Rev. Proc. 66-11

SECTION 1. PURPOSE.

The purpose of this Revenue Procedure is to furnish guides for taxpayers entitled to cost depletion deductions for the exhaustion of their capital investment in the ground water extracted by them in the Southern High Plains of Texas and New Mexico and disposed of by them in their business of irrigation farming.

SEC. 2. BACKGROUND.

.01 In Revenue Ruling 65-296, C.B. 1965-2, 181, dated December 13, 1965, it is stated that the Internal Revenue Service will follow the decision of the United States Court of Appeals for the Fifth Circuit in United States v. Marvin Shurbet, et ux. , 347 Fed.(2d) 103 (1965), in the disposition of cases involving taxpayers engaged in the business of irrigation farming in the Southern High Plans of Texas and New Mexico.

.02 In that case, the Court held that the taxpayers are entitled to a cost depletion deduction for the exhaustion of their capital investment in the ground water extracted and disposed of by them in their business of irrigation farming. The Court specifically stated, however, that its decision was not meant to furnish a precedent for the allowance of cost depletion except under the peculiar conditions of the Southern High Plains.

SEC. 3. DISCUSSION AND CONCLUSIONS.

.01 The Court found in the Shurbet case that one of the ways the taxpayer may establish the cost of the ground water at the time of acquisition is by comparing differences between the fair market values of dry lands and lands which contain water for irrigation in the area at that time. Any value attributable to nonfarm use of the land must be excluded from such cost and only the normal agricultural value at that time will be taken into account. As to any cost to be allocated to ground water for counties in the Southern High Plains area, the Service may use any other reasonable means of verifying claimed values, including, where proper, a range of acceptable values expressed as a percentage of the purchase price. In each allocation, appropriate consideration must be given to the value allocated to all improvements including the residence, if any, at the time of acquisition.

.02 Cost depletion will be allowed to irrigation farmers in the Southern High Plains under facts established to be similar to those in the Shurbet case. Taxpayers claiming cost depletion deductions on underground water deposits must establish to the satisfaction of the district director both the amount of water present at acquisition and their cost basis of the water. A proper allocation based upon relative market value as of the date of acquisition is necessary in cases where the water deposit was acquired with the land for a single price.

.03 In addition, the taxpayer will be required to establish the net amount of exhaustion of the water deposit beneath his land during the taxable year. In establishing the net amount of exhaustion of the water deposit underneath a taxpayer's land during the taxable year, the Service will not recognize that there has been any exhaustion in any year in which a recharge of water increases the water saturation level over its level at the end of a prior year of decrease. It is obvious that where there is an increase in any given year of available water, the taxpayer's supply has not been depleted during such year. Nor will any further deduction for depletion be allowed until such time as the water table again declines to a level below the previously known lowest level. See example below.

.04 The determination of the saturated thickness (the thickness of that part of the formation containing water) at acquisition subject to depletion and the net decrease of that depletable saturated thickness during a given year are dependent upon the particular facts in each case, and each taxpayer claiming a cost depletion deduction must establish these factors in his case to the satisfaction of the district director.

SEC. 4. EXAMPLE.

Taxpayers should maintain appropriate records to support depletion deductions claimed. The following example shows a general format which may be used for computing cost depletion in claiming a cost depletion deduction.

(1) Facts

In 1957 A, a farmer, who was on a calendar year basis, acquired some farmland in the Ogallala area of the Texas High Plains region. He paid $12,000 for the property, of which $10,000 represented the cost of the land and $2,000 the cost of improvements, including an irrigation well which was producing an ample supply of water from a reservoir with a depletable saturated thickness on the date of purchase of 250 feet. A's land had a value of $10,000 whereas without water it would have been worth only $6,000. As of the beginning of the taxable year 1962, the depletable saturated thickness was 200 feet and decreased to 190 feet as of the end of the year. In 1963, there was a further net decline of 20 feet. In 1964, the water formation actually rose above the previous year's saturated thickness so that there was no actual depletion of the water. But in 1965, the water level sank 15 feet. Of this amount, 10 feet was merely recapture of the prior excess, so that only the net decline of 5 feet was depletable. It is assumed that in some year subsequent to 1965 the remaining water would be drained off, and from that time on there would be no more water to deplete.

The cost depletion computation and depletion summary set forth below show the manner in which cost depletion would be computed for 1962 and subsequent years on the basis of the foregoing facts.

(2) Cost Depletion Computation-Water

     Cost of land and improvements at acquisition.........   $12,000

                Saturated thickness (in feet)