Reinke v. Commissioner

Ervin and Mary Reinke owned surface and mineral rights in a quarter-section of land and surface rights in two other quarter-sections. The Reinkes had two coal leases with Baukol-Noonan, Inc. (BNI) for their surface and mineral rights. The leases provided that the Reinkes would receive a 10-cent-per-ton royalty on coal. The Reinkes and BNI also had a surface-use agreement under which BNI promised to pay the Reinkes 10 cents per ton of coal to serve as payment for any damages to the Reinkes’ surface estate from the mining operations. In 1985, 1986, and 1987, BNI made payments under the coal leases and surface-use agreement. Mary (plaintiff), who filed federal-income tax returns alone following Ervin’s death in 1985, asserted that all payments for surface rights received under the leases and the surface-use agreement were compensation for damages BNI had caused to the land while mining. As a result, Mary claimed that the payments were recovery of capital up to her basis in the land and that any excess was capital gains. Mary based this argument on the United States Tax Court’s 1947 decision in Inaja Land Co. v. Commissioner. The Commissioner of Internal Revenue (the commissioner) (defendant) disagreed with Mary’s treatment of the surface payments and calculated substantial deficiencies in Mary’s returns. The commissioner asserted that the payments should be taxed as ordinary income because Mary had not shown that BNI’s mining operations had actually permanently damaged Mary’s surface interest. The record did not contain evidence of the amount of damage to Mary’s property. Mary challenged the commissioner’s decision in the United States Tax Court.