a) of the Tax Reform Act of 1976 (the "Act") (Pub. L. 94-455; 90 Stat. 1916 (1976-3 C.B. (Vol. 1) 392]) to provide rules for electing to amortize certain rehabilitation expenditures for certified historic structures. The temporary regulations provided by this document will remain in effect until superseded by final regulations on this subject.

PROVISIONS OF THE

REGULATIONS Under section 191, every person may elect to amortize expenditures incurred in a certified rehabilitation of a certified historic structure over a 60-month period. By reason of section 2124(a) (4) of the Act, this election applies only to additions to capital account made after June 14, 1976, and before June 15, 1981.

The temporary regulations provide the mechanism for electing to amortize the qualified rehabilitation expenses. To elect, the taxpayer attaches a statement to its return for the taxable year in which falls the first month of the amortization period chosen pursuant to section 191(a).

The election may be made after a request has been made for, but prior to, certification of the project by the Department of the Interior. In such a case, proof of certification is to be submitted with the first income tax return filed by the taxpayer after receipt of such certification. If a certification is not submitted within 30 months of the commencement of the amortization period, the taxpayer may be asked to agree to an extension of time for assessment of additional tax for the period in which deductions are claimed.

Once made, the election may be discontinued by filing written notice with the Internal Revenue Service

prior to the month in which amortiza- 60-month amortization period will be tion is to cease.

established for the amortizable basis

acquired by the taxpayer in any DRAFTING INFORMATION

month for which such an election is The principal author of this regu made. The statement claiming the lation was H. B. Hartley of the Legis- deduction shall include the following lation and Regulations Division of the information: Office of Chief Counsel, Internal (i) A description clearly identifyRevenue Service. However, personnel ing each certified rehabilitation of a from other offices of the Internal certified historic structure for which Revenue Service and Treasury De- an amortization deduction is claimed; partment participated in developing

(ii) The date on which the amorthe regulation, both on matters of

tizable basis, as defined in section substance and style.

191 (d) (2), was acquired; Adoption of amendments

(iii) The date the amortization to the regulations

period is to begin; Accordingly, the temporary Income

ly, the temporary Income (iv) the total amount of amorTax Regulations under the Tax Re

tizable basis claimed for the rehabiliform Act of 1976 are amended as set

tation of the historic structure, as of forth below:

the first month for which the amorParagraph 1. Paragraph (a) of tization deduction provided for by § 7.0 is amended by striking out the section 191(a) is elected; item relating to section 191 (b) of

(v) Either (A) a statement that the Code.

the historic structure and rehabilitaPar. 2. The following new section tion have been certified by the Secreis added at the appropriate place: tary of the Interior as provided for $ 7.191-1 Election to amortize cer

in sections 191(d) (1) and 191 (d) (3) tain rehabilitation expenditures

along with the dates of such certificafor certified historic structures.

tions; or (B), if the historic structure

and rehabilitation have not been cer(a) Time and manner of election

tified by the Secretary of the Interior, of amortization—(1) In general. Un

a statement that requests for cerder section 191(b), an election by the

tification have been made in accordtaxpayer to claim an amortization de

ance with procedures established by duction with respect to a certified historic structure shall be made by a

such Secretary with the dates of such statement to that effect attached to

requests.

" its return for the taxable year in which If subdivision (v) (B) of this subfalls the first month of the 60-month paragraph applies, the taxpayer shall amortization period selected. The 60- submit a statement showing receipt of month amortization period shall be the certifications required by section gin either with the month following 191 and their dates with its first inthe month in which the amortizable come tax return filed after the receipt basis, as defined by section 191(d) by the taxpayer of such certifications. (2), is acquired, or with the first (2) Failure to submit required cermonth of the taxable year succeeding tifications. If the required certificathe taxable year in which such amor- tions are not received within 30 tizable basis is acquired, whichever months of the date of the commencetizable basis is acquired, whichever months of the date of the the taxpayer selects. If a taxpayer ment of the 60-month amortization elects to begin the 60-month amor- period, the electing taxpayer may be tization period with the month fol. requested to consent to an agreement lowing the month in which the amor- under section 6501(c)(4) extending tizable basis is acquired, a separate the period of assessment for any tax relating to the time in which amortization deductions are claimed.

(3) Failure to elect as provided by this section. No method of making the election provided for in section 191(a) other than that prescribed in this section shall be permitted. A taxpayer who does not elect in the manner prescribed in this section to take amortization deductions with respect to the rehabilitation of a certified historic structure shall not be entitled to such deductions.

