Ltr. Rul. 8134134 (May 29, 1981)

Code Secs. 1033, 1031

   This is in response to the letter of November 24, 1980, submitted by
your authorized representative, in which a request for a determination
letter is made as to the application of section 1033 of the Internal
Revenue Code of 1954 to the situation set out below. The District Director
has waived jurisdiction and forwarded your request for our consideration.

   In 1979, Taxpayer was the owner of 2,456 acres of unimproved real
property located in County J, State K, held as an investment. Pursuant to
a threat of condemnation by the United States Fish and Wildlife Service,
Taxpayer sold the land at a profit. An election was made to defer the gain
from the sale of land on Taxpayer's Federal income tax return for calendar
year 1979. Taxpayer has and will continue in the future to acquire, as
Lessee, leases of oil and gas properties. By the terms of the lease
agreement, Taxpayer is acquiring an interest in oil and gas in place. It
is Taxpayer's intention to invest the entire sales proceeds of the land in
Mineral Leases within the time period prescribed by section 1033 of the
Code.

   You have requested a determination that the acquisition by Taxpayer, as
Lesee, of an interest in minerals in place, constitutes property which is
similar or related in service or use to the unimproved real property sold.

   Section 1033(a)(2)(A) of the Code provides, in pertinent part, that if
property (as the result of condemnation) is compulsorily or involuntarily
converted into money, the gain (if any) shall be recognized except if the
taxpayer during the period specified in subparagraph (B), for the purpose
of replacing the property so converted, purchases other property similar
or related in service or use to the property so converted, at the election
of the taxpayer the gain shall be recognized only to the extent that the
amount realized upon such conversion (regardless of whether such amount is
received in one or more taxable years) exceeds the cost of such other
property. Such elections shall be made at such time and in such manner as
the Secretary may be regulations prescribe.

   Section 1033(a)(2)(B) of the Code provides that the period referred to
in subparagraph (A) shall be the period beginning with the date of the
disposition of the converted property, or the earliest date of the threat
or imminence of requisition or condemnation of the converted property,
whichever is the earlier, and ending ----

   (I) 2 years after the close of the first taxable year in which any part
of the gain upon the conversion is realized.

   Section 1033(g)(1) of the Code provides, in pertinent part, that for
the purposes of subsection (a), if real property (not including stock in
trade or other property held primarily for sale) held for productive use
in trade or business or for investment is (as the result of condemnation)
compolsarily or involuntarily converted, property of a like kind to be
held either for productive use in trade or business or for investment
shall be treated as property similar or related in service or use to the
property so converted. Section 1033(g)(4) provides that in the case of a
compulsory or involuntary conversion described in paragraph (1),
subsection (a)(2)(B) shall be applied by substituting "3 years" for "2
years".

   Section 1.1033(a)-1(a) of Income Tax Regulations provides, in pertinent
part, that section 1033 applies to cases where property is compulsorily or
involuntarily converted. An "involuntary conversion" may be the result of
the condemnation of property. An "involuntary conversion" may be a
conversion into similar property or into money or into dissimilar
property. Section 1033 provides that, under certain specified
circumstances, any gain which is realized from an involuntary conversion
shall not be recognized. In cases where property is converted into other
property similar or related in service or use to the converted property,
no gain shall be recognized regardless of when the disposition of the
converted property occurred and regardless of whether or not the taxpayer
elects to have the gain not recognized. In other types of involuntary
conversion cases, however, the proceeds arising from the disposition of
the converted property must (within the time limits specified) by
reinvested in similar property in order to avoid recognition of any gain
realized. Section 1033 applies only with respect to gains; losses from
involuntary conversions are recognized or not recognized without regard to
this section.  Section 1.1033(a)-1(b) of the regulations provides, in
pertinent part, that for special rules relating to certain involuntary
conversions of real property held either for productive use in trade or
business or for investment and occurring after December 31, 1957, see
section 1.1033(f)-1.

   Section 1.1033(f)-1(a) provides that this section provides special
rules for applying section 1033 with respect to certain dispositions,
occurring after December 31, 1957, of real property held either for
productive use in trade or business or for investment (not including stock
in trade or other property held primarily for sale.) For this purpose,
disposition means the seizure, requisition, or condemnation (but not
destruction) of the converted property, or the sale or exchange of such
property under threat or imminence of seizure, requisition, or
condemnation. In such cases, for purposes of applying section 1033, the
replacement of such property with property of like kind to be held either
for productive use in trade or business or for investment shall be treated
as property similar or related in service or use to the property so
converted. For principles in determining whether the replacement property
is property of like kind, see paragraph (b) of section 1.1031(a)-1.

   Section 1.1031(a)-1(a) of the regulations provides, in pertinent part,
that under section 1031(a) no gain or loss is recognized if property held
for productive use in trade or business or for investment is exchanged
solely for property of a like kind to be held either for productive use in
trade or business or for investment. Under section 1031(a), property held
for productive use in trade or business may be exchanged for property held
for investment. Similarly, property held for investment may be exchanged
for property held for productive use in trade or business.

