Rev. Rul. 68-226

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the position set forth in I.T. 3693, C.B. 1944, 272.

This Revenue Ruling relates to whether the sale by a lessee of his entire leasehold interest (or an undivided portion thereof) in oil and gas in place is a sale of `real property' for Federal income tax purposes under section 1221 of the Internal Revenue Code of 1954 and whether, if the leasehold was held for more than six months and then sold or exchanged, it qualifies as `real property used in the trade or business' as defined in section 1231 of the Code. Also, if the sale was on the installment basis, this Revenue Ruling concerns whether the income therefrom may be returned under the provisions of section 453 of the Code.

The various state jurisdictions are not in agreement as to the characterization of such a leasehold as real property, personal property, or some other type of interest. The Federal revenue laws, however, are not to be deemed subject to state law unless the express language or necessary implication of the section involved so requires. Burnet v. Henry Harmel , 287 U.S. 103 (1932), Ct. D. 611, C.B. XI-2, 210 (1932), and J. Earl Morgan, Exr. (Morgan Estate ) v. Commissioner , 309 U.S. 78 (1940), Ct. D. 1441, C.B. 1940-1, 229.

The Surpreme Court of the United States has held that, for Federal income tax purposes, persons sharing in the depletion allowance with respect to oil leases are characterized as owners of economic interests in oil or mineral in place, regardless of the technical provisions of the instrument creating the lessee's interest. See E.G. Palmer v. Bender , 287 U.S. 551 (1933), Ct. D. 641, C.B. XII-1, 235 (1933); Thomas v. J. J. Perkins, et al. , 301 U.S. 655 (1937), Ct. D. 1237, C.B. 1937-1, 162.

Accordingly, the interest of a lessee in oil and gas in place, in this case, is an interest in `real property' for Federal income tax purposes, and is (except with respect to property held by a taxpayer primarily for sale to customers in the ordinary course of his trade or business) `real property used in the trade or business' of the taxpayer within the meaning of section 1221 of the Internal Revenue Code of 1954. It is, therefore, excluded from the term `capital asset' as defined therein. Where such a lease has been held for more than six months and is then sold or exchanged, it qualifies as `real property used in the trade or business' as defined in section 1231 of the Code and is subject to the treatment provided for in that section. Furthermore, income from the sale of such oil and gas leasehold interests may be reported on the installment basis under section 453 of the Code, if the sale otherwise meets the requirements of that section and the regulations thereunder. See section 1.453-1 (b) and (c) of the Income Tax Regulations.

I.T. 3693 is superseded, since the position set forth therein is restated under current law in this Revenue Ruling.

¹ Prepared pursuant to Revenue Procedure 67-6, C.B. 1967-1, 576.