During an Alaskan vacation last summer, my wife and I visited the El Dorado Gold Mine near Fairbanks. The tour included a train ride, musical entertainment, some explanations and demonstrations, and free cocoa and cookies in the Cook Shack. Ultimately, each of us was given a sack of dirt, and a pan. We sat on benches surrounding a pool of water, and, with appropriate instructions, proceeded to pan for gold.
Indeed, there was gold in "them 'thar" pans. We took the gold to the assaying office in the Cook Shack (which doubled, as it happened, as the gift shop), and were told that, between us, we had found $23.00 worth of gold nuggets. The Gold Mine would not pay us that amount, or any amount, for the gold. However, for an additional payment of about $30.00, they put our nuggets into a necklace, which my wife has enjoyed wearing ever since. Was there a taxable event?
Perhaps a few more facts would help. We enjoyed our panning adventure in the course of a two-week Alaskan vacation, including one week on board a cruise ship and one week on land. We paid one amount per person for the entire vacation package. Some small part of that payment was for the visit to the gold mine.
According to the gold mine company's website, had we walked in off the street, we would have paid $35.00 each. Presumably, the cruise line negotiated a lower price. Whether or not their volume discount was passed on to us is unknown. However, it seems clear that we paid some amount, but not over $35.00, for each admission to the gold mine.
The gold mine company wanted everyone to have a positive experience. Accordingly, when they gave each of us a sack of dirt, it was not any old sack of dirt. The dirt had been subjected to a statistical sampling process. We were assured that each sack of dirt had an average amount of gold nuggets-say $10.00 worth. But it was even better than that. If it turned out that there was no gold at all in a particular patron's sack of dirt, then that patron would be given a second sack of dirt, and invited to try again. In addition, if a patron had trouble getting the hang of the panning process, there were El Dorado Gold Mine staffers who would help you. They would even do the panning for you.
The sack of dirt was one of a number of goods and services provided by the El Dorado Gold Mine in exchange for the price of admission. When nuggets were found, they were worth either more or less than the allocated cost of the dirt. Accordingly, the tax issues are:
What was the patron's basis in the sack of dirt?
What was the value of the gold nuggets panned?
In light of (1) and (2), was there a gain or a loss?
Was that gain or loss realized?
If there was a loss, was it recognized?... and
Was the whole transaction imputed income, in which case, the first five questions are moot?
I conclude that, in the great majority of cases, there was a loss. Whether there was a gain or loss, there was no realization without sale of the nuggets to a third party. If there was a loss, it was a nondeductible, personal loss. I'm willing to get to the same place by declaring the whole thing imputed income. However, on balance, I prefer the first approach.
The sack of dirt is an asset, with a basis. The basis of my wife and myself in our sacks of dirt is problematic. It would be very difficult to isolate that sack of dirt from the myriad other pleasures we enjoyed, and paid for, on our two-week Alaskan cruise-tour package.
It is much simpler to imagine a tourist who paid $35 for a single ticket. Even that tourist's transaction has some complexities. How much of the $35 was for the train ride, the entertainment, the cocoa and cookies, etc., and how much was for the dirt? The question is: What was the taxpayer's basis in the sack of dirt? The answer is ultimately unknowable. However, I will assume the basis to be $15.00 apiece. Therefore, for the two of us, the basis was $30.00.
Value of the Nuggets, Gain or Loss
The highest value of gold panned in our group was $110.00. Although this precise valuation is questionable, for reasons set forth below, I assume that this lucky patron did indeed receive gold worth more than whatever he paid for the dirt. In contrast, my wife and I, if my assumptions are correct, lost $7.00; we paid $30.00 for the dirt and ended up with $23.00 worth of nuggets. I assume that the great majority of patrons, like us, lost money. If most patrons turned a profit, in these terms, then the El Dorado Gold Mine is in the wrong business. They should be mining the gold themselves.
Realization is tricky. We know that, if you walk down the street, and see a $100 bill on the sidewalk, you have realized taxable income of $100-assuming, of course, that you pick it up. We also know that, if you buy a used piano, and later discover $100 cash hidden in the back, the result is the same. If, however, instead of cash you found jewelry on the sidewalk or in the back of the piano, or if the piano turns out to be worth more than you paid for it, or if you buy land and later discover that there is an oil well underneath, things might be different.
Severability could be a problem. You can take cash, or even jewelry, out of the back of a piano without destroying the underlying piano. However, if you simply discovered that the piano was worth more than you thought, how do you physically separate the appreciation from the original value? Sometimes, as in the case of the expensive piano, severability is physically impossible. Sometimes, as in the case of oil deep below the ground, it is simply difficult.
Then there is the problem of valuation. We know what cash is worth. We don't know what jewelry is worth without an appraisal. We certainly don't know what an old piano is worth, and we have even less of an idea about oil reserves.
Applying these concerns to the sack of dirt leads to inconsistent results. Severability might be a problem when one is given a sack of dirt. However, once the nuggets have been panned, the separation is done, and severability is no longer an issue.