   Section 1.1031(a)-1(b) of of regulations provides that as used in
section 1031(a), the words "like kind" have reference to the nature or
character of the property and not to its grade or quality. One kind or
class of property may not, under that section, be exchanged for property
of a different kind or class. The fact that any real estate involved is
improved or unimproved is not material, for that fact relates only to the
grade or quality of the property and not to its kind or class.
Unproductive real estate held by one other than a dealer for future use or
future realization of the increment in value is held for investment and
not primarily for sale.

   Under section 1033(a) of the Internal Revenue Code if property is sold
under threat of condemnation after December 31, 1950 and the vendor
receives money, he may defer the recognition of gain to the extent he
reinvests the amount realized in property which is similar or related in
service or use to the property converted, within the time limitation
provided for in section 1033(a)(3)(B).

   Under the facts of this request, the sale under threat of condemnation
occurred in 1979 and the vendor received the money. It is represented that
the money will be reinvested within the time required in section 1033 of
the Code. Therefore, the only issue which must be resolved regarding
compliance with section 1033 is whether the funds were invested in
property similar or related in service or use.

   Under section 1033(g):

   (1) For purposes of subsection (a), if real property (not including
stock in trade or other property held primarily for sale) held for
productive use in trade or business or for investment is (as the result of
its seizure, requisition or condemnation or threat or imminence thereof)
compulsorily or involuntarily converted, property of a like kind to be
held either for productive use in trade or business or for investment
shall be treated as property similar or related in service or use to the
property so converted.

  Section 1.1033(g)-1(a) of the regulations refers to section 1.1031(a)-1
of the regulations in determining whether replacement property is property
of "like kind." Section 1.1031(a)-1(b) of the regulations defines "like
kind" to have reference to the

   * * * nature or character of the property and not to its grade or
quality. One kind or class of property not not, * * * be exchanged for
property of a different kind or class. The fact that any real estate
involved is improved or unimproved is not material, for that fact relates
only to the grade or quality of the property and not to its kind or class.
Unproductive real estate held by one other than a dealer for future use or
future realization of the increment in value is held for investment and
not primarily for sale.

   The taxpayer represents that he held real estate for investment
purposes at the time the involuntary conversion took place.

   An overriding royalty arises when a lessee of oil lands subleases the
working interest and retains a royalty. This has been considered an
interest in realty for Federal income tax purposes. Palmer v. Bender, 287
U.S. 551 (1932): I.T. 3693, C.B. 1944, 272, superseded by Rev. Rul. 68-
226, 1968-1 C.B. 362; Rev. Rul. 55-526, 1955-2 C.B. 574. It has also been
considered a continuing interest. Midfield Oil Co., 39 B.T.A. 1154 (1939);
Kay Kimbell, 41 B.T.A. 940 (1940); Bandini Petroleum Co., T.C. Memo 1951-
310.

   In Kate J. Crichton, 42 B.T.A. 490 (1940), Acq. 1952-1 C.B. 2, aff'd
122 F.2d 181 (5th Cir. 1941), the taxpayer owned a one-half interest and
each of her three children owned a one-sixth interest in certain improved
lands. The taxpayer also owned a one-half interest in a second parcel of
land. The taxpayer transferred an undivided three-twelfth interest in the
"oil gas and other minerals in on and under and that which may be produced
from" the second parcel to her three children in exchange for their
undivided three-sixth interest in the improved property. The taxpayer
contended that this was an exchange of property which was of "like kind"
and that she could defer recognition of gain under section 112 of the
Internal Revenue Code of 1939 (new section 1031). The court held that the
interests exchanged were continuing interests in realty and that the
interests were of the same class and thus were "like kind" property. The
Service has adopted the same position. Rev. Rul. 72-117, 1972-1 C.B. 226.

   Therefore, since under the facts the fee title to land (which is
clearly a continuing interest in real property) was replaced by an
overriding interest in oil and gas (which is both a continuing and
economic interest in real property), their is a replacement with "like
kind" property under section 1033(g) of the Code.

   Based on the information submitted and the representations made, it is
held that the acquisition by Taxpayer, as Lesee, of an interest in
minerals in place, constitutes property which is similar or related in
service or use to the unimproved real property sold.

   No opinion is expressed as to the tax treatment of the transaction
under the provisions of any other section of the Code and regulations
which may be applicable thereto or the effects resulting from the
transaction which are not specifically covered by the above ruling. Nor is
any opinion being expressed as to the amount of gain that qualifies for
non-recognition.

   A copy of this letter should be attached to the Federal income tax
return for the taxable year in which the transaction covered by this
ruling letter is consummated.

   Pursuant to a power of attorney on file with this office, a copy of
this letter has been sent to your designated representative.

   This ruling is directed only to the taxpayer who requested it. Section
6110(j)(3) of the Internal Revenue Code provides that it may not be used
or cited as precedent. Sincerely yours, John L. Crawford Chief,
Corporation Tax Branch