Rev. Rul. 77-400, 1977-2 CB 206
REV-RUL, Advanced royalties; timber., Rev. Rul. 77-400, 1977-2 CB 206, (Jan. 01, 1977)
Section 612.--Basis for Cost Depletion
26 CFR 1.612-3: Depletion; treatment of bonus and advanced royalty.
(Also Section 631; 1.631-2.)
[IRS Headnote] Advanced royalties; timber.--
Advanced royalties paid or accrued by a lessee under a timber cutting
contract are not deductible under the provisions of section 1.612-3(b)(3) of
the regulations, but are to be added to the lessee's depletable basis in the
timber.
In 1976, A, as lessor, entered into a contract for the disposal of timber with B, as lessee. Under the provisions of the contract, A retained an economic interest in the timber in accordance with section 1.611-1(b)(1) of the Income Tax Regulations and section 631(b) of the Internal Revenue Code of 1954. The contract provided for payment by B of a royalty of 10x dollars for each unit of timber cut and removed. B was also required to pay an advanced royalty of 1000x dollars at the beginning of each year of the two year contract. This payment was required whether timber was or was not cut during the year. The advanced royalties paid on account of units not cut during the year were to be applied as payment for timber cut in a subsequent year.
No timber was cut by B in 1976. On its Federal tax return for 1976, B claimed a deduction for advance royalties in the amount of 1000x dollars.
Section 1.612-3(b)(3) of the regulations discusses the deductibility of only advanced royalties paid or accrued by the lessee in connection with mineral property.
Section 1.631-2(e)(1) of the regulations provides that amounts paid by the lessee for timber, whether designated as rental, royalty, or bonus, shall be treated as the cost of timber and shall constitute a part of the lessee's depletable basis of the timber.
Section 1.612-3(b) (3 of the regulations applies only with respect to advanced royalties paid by lessees in connection with mineral property and does not apply to lessees in connection with timber.
Accordingly, since the advanced royalties paid by B in 1976 are not advanced royalties paid in connection with mineral property, they are not deductible in 1976, but are to be treated as the cost of timber that becomes part of B's depletable basis in the timber as provided by section 1.631-2(e)(1) of the regulations.