OCTOBER TERM, 1992
Syllabus
UNITED STATES
v. HILL ET ux.
CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE FEDERAL
CIRCUIT
No. 91-1421. Argued November 2, 1992-Decided January 25,
1993
Under § 57(a)(8) of the Internal Revenue Code of 1954, 26 U. S.
C. § 57(a)(8) (1976 ed.), "the excess of the deduction for
depletion ... over the adjusted basis of" "property (as defined in
[§ ]614)" is an "ite[m] of tax preference" on which a taxpayer must
pay a "minimum tax" for the tax year in question. See § 56(a). In
computing the minimum taxes due on their interests in oil and gas
deposits for tax years 1981 and 1982, respondents Hill calculated
their depletion allowances according to the "percentage depletion"
method, and included in the interests' adjusted bases the
unrecovered costs of certain depreciable tangible items used in
drilling and development (machinery, tools, pipes, etc.), as
identified in § 1.612-4(c)(1) of the applicable Treasury Department
regulations. The Commissioner of Internal Revenue disputed that
inclusion, and assessed larger minimum taxes based on the exclusion
of the tangible costs from the mineral interests' adjusted bases.
The Hills paid the resulting deficiencies and filed a refund claim,
which the Commissioner denied. The Claims Court granted summary
judgment for the Hills in their ensuing refund suit, and the Court
of Appeals affirmed.
Held: The term "adjusted basis," as used in § 57(a)(8),
does not include the depreciable drilling and development costs
identified in Treas. Reg. § 1.612-4(c)(1). Pp. 553-564.
(a) The definitional scheme established by the Code and
accompanying regulations suggests strongly that the "property" with
which § 57(a)(8) is concerned excludes just those improvements that
the Hills wish to include in adjusted basis. Section 614(a) defines
"property" for § 57(a)(8)'s purposes as "each separate interest
owned by the taxpayer in each mineral deposit." Treasury Reg. §
1.611-1(d)(4) defines "mineral deposit" as "minerals in place,"
while Treas. Reg. § 1.611-1(d)(3) defines "mineral enterprise" to
include "the mineral deposit or deposits
and improvements, if
any, used in ... the production of oil and gas." (Emphasis
added.) Because these regulatory definitions were well established
when Congress passed § 57(a)(8), it is reasonable to assume that
Congress relied on the accepted distinction between them in its
reference to "mineral deposit" in § 614. This conclusion is
confirmed by Treas. Reg. § 1.57-1(h)(3)'s incorporation into §
57(a)(8) of § 1016 of the Code, 26 U. S. C. § 1016 (1976 ed. and
Supp. V), which provides the rules
547
for making "[a]djustments to basis" in determining the amount of
gain or loss a taxpayer must recognize when he sells or otherwise
disposes of property. To follow § 1016(a)(2)'s directive that the
taxpayer subtract from his original basis in the property "not less
than the amount allowable" for exhaustion, wear and tear,
obsolescence, amortization, and depletion, a taxpayer must
determine whether parts of the item sold are subject to different
tax treatments, and must treat those parts as different properties
under the section. Depletion and depreciation are two of the major
categories of tax treatment, and a review of pertinent Code and
regulation provisions reveals that the boundaries between the two
are virtually impassable. Thus, if a depletable mineral deposit and
depreciable associated equipment are sold together, § 1016 requires
the seller to separate them. In light of the incorporation of this
rule into § 57(a)(8), and the Hills' failure to identify any
exception to the rule, it may be inferred that their tangible costs
may not be included in the basis of their depletable mineral
deposits. Pp. 553-560.
(b) This conclusion is confirmed by the astonishing results of
reading § 57(a)(8) in the manner urged by the Hills, whereby the
tangible costs at issue here would shelter, over the years a
taxpayer owned the capital item they represented, an amount of
percentage depletion many times that of the costs themselves. It is
hard to believe that Congress would enact a minimum tax to limit
the benefit that taxpayers could realize from "items of tax
preference," only to define one of those items in a way that would
create an even greater proportional tax benefit from investing in
tangible items, and to do so in an oblique fashion that, as far as
appears, has no precedent in federal income tax history. Pp.
560-561.
(c) Contrary to the Hills' contention, two other Treasury
Department regulations do not foreclose the foregoing conclusion.
First, Treas. Reg. § 1.612-1(b)(1)'s reference, in its title, to a
"[s]pecial rul[e]" excluding amounts recoverable through
depreciation deductions from the basis for "cost" depletion of
mineral property cannot have been intended to indicate that such
amounts should, as a general rule, be included in the calculation
of basis for percentage depletion, since that would allow the title
of one subsection of a regulation to defeat the entire Code
framework for determining basis, and since § 1.612-1(b)(1) was
issued long before the minimum tax was enacted. Second, excluding
tangible costs from the adjusted basis of mineral deposit interests
would not run counter to Treas. Reg. § 1.612-4(b)(1), which
specifies that certain intangible drilling and development costs
are recoverable through depletion, as adjustments to the bases of
the mineral deposit interests to which they relate. There is no
reason why this regulation's deviation from general
548
principles of basis allocation, if such it be, should force the
Government, or this Court, to create another deviation. Pp.