Valuation, however, is a problem. The El Dorado Gold Mine suggests a value, but they will not pay it. The airwaves are full of advertisers offering to pay cash for gold. However, many of the advertising firms are less than trustworthy. Valuing gold is neither certain nor easy. One must know not only the weight, but the fineness. That is enough to defeat realization. Gains or losses should not be realized unless the nuggets are sold to a third party. Wearing them around one's neck just doesn't cut it.
Losses: Recognition and Deductibility
Take the $7.00 allegedly lost by my wife and myself. Is it deductible? No. It is a nondeductible, personal loss. Some pan gold for a living. The patrons of the El Dorado Gold Mine, however, do not. Anyone who had any serious desire to make money panning gold would do it in some other way. El Dorado patrons are not in the trade or business of mining, and they have not entered into a transaction for profit. The loss is personal, and nondeductible.
In an article about baseballs and other found property, Professors Zelenak and McMahon argue that the treasure trove regulations should be abolished, and that found property, like self-created property, should generate tax-free imputed income. One way or another, their analysis would apply to my gold panning adventure. I agree with their result.
Zelenak and McMahon analyze a variety of scenarios. Two of them are recreational fishing and catching record-setting baseballs. It is generally agreed that recreational fishing generates tax-free imputed income, whether or not one consumes the fish. As to catching record-setting baseballs, however, they could be taxed at fair market value, taxed at the $12.99 retail value of a baseball, or tax-free imputed income. I think recreational fishing is a better analogy to gold panning.
You can't go fishing without trying to catch fish. You can't pan for gold without trying to find nuggets. But you can go to a ball game with no intention whatsoever of catching a ball. The fish that you catch in fishing and the nuggets that you find in panning are the direct, universally intended result of the recreational activity. Therefore, they should be tax-free imputed income, at least until sale to a third party. The baseball? Maybe, maybe not.
I still like the basis and amount (un)realized approach a little better, because the gold panning activity has a uniquely good claim for basis. In all three instances, the participant might pay something up front. In the case of fishing, one might simply fish off a public pier, for free. However, one might also pay a substantial sum to charter a fishing expedition. As to gold panning, one might pan for free in a stream by the side of a public road, or one might pay to pan at the El Dorado Gold Mine. Baseball is the clearest case, in that one cannot legally attend a game without paying to do so.
What one purchases, however, is not the same in the three cases. On a charter fishing expedition, one hires the services of the captain and crew, and rents the fishing boat. No tangible asset is purchased. In the baseball case, one buys a ticket--a tangible piece of cardboard. However, that cardboard really represents an intangible bundle of rights. In the gold panning example, by contrast, one actually buys a sack of dirt. It is closer to a grab bag than a lottery ticket. That dirt may turn out to be worth a little, or a lot, directly causing the gain or loss. So, at the El Dorado Gold Mine, one purchases a real, tangible asset, and basis should be applied.
When people engage in casual, recreational activity, they should not have to keep records. Keeping records takes away from the fun. In the case of panning for gold at the El Dorado Gold Mine, the activity, if viewed from a profit and loss perspective, will be a loss for almost everybody, and a nondeductible loss at that. It makes no sense to make those happy losers keep records for a non-reportable transaction.
A few will make a little money, or will find enough nuggets so that it would be unclear without careful analysis whether there was a profit or a loss. But the tax revenue at stake is minimal. Again, it does not make sense to spoil their fun for the sake of an overblown view of tax compliance.
A very few people will find nuggets of substantial value-a significant accession to wealth. These, however, are precisely the people who are most likely to sell the nuggets to a third party. We should wait for them to do so, and tax them only then.
Either of the two approaches described above-that the finding of the gold is not a realization event and that any loss is personal and nondeductible, or that the entire enterprise is tax-free imputed income-reaches the same result. Some may think of the nuggets as potential profit; I think of them as a souvenir.
 . http://www.eldoradogoldmine.com.
 . That would be me.
 . When a single payment is made for a bundle of assets and rights, it is always difficult to allocate basis. Sometimes, the courts give up, as in Inaja Land Co. Ltd, v. Commissioner, 9 T.C. 727 (1947). Sometimes, the courts come up with clever solutions. For example, In Gamble v. Commissioner, 68 T.C. 800 (1977), a single payment was made for a pregnant racehorse. When the ensuing colt was sold (but not the mother), the court used the insurance value placed upon the colt in utero to assign basis. In doing so, they rejected the taxpayer's argument that the father's stud fee should have been used.
Professor Joseph Dodge argues that, when one buys a ticket to a professional baseball game and catches a valuable ball, "...the price of the ticket is exhausted by the entertainment value of the game. ... There is no separate basis in the remote opportunity to obtain the record-setting baseball." Joseph Dodge, "Accessions to Wealth, Realization of Gross Income, and Dominion and Control: Applying the 'Claim of Right Doctrine' to Found Objects, Including Record-Setting Baseballs," 41 Florida Tax Rev. 685, 725 (2000). One might apply his reasoning to assign zero basis to the sack of dirt. However, in the baseball case, the entertainment value of the game is largely separate from the chance to catch the ball. In the gold panning case, the entertainment value is the chance to pan for gold in the sack of dirt.
