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A taxpayer should not be charged with gain on pure conjecture unsupported by any foundation of ascertainable fact.
Petitioner Inaja Land Company, Ltd. (Inaja) is a stock corporation, organized under the laws of California. On or about January 26, 1928, Inaja acquired approximately 1,236 acres of land in Mono County, California, together with all water and water rights appurtenant or belonging thereto, at a cost of approximately $61,000. This property was located along the banks of the Owens River, which flows through and over Inaja’s land, involved in this controversy. The Department of Water and Power of the City of Los Angeles commenced the construction of Mono Craters Tunnel in Mono County. The object of the tunnel project was, and the result accomplished is, to divert waters which would naturally remain in the Mono Basin into the Owens River at a point upstream from Inaja’s lands. These waters flow through or over petitioner's lands. Between September 25, 1934, the date the Mono Craters Tunnel project was commenced, and August 11, 1939, Inaja and its attorneys complained to the city and its officials concerning trespasses and invasions by the city and its employees and against unauthorized fishing and poaching by city employees upon petitioner's lands and rights. Under the indenture of August 11, 1939, Inaja reserved substantial beneficial interests in its properties and has continued to function and operate as a fishing club, with incidental leasing out of its lands for grazing livestock from the date of the indenture to the present time. The indenture permitted the city to release foreign waters into the Owens River in such quantities that the total of the foreign and natural waters flowing into that river as it enters petitioner's lands shall not exceed 400 cubic feet per second. The adjusted basis of petitioner's properties was more than $50,000 on January 1, 1939. Disregarding the sum in controversy, no event occurred in 1939 which would cause or require the adjusted basis of these properties to be reduced below $50,000 for the taxable year involved. Inaja’s income and excess profits tax return for the taxable year 1939 did not report receipt of any income from the city of Los Angeles, but included a schedule which reported receipt of $50,000 from the city in connection with a certain written agreement and settlement of certain specified matters, wherein expenses amounted to $1,055, and Inaja received a net amount of $48,945. In his deficiency notice the respondent included the sum of $48,945 as taxable income to Inaja under section 22 (a) of the Internal Revenue Code.
Did Inaja receive taxable income of $48,945 under a certain indenture of August 11, 1939, whereby it granted the city of Los Angeles, California, certain easements over its land and settling all claims arising out of the release of foreign waters from the city's Mono Craters Tunnel project?
The court concluded that no part of the recovery was paid for loss of profits, but was paid for the conveyance of a right of way and easements, and for damages to petitioner's land and its property rights as riparian owner. Hence, the respondent's contention has no merit. Capital recoveries in excess of cost do constitute taxable income. Inaja has made no attempt to allocate a basis to that part of the property covered by the easements. It is conceded that all of petitioner's lands were not affected by the easements conveyed. Inaja does not contest the rule that, where property is acquired for a lump sum and subsequently disposed of a portion at a time, there must be an allocation of the cost or other basis over the several units and gain or loss computed on the disposition of each part, except where apportionment would be wholly impracticable or impossible. Inaja argued that it would be impracticable and impossible to apportion a definite basis to the easements here involved, since they could not be described by metes and bounds; that the flow of the water has changed and will change the course of the river; that the extent of the flood was and is not predictable; and that to date the city has not released the full measure of water to which it is entitled. In Strother v. Commissioner, 55 Fed. (2d) 626, the court says: A taxpayer should not be charged with gain on pure conjecture unsupported by any foundation of ascertainable fact. This rule is approved in the recent case of Raytheon Production Corporation v. Commissioner, supra. Apportionment with reasonable accuracy of the amount received not being possible, and this amount being less than petitioner's cost basis for the property, it can not be determined that petitioner has, in fact, realized gain in any amount. Applying the rule as above set out, no portion of the payment in question should be considered as income, but the full amount must be treated as a return of capital and applied in reduction of Inaja’s cost basis.