561-564.
945 F.2d
1529, reversed.
SOUTER, J., delivered the opinion for a unanimous Court.
Kent L. Jones argued the cause for the United States.
With him on the briefs were Solicitor General Starr, Acting
Assistant Attorney General Bruton, Deputy Solicitor General
Wallace, Ann Belanger Durney, and Charles Bricken.
Richard B. Robinson argued the cause for respondents.
With him on the brief was
Robert A. Wherry, Jr. *
JUSTICE SOUTER delivered the opinion of the Court. Under §§ 56
and 57(a)(8) of the Internal Revenue Code of 1954, 26 U. S. C. §§
56, 57(a)(8) (1976 ed.), a taxpayer must pay a "minimum tax" on the
excess of the allowable depletion deduction for an interest in a
mineral deposit over the taxpayer's adjusted basis for that
interest. The question presented here is whether the term "adjusted
basis," as used in § 57(a)(8), includes certain depreciable
drilling and development costs identified in § 1.612-4(c)(1) of the
Treasury Department regulations. We hold that the term does not
cover such costs.
I
In 1981 and 1982, respondents William F. and Lola E. Hill were
in the oil and gas exploration and production business, and, on
their federal income tax returns for those respective years, they
deducted $439,884 and $371,636 for depletion with respect to their
interests in oil and gas deposits. Under 26 U. S. C. § 57(a)(8)
(1976 ed.), the excess of the allowable depletion deduction for
each of the deposit interests over the interest's "adjusted basis"
is an "ite[m] of tax prefer-
*Timothy B. Dyk filed a brief for the National Coal
Association et al. as
amicus curiae urging affirmance.
549
ence" on which a taxpayer must pay a "minimum tax" for the tax
year in question.1 See § 56(a). In determining the adjusted bases
of their deposit interests, the Hills included not only the
unrecovered portions of the amounts they originally paid to
purchase the interests, but also the unrecovered costs of
depreciable tangible items (machinery, tools, pipes, and so forth)
used to exploit the deposits. Having thus reduced the amount of
each item of tax preference under § 57(a)(8), they calculated and
paid minimum taxes on those items of $29,812 for 1981 and $26,736
for 1982.
The Commissioner of Internal Revenue disputed the inclusion of
the tangible costs in the deposits' adjusted bases, and assessed a
larger minimum tax based on their exclusion. The Hills paid the
resulting respective deficiencies of $30,963 and $18,733, and filed
a refund claim, which the Commissioner denied. The taxpayers then
sued the United States, petitioner here, for a refund in the Claims
Court, which granted summary judgment in their favor. 21 Cl. Ct.
713 (1990). The Court of Appeals for the Federal Circuit affirmed.
945 F.2d
1529 (1991). Because of the importance of the issue to the
federal fisc, we granted certiorari. 503 U. S. 1004 (1992). We now
reverse.
1 All references to the Internal Revenue Code and related
Treasury Regulations are to those that applied during the tax years
at issue. The Treasury Regulations are cited as codified in the
1981 and 1982 editions of Title 26 of the Code of Federal
Regulations. In the course of enacting the Internal Revenue Code of
1986, Congress redesignated § 57(a)(8) as § 57(a)(1) for taxable
years beginning after 1986. See Tax Reform Act of 1986, Pub. L.
99-514, §§ 701(a) and 701(f)(1), 100 Stat. 2333, 2343. In October
1992, Congress enacted the Energy Policy Act of 1992, Pub. L.
102486, 106 Stat. 2776. Section 1915(a) of that Act amends §
57(a)(1) of the Internal Revenue Code and provides that, for
taxable years beginning after December 31, 1992, the depletion
allowance permitted under § 613A(c) of the Code will not be treated
as an item of tax preference subject to taxation as alternative
minimum taxable income. See n. 3,
infra.
550
II
An oil and gas producer cannot ordinarily depreciate or
otherwise recover (before disposition) his investment in land on
which he drills wells because the process of producing his taxable
income does not wear out or use up the land. See,
e. g.,
Treas. Reg. § 1.167(a)-2 (disallowing a depreciation deduction for
"land apart from the improvements or physical development added to
it"). Part of the purchase price of a fee simple interest in the
land, however, represents investment in the right to extract any
oil and gas from subsurface deposits, which (unlike the land) are
"wasting assets," gradually depleted as the minerals are removed.