 . Or so they said at the Cook Shack.
 . See Notes 10 and 11, infra and accompanying text.
 . Professor Dodge writes, "In the typical pleasureable hobby activity involving saleable self-obtained property, it is likely that the costs of pursuing the activity will exceed the value of the product or harvest. " Dodge, supra Note 3 at 704.
 . Cesarini v. United States, 296 F. Supp. 3, (N.D. Ohio 1969), aff'd per curiam 428 F.2d 812 (6th Cir. 1970).
 . Eisner v. Macomber, 252 U.S. 189, 207 (1920) requires a "...gain, profit, something of exchangeable value...severed from the capital."
 . In Hornung v. Commissioner, 47 T.C. 428 (1967) and Ames v. Commissioner, 112 T.C. 304 (1999), the difficulty of getting at the income was relevant to the issue of constructive receipt. Constructive receipt is about timing. So is realization.
 . See "Cashing In For Gold? Here's the Catch," 74 Consumer Reports 9 (Nov. 2009);http://www.myfoxdc.com/dpp/money/cash-for-gold-11029.
 . Try http://www.dendritics.com/scaled/metal-calc.asp. Note that, using that website, gold cannot be valued unless one knows the quality of the gold as well as the quantity.
Catching a record-setting baseball is, in some ways, similar to panning for gold. I address baseballs generally below. As to the valuation question, Andrew Appleby suggests that anyone who catches a baseball should be taxed on the retail price of the ball, which was $12.99 in 2008. Andrew Appleby, "Ball Busters: How the IRS Should Tax Record-Setting Baseballs and Other Found Property Under the Treasure Trove Regulation," 33 Vermont L. Rev. 43 (2008). Appleby's proposal works better for baseballs than for nuggets. All baseballs have the same retail price. All nuggets do not.
Lawrence Zelenak and Martin McMahon suggest that either found property or self-created property should generate tax-free imputed income, unless the found or created property is highly liquid, like gold bullion. Lawrence Zelenak and Martin McMahon, Jr., "Professors Look at Taxing Baseballs and Other Found Property, Tax Notes, Aug. 30, 1999, p. 1299. I agree. However, gold nuggets are not gold bullion. Gold bullion comes in standard bars, ingots, or coins, and must be at least 99.5% pure. http://www.investorglossary.com/gold-bullion.htm.
 . §262. Could the loss be treated as a wagering loss under §165(d)? I say no. Admittedly, the sack of dirt could be analogized to a lottery ticket, but it would be a strange lottery ticket. In a true lottery, a few win, and everyone else walks away with nothing. Here, everyone gets something.
Many expenditures come with risk and a variable return-stock purchases, the costs of hang gliding, law school tuition, to name a few. But that doesn't make them gambling. The predominant aspect of gold panning in a place like the El Dorado Gold Mine is a tourist recreational activity, more like fishing than betting on the ponies.
 . Even moderately serious recreational Alaskan gold panners would do well to consider other alternatives. For example, at the Crow Creek Mine near Anchorage, one pays $15.00 per day for gold panning ($5.00 for children under 12 and $10.00 for seniors and active military). Suction dredges can be rented by the day, for an additional fee. http://www.akmining.com/mine/crow.atm. We probably spent a half hour panning, not a whole day.
 . §165(a)(1). If they were in the mining business, then "'gross income' means the total sales, less the cost of goods sold." Reg. §1.61-3(a) (emphasis added).
 . §165(a)(2). Presumably, most of us were like my wife and myself. We had a list of things we particularly wanted to do in Alaska, and panning for gold was not one of them. It just came as part of a package deal. We could not have had a profit motive for our gold planning adventure, since we really didn't have any motive at all.
 . Zelenak and McMahon, supra Note 11.
 . Zelenak and McMahon, supra Note 11. The fact that some fishermen routinely throw back what they catch is proof that the enjoyment of fishing does not necessarily depend upon the value of what is caught. For some, the glory of the battle-man vs. fish--is the essential thing. See Ernest Hemingway, "The Old Man and the Sea."
 . Dodge, supra Note 3.
 . Appleby, supra Note 11.
 . Zelenak and McMahon, supra Note 11. Zelenak and McMahon, however, would tax the valuable, record-setting baseball later, upon its sale to a third party.
 . Some may object that all of these activities could have more than one motivation. For some, going to a baseball game is merely an excuse to sit in the sun and drink beer. The same can be said for fishing. However, the baseball game is far more likely to have one dominant recreational motive (watching the game), and a second, entirely separate motive (catching the ball), that is much more profit-seeking.
 . One might, however, need to buy a fishing license.
The material in this publication should not be construed as legal advice or legal opinion on specific facts. The informationin this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.
This article is republished with the permission of Joel Newman. Further duplication without the permission of Joel Newma is prohibited. All rights reserved.
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