(b) Election to discontinue amor. tization. An election to discontinue the amortization deduction provided by section 191(c) shall be made by a statement filed with the district director, or with the director of the internal revenue service center, with whom the return of the taxpayer is required to be filed for its taxable year in which falls the first month for which the election terminates. This statment shall specify the month as of the beginning of which the taxpayer elects to discontinue the amortization deductions, and it must be filed before the beginning of that month. In addition, the statement shall contain a description clearly identifying the certified historic structure and rehabilitation with respect to which the taxpayer elects to discontinue the amortization deduction. If certifications of the structure or rehabilitation have been issued. their dates shall be shown. If, at the time of the election to discontinue amortization deductions, certifications have not been issued. the taxpayer shall file the dates with its next succeeding tax return after their receipt. For purposes of this paragraph, notifica tion to the Secretary or his delegate from the Secretary of the Interior that the historic structure or the rehabilitation no longer meet the requirements for certification shall have the same effect as notice from the taxpayer electing to terminate amortization as of the first day of the month following the month that the struc

ture or rehabilitation ceased to meeting is to update and restate, under the the requirements of section 191. current statute and regulations, the

There is a need for immediate positions set forth in I.T. 4006, 1950-1 guidance with respect to the provi- C.B. 48. sions in this Treasury decision. For The questions presented concern the this reason it is found impracticable treatment for Federal income tax purto issue it with notice and public pro- poses of geological and geophysical cedure thereon under subsection (b) exploration expenditures for the purof section 553 of Title 5 of the United pose of obtaining and accumulating States Code or subject to the effec- data that will serve as a basis for the tive date limitation of subsection (d) acquisition or retention of property of that section.

by a taxpayer who is engaged in ex(This Treasury decision is issued ploring for minerals under the circumunder the authority contained in sec- stances described below. tions 191(b) and 7805 of the In

It is customary in the search for ternal Revenue Code of 1954 (90

mineral producing properties for a taxStat. 1916, 68A Stat. 917; 26 U.S.C.

payer to conduct an exploration pro191(b), 7805).)

gram in one or more identifiable projWILLIAM E. WILLIAMS, ect areas. Each project area encom

Acting Commissioner passes a territory that the taxpayer

of Internal Revenue determines can be explored advanApproved March 25, 1977.

tageously in a single integrated opera

tion. This determination is made after LAURENCE N. WOODWORTH,

analyzing certain variables such as the Assistant Secretary

size and topography of the project of the Treasury.

area to be explored, the existing in(Filed by the Office of the Federal Register formation available with respect to the on April 5, 1977; 8:45 a.m., and pub.

project area and nearby areas, and lished in the issue of the Federal Register for April 6, 1977, 42 F.R. 18275)

the quantity of equipment, the number

of men, and the amount of money Part IX.-Items Not Deductible

available to conduct a reasonable ex

ploration program over the project Section 263.—Capital

area. Expenditures

The taxpayer selects a specific 26 CFR 1.263(a)-1: Capital expenditures;

project area from which geological in general.

and geophysical data are desired and (Also Sections 165, 614, 615, 617; 1.165-1, conducts a reconnaissance-type survey 1.614-1, 1.615-1, 1.617-1.)

utilizing various geological and geoGeological and geophysical ex physical exploration techniques that ploration expenditures. The tax are designed to yield data that will treatment of geological and geo- afford a basis for identifying specific physical exploration expenditures, geological features with sufficient minfor the purpose of obtaining data eral producing potential to merit furthat will serve as a basis for the ac- ther exploration. quisition or retention of a mineral Each senarabl property by a taxpayer engaged intion of the original project area in exploring for minerals is discussed; which such a specific geological fea1.T. 4006 superseded.

ture is identified is a separate “area Rev. Rul. 77-188'

of interest." The original project area

is subdivided into as many small projThe purpose of this Revenue Rul- ects as there are areas of interest 1 Prepared pursuant to Rev. Proc. 67-6, 1967-1 C.B. located and identihed within the 576.

original project area. When the cir

po ceneral.2004615.617; 1.165-1,

area of ihentification of the urred prior

jest to certain til mare deductible, other

cumstances permit a detailed explora. tory survey to be conducted without an initial reconnaissance-type survey, the project area and the area of interest will be coextensive.

The taxpayer seeks to further define the geological features identified by the prior reconnaissance-type surveys by additional, more detailed, exploratory surveys conducted with respect to each area of interest. For this purpose, the taxpayer engages in more intensive geological and geophysical exploration employing methods that are designed to yield sufficiently accurate sub-surface data to afford a basis for a decision to acquire or retain properties within or adjacent to a particular area of interest or to abandon the entire area of interest as unworthy of development by mine or well.