An owner of such wasting assets, according to basic income tax
theory, should accordingly be allowed a "reasonable allowance for
depletion," 26 U. S. C. § 611(a) (1976 ed.), "to compensate [him]
for the part exhausted in production, so that when the minerals are
gone, the owner's capital and his capital assets remain
unimpaired."
Paragon Jewel Coal Co. v.
Commissioner,
380 U. S. 624,
631 (1965).
To a degree, however, practice and theory have drifted apart.
The Code and associated Treasury Department regulations require
taxpayers to calculate depletion allowances by whichever of two
methods produces the larger deduction for the current taxable year.
Treas. Reg. § 1.611-1(a)(1); see also 26 U. S. C. § 613(a) (1976
ed.) ("In no case shall the allowance for depletion under section
611 be less than it would be if computed without reference to this
section [concerning percentage depletion]"). The first method,
"cost depletion," remains firmly moored to the rationale
articulated in
Paragon Jewel. Under that method, the
taxpayer estimates the number of recoverable units in his mineral
deposit, and deducts an appropriate portion of the deposit's
adjusted basis for each unit extracted and sold. See Treas. Reg. §§
1.611-2, 1.612-1. When the sum of prior deductions equals the cost
or other basis of the deposit, plus allowable capital addi-
551
tions,2 "[n]o further deductions for cost depletion shall be
allowed." Treas. Reg. § 1.611-2(b)(2). The second method,
"percentage depletion," has no such ties. It generously allows the
taxpayer extracting minerals from a deposit to deduct a specified
percentage of his gross income, even when his prior depletion
deductions have exceeded his investment in the deposit. See 26 U.
S. C. § 613 (1976 ed. and Supp. V); Treas. Reg. § 1.613-1. For the
tax years at issue, percentage depletion produced the larger
deduction for the Hills, and they accordingly calculated their
depletion allowance according to that method.
For those tax years, however, percentage depletion's gleam is
dimmed by the minimum tax.3 Section 57(a)(8) of
2 Allowable capital additions include intangible drilling and
development costs that are "not represented by physical property,"
such as expenditures for clearing ground, draining, road making,
surveying, geological work, grading, and the drilling, shooting,
and cleaning of wells, to the extent that the taxpayer opts to
capitalize these costs rather than deducting them as expenses.
Treas. Reg. § 1.612-4(b)(1). For further discussion of these costs,
see
infra, at 563-564.
3 The Tax Equity and Fiscal Responsibility Act of 1982, Pub. L.
97-248, § 201, 96 Stat. 411, repealed the "minimum tax" for
noncorporate taxpayers for tax years beginning after December 31,
1982. See §§ 201(c)(1), 201(e)(1). At the same time, however, the
Act also included items of tax preference, such as excess
percentage depletion under § 57(a)(8), in the calculation of a
taxpayer's "alternative minimum taxable income." § 201(a). While
the "minimum tax" was simply added to the amount of income tax due
under the normal provisions, the "alternative minimum tax"
provision, 26 U. S. C. § 55 (1982 ed.), requires the recalculation
of a taxpayer's income under a different set of rules. A tax is
then imposed at a graduated rate on the taxpayer's "alternative
minimum taxable income"; if the amount of alternative minimum tax
so calculated is greater than the income tax calculated under the
ordinary provisions, the taxpayer must pay both the normal tax and
the amount by which his alternative minimum tax liability exceeds
his ordinary tax liability. Because items of tax preference were
added to "alternative minimum taxable income," the issue in this
case continued to be relevant for tax years beginning after
December 31, 1982. For the subsequent history of § 57(a)(8), see n.
1, supra.
552
the Code requires a taxpayer to calculate as a "tax preference"
"[w]ith respect to each [interest in a mineral deposit],4 the
excess of the deduction for depletion allowable under section 611
for the taxable year over the adjusted basis of the [mineral
deposit interest] at the end of the taxable year (determined
without regard to the depletion deduction for the taxable year)."
In turn, § 56 of the Code requires a taxpayer to pay an extra
minimum tax of 15% on the amount by which the sum of the enumerated
tax-preference items in § 57(a) exceeds the specific deductions
permitted by § 56. Because the amount subject to the extra tax is
reduced dollar for dollar by every outlay that can be added to the
adjusted basis of the mineral deposit interest, a taxpayer would
like as long a list of eligible outlays as possible.
In this case the dispute is about the inclusion in the adjusted
basis of certain tangible drilling and development costs, as
defined by the Treasury Regulations implementing §§ 263(c) and 612
of the Code. Section 263(c) grants taxpayers an option to deduct
against current income certain "intangible drilling and development
costs." The regulations limit the costs recoverable under that
option by distinguishing "intangible costs" from costs for "capital
items," which the parties refer to as "tangible costs":
"The option with respect to intangible drilling and development
costs does not apply to expenditures by which the taxpayer acquires
tangible property ordi-
4 Section 57(a)(8) applies to "each property (as defined in
section 614)."
