Category: Sales & Exchanges; Accounting Periods & Methods
Subject: Sale of Oil & Gas Property
Title: Treatment of Oil and Gas Interest For Purposes of Sections 453(g) and 1239
IRC Sections: 1239, 453(g)
Filename: 1219.html
Date Produced: 04/95

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Background
Taxpayer (TP) owns a working interest in oil and gas property. The interest consists of land, equipment, and the interest in the oil and gas itself. TP plans to sell the entire interest to a related party. TP wishes to use the installment method.

Section 1239 prohibits capital gain treatment and Section 453(g) prohibits installment sale reporting of depreciable property sold to certain related parties.

Issue
Is the oil and gas interest (viewed separately from the land and the equipment) considered depreciable property for purposes of Sections 453(g) and 1239?

Answer
Oil and gas property is not considered depreciable property for purposes of Section 453(g) and 1239. Accordingly, the oil and gas interest (but not the related equipment) can be sold on the installment method. Also, Section 1239 does not recharacterize the income from sale of the interest as ordinary gain (although other provisions, i.e., Section 1254, may apply).

Discussion
Sections 1239(a) and 453(f) define the term depreciable property for purposes of Sections 1239 and 453(g), respectively, as property which in the hands of the transferee is subject to the allowance for depreciation under Section 167. Superficially, it would seem that since an oil and gas interest is subject to an allowance for depletion under Section 611 rather than an allowance for depreciation under Section 167, Sections 1239 and 453(g) would not apply to the sale of such property.

Initially, that conclusion troubled me on an intuitive level. Depletion is conceptually similar to depreciation in many respects. Both depletion and depreciation have as their overall purpose recovery through periodic tax deductions of the economic investment in a wasting asset. Yet, depreciable property seems to be treated differently for purposes of Sections 453(g) and 1239 than depletable property.

The issue becomes whether there is some less-than-readily-apparent link between depreciation and depletion that would cause Sections 1239 and 453(g) to come into play with the sale of an oil and gas interest. After researching the matter, it is apparent that there is no such link between depreciation and depletion. In fact, Regulation Section 1.167(a)-2 provides that the allowance for depreciation does not apply to natural resources which are subject to the allowance for depletion provided in Section 611. Not only is there no link between Section 167 and the depletion provisions, depletable assets are explicitly excluded from the ambit of Section 167 by the language of the regulation set forth above.

Accordingly, it is apparent that despite my misgivings, Sections 1239 and 453(g) do not apply to an oil and gas interest sold to a related party. It is unclear whether the drafters of these provisions excluded depletable assets purposely or through oversight, but both statutes are clear on their faces that only depreciable assets are considered, and the tax literature is devoid of any indication that depletable assets should be considered for this purpose at all.