Geological and geophysical exploration expenditures are incurred by the taxpayer for the purpose of obtaining and accumulating data that will serve as a basis for the acquisition or retention of properties. Such exploration expenditures are capital in nature and are not deductible as ordinary and necessary business expenses. See Louisiana Land and Exploration Co., 7 T.C. 507 (1946), af'd on other issues, 161 F.2d 842 (5th Cir. 1947); Schermerhorn Oil Corporation, 46 B.T.A. 151 (1942); G. E. Cotton, 25 B.T.A. 866 (1932); C. M. Nusbaum, 10 B.T.A. 664 (1928); and Seletha 0. Thompson, 9 B.T.A. 1342 (1928).

Accordingly, the expenditures attributable to such exploration are al locable to the cost of the property acquired or retained. The term “property" is used in this connection in the sense of an interest in a property as defined in section 614 of the Internal Revenue Code of 1954 and the regulations thereunder, and includes an economic interest in a tract or parcel of land notwithstanding that a mineral deposit has not been established or proven.

However, exploration expenditures, including geological and geophysical

exploration expenditures, paid or in- area of interest, the entire geological curred prior to January 1, 1970, for and geophysical exploration expendithe purpose of ascertaining the exist- tures, including those incurred prior ence, location, extent, or quality of to the identification of the particular any deposit of ore or mineral (other area of interest but allocated thereto, than oil or gas) are deductible, sub- are to be allocated to that property as ject to certain limitations, at the elec- a capital cost under section 263(a) tion of the taxpayer under section 615 of the Code or deducted in approprior section 617 of the Code if such ate cases, at the election of the taxexpenditures result in the acquisition payer, under the provisions of section or retention of mineral properties. 615 or section 617. Where more than Limited amounts of exploration ex- one property is acquired or retained penditures may be deferred at the elec- within or adjacent to an area of intion of the taxpayer under section 615 terest, it is proper to determine the and deducted ratably as the mineral amount of the geological and geobenefited is sold. Any or all such ex- physical exploration costs allocable to ploration expenditures paid or in- each such property by allocating the curred after December 31, 1969, are entire expenditure for the geological deductible at the election of the tax- and geophysical operations among the payer only under section 617 and are properties so acquired or retained on subject to the recapture provisions of the basis of the comparative acreage that section if production is obtained. of the properties.

If, on the basis of data obtained However, if no property is acquired from the preliminary geological and or retained within or adjacent to that geophysical exploration operations, area of interest, the entire geological only one area of interest is located and geophysical exploration expendiand identified within the original proj ture allocable to the area of interest is ect area, the entire expenditure for

deductible as a loss under section 165 those exploratory operations is to be of the Code for the taxable year in allocated to that one area of interest. which such area of interest is abanIf two or more areas of interest are doned as a potential source of mineral located and identified within the origi

production. nal project area, the entire expendi

I.T. 4006 is superseded since the ture for the exploratory operations is

positions set forth therein are upto be allocated equally among the

dated and restated under current law various areas of interest.

in this Revenue Ruling. However, if from data obtained by the exploratory operations no areas of interest are located and identified 26 CFR 1.263(a)-1: Capital expenditures; by the taxpayer within the original in general. project area, the entire expenditure Whether certain expenses incurred by a for the geological and geophysical ex trustee in bankruptcy are capital expendiploration on the project area is de

tures. See Rev. Rul. 77-204, page 40.

tur ductible as a loss under section 165 of the Code for the taxable year in 26 CFR 1.263(c)-1: Intangible drilling which that particular project area is

and development costs in the case of oil

and gas wells. abandoned as a potential source of (Alsö Sections 61, 451, 612, 614, 1001, mineral production.

7805; 1.61-2, 1.451-1, 1.612-4, 1.614-1, Furthermore, if, on the basis of data

1.1001-1, 301.7805-1.) obtained from a detailed survey that Operating interest in oil and gas does not relate exclusively to any par property received for drilling well. ticular property within a particular The proper treatment is shown for area of interest, a property is acquired an arrangement under which, in or retained within or adjacent to that consideration for drilling an oil and gas well at a designated location the tract exclusive of the drill site. The gross income when actually or conon a leased tract of land, the driller agreement provided further that after structively received. receives from the lessee of the recovery by X of all costs of drilling, In the case of the compensatory reland an assignment of the entire equipping, and operating the well outceipt of property other than cash, the working interest in the drill site of the proceeds from the working in fair market value of such property, deand an undivided fraction of the terest share of all oil, gas, and other

erest share of all oil, gas, and other termined as of the date of transfer or st in the remainder hydrocarbons, produced, saved, and receipt, actual or constructive, is inof the tract.