Section 614(a) defines "property," "[f]or the purpose of
computing the depletion allowance in the case of mines, wells, and
other natural deposits," as "each separate interest owned by the
taxpayer in each mineral deposit in each separate tract or parcel
ofland." (The remainder of § 614 provides detailed rules about when
a taxpayer may, and sometimes must, combine separate interests and
treat them as one "property.") Section 1.614-1(a) of the Treasury
Department regulations makes the definition in § 614 applicable
"[f]or purposes of subtitle A of the [Internal Revenue] Code."
553
narily considered as having a salvage value. Examples of such
items are the costs of the actual materials in those structures
which are constructed in the wells and on the property, and the
cost of drilling tools, pipe, casing, tubing, tanks, engines,
boilers, machines, etc .... These are capital items and are
returnable through depreciation." Treas. Reg. § 1.612-4(c)(1).5
It is the cost of such capital items as these, to the extent
that they have not already been recovered through depreciation,
that the Hills would like to add to the bases of their mineral
deposit interests for purposes of calculating the amount of their
percentage depletion deductions subject to the minimum tax.
III
The taxpayers enter the race with a handicap. As we have noted,
see n. 4,
supra, § 57(a)(8) defines the "property" with
which it is concerned by reference to § 614, which speaks in terms
of the adjusted basis of "each separate interest owned by the
taxpayer in each mineral deposit." 26 U. S. C. § 614(a) (1976 ed).
A regulation defines "mineral deposit" as "minerals in place,"
Treas. Reg. § 1.611-1(d)(4), while a neighboring regulation defines
another term, "mineral enterprise," to include "the mineral deposit
or deposits
and improvements, if any, used in mining or in the
production of oil and gas," Treas. Reg. § 1.611-1 (d) (3)
(emphasis added). Because these regulatory definitions were well
established at the time Congress passed § 57(a)(8), see 25 Fed.
Reg. 11796 (1960); Pub. L. 91-172, § 301, 83 Stat. 580, 582, we
think it reasonable to assume that Congress relied on the accepted
distinction between them in its reference to
5 The regulations also foreclose the option with respect to the
cost of "labor, fuel, repairs, hauling, supplies, etc., in
connection with the operation of the wells and of other facilities
on the property for the production of oil or gas." Treas. Reg. §
1.612-4(c)(2). These costs must be "charged off as expense."
Ibid.
554
"mineral deposit" as contained in § 614. Thus the definitional
scheme suggests strongly that the "property" we are concerned with
in § 57(a)(8) excludes just those improvements that the Hills wish
to treat as part of the property's adjusted basis.
They assert, however, (and the Government does not dispute) that
the term "mineral enterprise" occurs in only that one operative
provision in the regulations, Treas. Reg. § 1.611-1(d)(4), which
concerns the allocation of a portion of the cost of a mineral
enterprise to a mineral deposit or deposits. On that basis, the
Hills argue that the term has the limited function of "assist[ing]
in identifying depletable and depreciable costs when an operating
mineral property is acquired as a unit." Brief for Respondents 18,
n. 21. Consistently with that view, they note, a regulation
implementing § 57(a)(8) directs us to "see section 1016 and the
regulations thereunder ... [f]or the determination of the adjusted
basis of the property." Treas. Reg. § 1.57-1(h)(3). The computation
of adjusted basis under 26 U. S. C. § 1016 (1976 ed. and Supp. V),
they argue, is independent of the definition and function of
"mineral enterprise" in the § 611 regulations; thus, the
implications of this term's definition do not extend to the
calculation at issue in this case.
We agree that § 1016 is the proper place to look for the rules
concerning adjustment of basis; but we conclude that the
computation of adjusted basis under § 1016 is wholly predicated on,
rather than independent of, an understanding of "mineral deposit"
as distinct from "improvements" within the meaning of the
regulations under § 611.
Section 1016 is one of a number of general provisions that
together determine the amount of gain or loss a taxpayer must
recognize when he sells or otherwise disposes of any type of
property. Section 1001(a) provides the basic rule: gain or loss is
determined by subtracting "adjusted basis" from "amount realized."
Section 1011(a) defines "adjusted basis" as "basis (determined
under section 1012 [or other
555
parts of the Code]), adjusted as provided in section 1016."
Section 1016 provides the rules for making "[a]djustments to
basis."
The taxpayers, acknowledging the centrality of § 1016, seize on
the last phrase of a regulation addressing that section:
"The cost or other basis shall be properly adjusted for any
expenditure ... or other item, properly chargeable to capital
account, including the cost of improvements and betterments made to
the property." Treas. Reg. § 1.1016-2(a).