sold from the drill site, Y will have the cludible in the gross income of the

right to convert the overriding royalty Rev. Rul. 77-1761

taxpayer in the taxable year such interest to an undivided one-half of

property is actually or constructively Advice has been requested regard the working interest in the drill site.

received. Sisson v. United States, 487 ing the Federal income tax conse- X successfully drilled and completed F.2d 1393 (2d Cir. 1974): Deshotels quences of the transaction described the well as a commercial producer of v. United States, 450 F.2d 961 (5th below.

oil and gas. In accordance with the Cir. 1971), cert. denied, 406 U.S. 920 Corporation X uses the cash receipts

agreement, Y thereupon promptly as-
agreement, thereupon prom

(1972); Thomas W. Blake, Jr., 20 and disbursements method of account- signed to

signed to X the entire working inter-
the entire working inter-

T.C. 721 (1953), acg., 1954-2 C.B. 3. ing and files its Federal income tax est in the drill site, subject to the reser When property other than cash is returns on the calendar year basis. X vation by Y of an overriding royalty

transferred as compensation for servhas properly exercised the option prointerest of an undivided 1/16 of all

ices that are not readily subject to invided by section 1.612-4 of the Income oil, gas, and other hydrocarbons pro

dependent valuation or in satisfaction Tax Regulations, implementing secduced, saved, and sold from such drill

of an unliquidated claim, the courts tion 263 (c) of the Internal Revenue site, and an undivided one-half of the

have held that the transfer is treated Code of 1954, to treat drilling and de- working interest in the balance of the

as the sale for the equivalent of the velopment costs as expenses. tract of land.

fair market value on the date of transX entered into a written agreement

Section 61(a) of the Code provides, fer of the property with the transferor with corporation Y, the owner of an in part, that gross income means all realizing gain if the transferor's basis oil and gas lease on a single undevel

income from whatever source derived, in the property is less than the fai oped 16x acre tract of land. Pursuant including, insofar as is pertinent here, market value and loss if such basis is to the terms of the agreement, X as compensation for services.

greater. United States v. Davis, 370 sumed the obligation for the drilling Section 1001(a) of the Code pro- U.S. 65 (1962), 1962-2 C.B. 15; Inof a well to a specified depth at a des- vides, in part, that the gain from the ternational Freighting Corp. v. Comignated location on the leased acreage, sale or other disposition of property is missioner, 135 F.2d 310 (2d Cir. for the completing and equipping of the excess of the amount realized 1943); Kenan v. Commissioner, 114 the well if commercially productive, or therefrom over the adjusted basis for F.2d 217 (2d Cir. 1940). for the plugging and abandoning

determining gain, and the loss is the
determining gain, and the loss is the

G.C.M. 22730, 1941-1 C.B. 214, thereof if dry. In consideration of the excess of the adjusted basis over the

provides, in part, that when drillers or undertaking by X, the agreement pro- amount realized.

equipment suppliers and investors convided that upon the abandonment or Section 1001(b) of the Code defines tribute materials and services in concompletion of the well pursuant to the the amount realized from the sale or nection with the development of a agreed terms, Y would assign to X the other disposition of property as the mineral property in exchange for an following: (1) the entire working or sum of money received plus the fair economic interest in such property, the operating interest in the 3x-acre drill market value of the property (other receipt of the economic interest does site (the spacing unit assigned to the than money) received.

not result in realization of income. The well by the state regulatory body), sub Section 1.61-2(d)(1) of the regula contributors are viewed as not perject, however, to the reservation by Y tions provides, in part, that if services forming services for compensation, but of an overriding royalty interest of an are paid for other than in money, the as acquiring capital interests through undivided 1/16 of all oil, gas, and fair market value of the property or an undertaking to make a contribution other hydrocarbons produced, saved, services taken in payment is includible to the pool of capital. To come within and sold from such drill site; and (2) in income.

the holding of G.C.M. 22730, the ecoan undivided one-half of the working

Section 1.451-1 (a) of the regula- nomic interest acquired must be in the or operating interests in the portion of

tions provides that under the cash re- same property to the development of ceipts and disbursements method of which the materials and services are accounting income is includible in contributed. With respect to the trans

half of oil and ,

intars that

feror of the economic interest, G.C.M. Rev. Rul. 69-332, 1969-1 C.B. 87, tract exclusive of the drill site was a 22730 states that such transferor has deals with a situation in which a tax- second property. Likewise, Y retained parted with no capital interest but has payer, in consideration of drilling a two separate properties in the tract or merely given the transferee (driller, test well on a specified lease, received parcel of land. The overriding royalty equipment supplier, or investor) a an undivided 5/8 interest in the lease, interest reserved in the drill site was right to share in production in consid- and was to receive a sum of money one property, and the undivided oneeration of an investment made. equal to its total costs from all of the half of the working interest retained