The ordinary meanings of the terms "improvements" and
"betterments," the Hills say, include all valuable additions to
property that are more than mere repairs; the tangible costs that
they have incurred to exploit their mineral deposits increase the
value of those deposits, and in any case are specifically referred
to in the regulations implementing § 611 as "improvements," see
Treas. Reg. § 1.611-5; therefore, those costs should be included in
the adjusted basis of the mineral deposit for purposes of §
1016.
The Hills' chosen passage, however, cannot carry the weight they
ask it to bear. The purpose of the phrase "including the cost of
improvements and betterments made to the property" in Treas. Reg. §
1.1016-2(a) is not to provide guidance in particular cases as to
whether, for tax accounting purposes, an expense should be added to
the basis of an existing "property," or treated as a separate
"property" of its own. Rather, it is to ensure coordination of §
1016 with § 263, the Code section from which the term "improvements
and betterments" (which should probably be read as a unit) is
borrowed. Section 263(a)(1) provides that an expenditure may not
currently be deducted from income if it is "paid out for new
buildings or for permanent improvements or betterments made to
increase the value of any property or es-
556
tate." 6 26 U. s. C. § 263(a)(1) (1976 ed. and Supp. V). We have
said that "[t]he purpose of § 263 is to reflect the basic principle
that a capital expenditure may not be deducted from current income.
It serves to prevent a taxpayer from utilizing currently a
deduction properly attributable, through amortization, to later tax
years when the capital asset becomes income producing."
Commissioner v.
Idaho Power Co., 418 U. S. 1, 16 (1974). In
turn, inclusion of the term "improvements and betterments" in
Treas. Reg. § 1.1016-2(a) ensures the fulfillment of § 263's
implicit promise: If a taxpayer cannot deduct an expenditure from
current income because it has been deemed an "improvement or
betterment" to property, he will be able to recover it later,
either through a form of cost recovery such as depreciation or
depletion, or upon sale as a deduction from the amount
realized.7
6 Section 263(a)(I) has one of the longest lineages of any
provision in the Internal Revenue Code. The Revenue Act of 1864
included a provision specifying that "no deduction shall be made
for any amount paid out for new buildings, permanent improvements,
or betterments, made to increase the value of any property or
estate." § 117, 13 Stat. 282. The wording of this provision
remained the same in § 28 of the Revenue Act of 1894, 28 Stat. 553,
and in § 2(B) of the Revenue Act of 1913, 38 Stat. 167. The current
wording of the provision was adopted in the Revenue Act of 1918.
See § 215(b) of the Revenue Act of 1918, 40 Stat. 1069. The
language of Treas. Reg. § 1.1016-2(a) apparently originated in a
passage in a House Committee Report on the Revenue Act of 1924,
discussing the progenitor of 26 U. S. C. § 1016. See H. R. Rep. No.
179, 68th Cong., 1st Sess., 50 (1924) ("Under this provision
capital charges, such as improvements and betterments ... are to be
added to the cost of the property in determining the gain or loss
from its subsequent sale"). The forerunner to Treas. Reg. §
l.1016-2(a) was issued that same year. See Treas. Regs. 65, Art.
581 (1924).
7 After tracing the word "improvement" from the regulations
implementing § 611 through the regulations implementing § 1016 to
the text of § 263, one might hope that § 263 itself would provide
some insight into whether tangible development costs should be
treated as an "improvement" to the mineral deposit, or as a
separate property. Two circumstances dash this hope. First, as we
said above, the phrase "improve-
557
Thus it is not by deciphering particular terms in the
regulations accompanying § 1016 that the question in this case is
answered, but by relying on the basic principles embodied in §
1016's directives. For our purposes, the most important mandate is
found in § 1016(a)(2), which requires a taxpayer to subtract from
his original basis in the property sold or exchanged "not less than
the amount allowable [for exhaustion, wear and tear, obsolescence,
amortization, and depletion] under this subtitle or prior income
tax laws." In other words, whether or not the taxpayer ever took a
depreciation, amortization, or depletion deduction with respect to
the item he is selling, he must, for purposes of § 1016, determine
whether such deductions were allowable with respect to that item,
and reduce his basis by at least that allowable amount.8
To follow this directive, the taxpayer must determine whether
parts of the item sold are subject to different tax treatments, and
must treat those parts as different properties for purposes of §
1016. Thus, a taxpayer who bought an apartment building and the
land it sits on for a single price must determine how much of that
price went to pay for each, and must treat each cost as a separate
asset for purposes of
ments and betterments," as used in the § 1016 regulations and in
§ 263, should probably be read as a single term unrelated to the
term "improvements" in § 611 and the regulations thereunder.
Second, § 263 is concerned only with identifying those payments
that "serv[e] to create or enhance ... what is essentially a
separate and distinct additional asset."
Commissioner v.
Lincoln Savings &
Loan Assn., 403 U. S. 345,354 (1971).
So long as one can say that a payment must either be "creating" a
separate asset or "enhancing" one that already exists, one need
not, for purposes of § 263, identify which of these is the case.
Here, we are presented with precisely that question.
S The directive is phrased "not less than the amount allowable"
to account for the case in which a taxpayer has erroneously
deducted
more than that amount in a prior year. In that
case, the taxpayer must reduce the basis by the greater amount
actually deducted, to the extent that it resulted "(by reason of
the deductions so allowed) in a reduction for any taxable year of
[his] taxes." 26 U. S. C. § 1016(a)(2)(B) (1976 ed.); see §
1016(a)(2)(A).
558
§ 1016. This is so because the depreciation deduction allowable
for the building (if the building is used to produce income) must,
upon the sale or exchange of the property, be subtracted from the
taxpayer's basis in the building whether the deduction was taken or
not; but there is no subtraction from the land's basis since no
such deduction is allowable for the land. See,
e. g., Treas.
Reg. § 1.167(a)-5 (requiring an apportionment of basis when a
taxpayer has acquired "a combination of depreciable and
nondepreciable property for a lump sum, as for example, buildings
and land").
Although the Code and regulations allow some flexibility within
such major categories of tax treatment,9 the boundaries between the
major categories are almost completely impassable. When a taxpayer
is dealing with associated items falling into two different major
categories, he cannot, as a general matter, choose to treat those
items as a single property falling into one category or the other;
a taxpayer may not, for example, decide to treat some or all of his
apartment building as more land. Nor may a taxpayer choose to add
"improvement" costs to the basis of whichever item he pleases: some
costs, say of a new roof, must be treated as adding to the value of
the depreciable building (or as separate depreciable assets),
whereas other costs, like that of grading a building site, must be
treated as additions to the value of the nondepreciable land. See,
e. g., Rev. Rul. 74265, 1974-1 Cum. Bull. 56 (distinguishing
between depreciable and nondepreciable improvements to land).
Depletion and depreciation are two of these major categories of
tax treatment. As this Court said almost a half-
9 For example, a taxpayer may set up a depreciation account for
a new furnace separate from that of the account of the building in
which it is installed; he may also, under some circumstances, set
up a "composite" account which combines the cost of the building
with the cost of "improvements," such as the furnace. See generally
Treas. Reg. § 1.167(a)-7 (describing "group," "classified,"
"composite," and component accounts for depreciable property).
559
century ago, "[t]h[e] distinction between depletion and
depreciation runs through the basis provisions of the [Internal
Revenue Code]."
Choate v.
Commissioner, 324 U. S. 1, 3 (1945).
Thus, the Code's depreciation allowance "does not apply to natural
resources which are subject to the allowance for depletion provided
in section 611." Treas. Reg. § 1.167(a)-2. Accordingly, § 611
itself carefully appends, to its provision for "a reasonable
allowance for depletion" in the case of natural deposits and
timber, the qualification "and for depreciation of improvements,
according to the peculiar conditions in each case." 10 26 U. S. C.
§ 611(a) (1976 ed.); see Treas. Reg. § 1.611-5(a). To implement
this distinction, the regulations under § 611, mentioned above,
separately define "mineral deposit" as "minerals in place," Treas.
Reg. § 1.6111(d)(4), and "mineral enterprise" as including "the
mineral deposit or deposits and improvements," § 1.611-1(d)(3). The
section defining "mineral deposit" then further provides that
"[w]hen a mineral enterprise is acquired as a unit, the cost of any
interest in the mineral deposit or deposits is that proportion of
the total cost of the mineral enterprise which the value of the
interest in the deposit or deposits bears to the value of the
entire enterprise at the time of its acquisition." Treas. Reg. §
1.611-1(d)(4); see also § 1.611-2(g)(2)(vii) (requiring a statement
to be attached to the taxpayer's return showing "[a]n allocation of
the cost or value among the mineral property, improvements and the
surface of the land for purposes other than mineral production").
These provisions are designed to isolate those portions of the cost
of a "mineral enterprise" that are subject to recovery through
depletion.
Thus, just as one generally cannot calculate an adjusted basis
under § 1016 by treating an apartment building as "more land," one
generally cannot treat tangible tools and
10 As we have noted, see n. 7, supra, the word "improvements"
carries a different meaning here than it does within the term
"improvements or betterments" as used in § 263(a).