Section 263(c) of the Code, as a proceeds of all production from the by Y in the balance of the tract excluspecific exception to the basis provi. well for the complete payout period. sive of the drill site was a second propsion of section 263(a), directs the Sec- Rev. Rul. 69-332 holds that, because erty. retary of the Treasury or the Secre- the taxpayer was the owner of the en- Having received the entire working tary's delegate to prescribe regulations tire working or operating interest in interest in the drill site for the period corresponding to the regulations that the well under the agreement that of complete payout, X is regarded ungranted the option to deduct as ex- provided for complete recoupment of der the holdings of Rev. Rul. 69-332 penses intangible drilling and develop- all costs, the taxpayer was entitled to and Rev. Rul. 71-207 as having rement costs in the case of oil and gas deduct 100 percent of the intangible ceived the grant wells and that were recognized and drilling and development costs in

or operating interest in the drill site, approved by Congress in House Con- curred in the drilling of the well.

the separate oil and gas property on current Resolution 50, Seventy-ninth Rev. Rul. 71-207, 1971-1 C.B. 160, which the well was drilled. Congress.

deals with a situation in which the as- Inasmuch as X received all of the Section 1.612-4(a) of the regula

signee, in consideration of the receipt
signee, in consideration of the recei

operating rights in the drill site, X is tions provides, in part, as follows:

of an undivided one-half operating in- entitled, under section 1.612-4(a) of In accordance with the provisions of sec terest in an undeveloped oil and gas the regulations, to deduct all of the tion 263 (c), intangible drilling and devel- lease, agreed to drill, complete, equip, intangible drilling and development opment costs incurred by an operator (one who holds a working or operating interest

and operate a well on the lease. The costs that were actually paid or inin any tract or parcel of land either as a assignee would completely recoup all cured in the drilling and completion fee owner or under a lease or any other costs of drilling, completing, equipping of the well, regardless of the fact that form of contract granting working or oper. ating rights) in the development of oil and

and operating the well before the as- in consideration of such drilling X gas properties may at his option be charge signor and the assignee became co- also received property in addition to able to capital or to expense * * *. In

owners of the lease, sharing equally in the working interest in the drill site. cluded in this option are all costs of drilling and development undertaken (directly or

the costs and income from the well. Neither X nor Y realized income as through a contract) by an operator of an Since the assignee owned the entire a result of the transfer of the entire oil and gas property whether incurred by

operating interest in the oil and gas him prior or subsequent to the formal grant

working interest in the drill site from or assignment to him of operating rights lease during the period of complete

Y to X. This working interest is in the

y to (a leasehold interest, or other form of op payout, the assignee was entitled to erating rights, or a working interest); ex

same property to which X made its deduct as expense all the intangible cept that in any case where any drilling or

contribution in the form of drilling. development project is undertaken for the drilling and development costs of drill

The receipt by X of the working intergrant or assignment of a fraction of the ing the well. operating rights, only that part of the costs

est in the drill site does not represent thereof which is attributable to such frac Before the assignment of the work payment in the property for services tional interest is within this option. In the excepted cases, costs of the project under ing interests to X in the instant case, rendered or supplies furnished, but is, taken, including depreciable equipment the oil and gas lease was, within the instead, a capital interest acquired furnished, to the extent allocable to frac- meaning of section 614(a) of the Code

through the undertaking of X to make

through the unuti tions of the operating rights held by others, must be capitalized as the depletable capi and section 1.614-1(a) of the regula

nd section 1.614-1(a) of the regula a contribution to the pool of capital. cost of the fractional interest thus tions, one property in the hands of Y.. Y does not realize income upon the acquired. Upon assignment, X received two sep

transfer of the working interest in the Section 1.614-1(a) (1) of the regu- arate economic interests in the tract or drill site to X, because Y is not relations provides, in part, that for pur- parcel of land, each such interest being garded as having parted with a capital poses of subtitle A of the Code, in the a separate section 614 property. The case of mines, wells, and other natural entire working interest in the drill site quired investment and the risks and deposits, the term “property" means to which X made a contribution in burdens attending development of the each separate interest owned by the the form of drilling was one property, drill site. taxpayer in each mineral deposit in and the undivided one-half of the Because the acreage exclusive of the each separate tract or parcel of land. working interest in the portion of the drill site is a property separate from