560
equipment as "more mineral deposit." If a mineral deposit and
associated equipment are sold together, § 1016 requires the seller
to separate them for the purpose of determining his gain or loss on
the sale, just as §§ 167 and 611 required him to keep them separate
for the purpose of calculating his depreciation and depletion
deductions. Since, as the Hills point out, a regulation
incorporates the § 1016 rule into § 57(a)(8), and since the Hills
have identified no exception to this rule, we infer that the Hills'
tangible costs may not be included in the basis of depletable
mineral deposits for purposes of calculating the amount of
percentage depletion subject to the minimum tax.
IV
Our conclusion is confirmed by the astonishing, circuitously
achieved results of reading § 57(a)(8) as the taxpayers urge. A
regulation that the Hills do not challenge provides that "[i]n no
event shall percentage depletion in excess of cost or other basis
of the property be credited to the improvements account or the
depreciation reserve account." Treas. Reg. § 1.611-2(b)(2). The
tangible costs at issue here are recorded in these accounts. Thus,
under this regulation, a tangible cost is not itself adjusted for
the amount of percentage depletion that on the Hills' theory it
would shelter from the minimum tax each year. As a result, the
tangible cost would shelter, over the years the taxpayer owned the
capital item it represented, an amount of percentage depletion many
times that of the cost itself. For example, a $21,000 capital item,
subject to straight-line depreciation over 20 years with a salvage
value of $1,000, would add $20,000 to the basis of the mineral
deposit the first year,11
11 Under § 57(a)(8), percentage depletion is offset by "the
adjusted basis of the [mineral deposit interest]
at the end of
the taxable year." (Emphasis added.) Assuming that the capital
item was placed in service at the
561
$19,000 the second year, and so on for 20 years. At the end of
the 20th year, the item would be fully depreciated, and the
taxpayer's basis in the item would then remain at $1,000, the
salvage value, for as many more years as he continued to own it.
Thus, over the first 20 years, the capital item would shelter
$210,000, or 10 times its cost, from the minimum tax; beginning in
the 21st year, it would shelter $1,000 per year for as long as it
remained in the taxpayer's hands. At a minimum tax rate of 15%, a
taxpayer would realize a tax benefit, from his $21,000 investment,
of $31,500 over the first 20 years from § 57(a)(8) alone, without
regard to the additional tax benefit from ordinary depreciation of
the item. It is hard to believe that Congress would enact a minimum
tax to limit the benefit that taxpayers could realize from "items
of tax preference," only to define one of those items in a way that
would create an even greater proportional tax benefit from
investing in tangible items, and to do so in an oblique fashion
that, as far as we know, has no precedent in the history of the
federal income tax.
v
The Hills contend that two Treasury Department regulations we
have not yet discussed foreclose our conclusion. They point first
to one of the cost depletion regulations under § 612, which, but
for its title and one adjective, would independently reinforce our
conclusion:
"The basis for cost depletion of mineral or timber property does
not include:
beginning of a taxable year, by the end of the year the
taxpayer's basis in it would be reduced by the first year's
depreciation. Thus, in our example, the $21,000 capital item would
add $20,000 to the taxpayer's basis in the mineral deposit, for
purposes of § 57(a)(8), the first year it was placed in
service.
562
"(i) Amounts recoverable through depreciation deductions,
through deferred expenses, and through deductions other than
depletion, and
"(ii) The residual value of land and improvements at
the end of operations." Treas. Reg. § 1.612-1(b)(1).
This, of course, is exactly the conclusion in the case of
percentage depletion that we have reached after a long detour
through § 1016. Section 1.612-1(b)(1) applies by its terms,
however, only to the determination of mineral deposit basis for the
purpose of calculating
cost depletion; and the title of §
1.612-1(b) is
"Special rules." Therefore, reason the Hills,
the "general rule" for determining mineral deposit basis under §
1016 must include the items, such as "[a]mounts recoverable through
depreciation deductions," excluded in the "special rule." But this
argument proves too much. If the Hills stuck to their logic, they
would have to claim that they could also add "[t]he residual value
of land and improvements at the end of operations" to their bases
in their mineral deposit interests, an absurdity that they cannot,
and do not try to, support. The simple answer is that when an
arguable suggestion of the title of one subsection of a regulation
is pitted against the entire Code framework for determining basis,
the Code wins, and the title is at most an infelicity.
The infelicity is understandable here. The calculation of
percentage depletion is unconnected to the concept of basis; the
annual percentage depletion deduction is not measured in relation
to basis, nor are the cumulative deductions limited by basis. See
26 U. S. C. § 613 (1976 ed. and Supp. V). The concepts of basis and
percentage depletion meet only in the minimum tax provisions, for
the purpose of calculating the item of tax preference in §
57(a)(8). Since § 1.612-1(b)(1) was issued long before the minimum
tax was enacted, see 25 Fed. Reg. 11801 (1960); Pub. L. 91-172, §
301, 83 Stat. 580, that regulation's reference to a "special rule"
for "cost" depletion cannot have been intended to indicate that
some
563
other rule applied to the calculation of basis for percentage
depletion. After the minimum tax was enacted, the Treasury
Department inserted a regulation about basis for percentage
depletion where one would expect it: among the regulations
implementing the minimum tax. That regulation, § 1.57-1(h)(3),
directs us to § 1016, but unfortunately contains no correlative
reference to the regulations under § 612.
Second, the Hills argue that excluding tangible costs from the
adjusted basis of their mineral deposit interests would run counter
to regulations specifying the inclusion of certain intangible
costs. As we have already noted, 26 U. S. C. § 263(c) (1976 ed.,
Supp. V) grants taxpayers an option to deduct as expenses certain
"intangible drilling and development costs." If a taxpayer chooses
instead to capitalize those costs, the regulations require the
taxpayer to sort the costs into two bins. Costs "represented by
physical property" are recoverable through depreciation, either
through adjustments to the bases of pre-existing items to which the
costs relate, or through an initial entry in a new depreciation
account. Treas. Reg. § 1.612-4(b)(2). Costs "not represented by
physical property" are recoverable through depletion, as
adjustments to the bases of the mineral deposit interests to which
they relate. § 1.612-4(b)(1); see § 1.612-4(d) (if a taxpayer fails
to elect to expense intangible costs correctly, "he shall be deemed
to have elected to recover such costs through depletion to the
extent that they are not represented by physical property, and
through depreciation to the extent that they are represented by
physical property"). Since these latter costs are added to
depletable basis, the taxpayers argue, so should the tangible costs
that are excluded altogether from the § 263(c) option. We fail to
see the logic of this argument. To the extent that the regulation
allowing intangible costs "not represented by physical property" to
be added to a mineral deposit's basis deviates from general
principles of basis allocation, we see no reason why
564
one deviation should force the Government, or this Court, to
create another. Nor have the Hills explained why this regulation in
fact represents a deviation.12
The judgment of the Court of Appeals is
Reversed.
12 The taxpayers also cite Internal Revenue Service Technical
Advice Memorandum 8314011 (Dec. 22, 1982), which holds that
unamortized deferred development expenditures under § 616 of the
Code are included in the basis of a mineral deposit for purposes of
§ 57(a)(8). As respondents acknowledge, the Code specifically
provides that such memoranda "may not be used or cited as
precedent." 26 U. S. C. § 6110(j)(3) (1976 ed.). In any case, § 616
sets up a system for the treatment of development expenditures
entirely different from the system at issue here; in particular, §
616(c) specifically mandates that expenses deferred under § 616(b)
"shall be taken into account in computing the adjusted basis of the
mine or deposit." Thus, Technical Advice Memorandum 8314011 simply
is not relevant to the question presented in this case.
565
REPORTER'S NOTE
The next page is purposely numbered 801. The numbers between 564
and 801 were intentionally omitted, in order to make it possible to
publish the orders with permanent page numbers, thus making the
official citations available upon publication of the preliminary
prints of the United States Reports.
566
OCTOBER 5, 1992
Affirmed on Appeal
No. 91-1546. SLAGLE V. TERRAZAS ET AL. Affirmed on appeal from
D. C. W. D. Tex. Reported below: 789 F. Supp. 828.
JUSTICE STEVENS, with whom JUSTICE BLACKMUN joins,
dissenting.
The Report of the Special Committee of the Fifth Circuit
Judicial Council demonstrated that neither corruption nor improper
motive affected the District Court's determination of the
boundaries of Senate Districts 19 and 26. Nevertheless, the
procedures that were followed in drawing the boundaries of those
districts, as established in the order under review, represented
such a serious departure from procedures that should be observed in
fashioning relief in adversary litigation that I would vacate the
judgment of the District Court with instructions to redraw the
boundaries of those two Senate Districts after the parties have
been given an adequate opportunity to be heard on issues that
relate to those two districts.
No. 91-2038. POPE ET AL. V. BLUE ET AL. Affirmed on appeal from
D. C. W. D. N. C. JUSTICE BLACKMUN would note probable jurisdiction
and set case for oral argument. Reported below: 809 F. Supp.
392.
Vacated and Remanded on Appeal
No. 91-1862. GANTT ET AL. V. SKELOS ET AL. Appeal from D. C. E.
D. N. Y. Judgment vacated and case remanded with instructions to
dismiss the appeal as moot.
United States v.
Munsingwear,
Inc., 340 U. S.
36 (1950). Reported below: 796 F. Supp. 677.
Certiorari Granted-Vacated and Remanded
No. 91-1493. GEORGIA V. CARR. Sup. Ct. Ga. Certiorari granted,
judgment vacated, and case remanded for further con sid801
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