[Code of Federal Regulations]
[Title 26, Volume 7]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.636-4]

[Page 549-551]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.636-4  Effective dates of section 636.

    (a) In general. Except as provided hereinafter in this section, 
section 636 and Sec. Sec. 1.636-1, 1.636-2, and 1.636-3 apply to 
production payments created on or after August 7, 1969, other than 
production payments created before January

[[Page 550]]

1, 1971, pursuant to a binding contract entered into before August 7, 
1969.
    (b) Election. Under section 503(c)(2) of the Tax Reform Act of 1969, 
if the taxpayer so elects, section 636(a) of the Code and Sec. Sec. 
1.636-1 and 1.636-3 apply to all production payments carved out by him 
after the beginning of his last taxable year ending before August 7, 
1969, including such production payments created after such date 
pursuant to a binding contract entered into before such date. No 
interest shall be allowed on any refund or credit of any overpayment of 
tax resulting from an election under section 503(c)(2) for any taxable 
year ending before August 7, 1969. The provisions of this paragraph may 
be illustrated by the following example:

    Example. A, a fiscal-year taxpayer whose taxable year ends on 
October 31, carved out and sold (from a producing property) production 
payments on October 1, 1967, and on July 9, 1969. On August 1, 1969, A 
entered into a binding contract to create another carved-out production 
payment (from a different producing property) and the production payment 
was carved out on December 22, 1969. If A elects under section 
503(c)(2), the production payments carved out on July 9, 1969, and 
December 22, 1969, are treated as mortgage loans under section 636(a). 
The production payment carved out on October 1, 1967, is not treated as 
a mortgage loan under section 636(a) because it was carved out before 
the beginning of A's last taxable year ending before August 7, 1969.

    (c) Time and manner of making election. (1) Any election under 
section 503(c)(2) of the Tax Reform Act of 1969 must be made not later 
than May 30, 1973.
    (2) An election under section 503(c)(2) shall be made by a statement 
attached to the taxpayer's income tax return (or amended return) for the 
first taxable year in which the taxpayer created a production payment 
(i) to which the election applies, and (ii) which, in the absence of 
section 636, would not have been treated as a loan. A statement shall 
also be attached to an amended return for each subsequent taxable year 
for which he has filed his income tax return before making the election, 
but only if his tax liability for such year is affected by the election. 
Each such statement shall indicate the taxpayer's election under section 
503(c)(2), and shall identify by date, amount, parties, and burdened 
mineral properties all production payments described in subdivisions (i) 
and (ii) of this subparagraph which have been created by the date on 
which the statement is filed. However, a taxpayer who, prior to the date 
on which permanent regulations under this section are published in the 
Federal Register, made a valid election under section 503(c)(2) pursuant 
to Sec. Sec. 301.9100-17T and 301.9100-18T of this chapter are not 
required to amend statements previously furnished which meet the 
requirements of Sec. 301.9100-17T(b)(1)(ii) of this chapter unless 
requested to do so by the district director. In applying the election to 
the taxable years affected, there shall be taken into account the effect 
that any adjustments resulting therefrom have on other items affected 
thereby and the effect that adjustments of any such items have on other 
taxable years. In the case of a member of a consolidated return group 
(as defined in paragraph (a) of Sec. 1.1502-1), section 503(c)(2) and 
paragraphs (b), (c), and (d) of this section shall be applied as if such 
member filed a separate return.
    (d) Revocation of election. A valid election under section 503(c)(2) 
shall be binding upon the taxpayer unless consent to revoke the election 
is obtained from the Commissioner. The application to revoke such 
election must be made in writing to the Commissioner of Internal 
Revenue, Washington, D.C. 20224, not later than May 30, 1973. Such 
application must set forth the reasons therefor and a recomputation of 
the tax reflecting such revocation for each prior taxable year affected 
by the revocation, whether or not the period of limitations for credit 
or refund or assessment and collection has expired with respect to such 
taxable year. Consent shall not be given in any case in which the 
revocation would result in an increase in the taxpayer's tax liability 
for a taxable year for which such period of limitations has expired 
unless the taxpayer waives his right to assert the statute of 
limitations.
    (e) Special rule. (1) Except as provided in subparagraph (2) of this 
paragraph, in the case of a taxpayer who does not make the election 
provided in section 503(c)(2) of the Tax Reform Act of 1969,

[[Page 551]]

section 636 of the Code applies to production payments carved out during 
the taxable year which includes August 7, 1969, as provided in paragraph 
(a) of this section, only to the extent that the aggregate amount of 
such production payments exceeds the lesser of:
    (i) The excess of:
    (a) The aggregate amount of production payments carved out and sold 
by the taxpayer during the 12-month period immediately preceding his 
taxable year which includes August 7, 1969, over
    (b) The aggregate amount of production payments carved out and sold 
before August 7, 1969, by the taxpayer during his taxable year which 
includes such date, or
    (ii) The amount necessary to increase the amount of the taxpayer's 
gross income within the meaning of chapter 1 of subtitle A of the Code, 
for his taxable year which includes August 7, 1969, to an amount equal 
to the amount of his deductions (other than any deduction under section 
172) allowable for such year under such chapter.

In applying the preceding sentence, production payments carved out for 
exploration or development are to be taken into account only to the 
extent, if any, that gross income from the property (for purposes of 
section 613) would have been realized by the taxpayer creating such 
production payment under the law existing at the time of the creation of 
such production payment, in the absence of section 636(a).
    (2) Subparagraph (1) of this paragraph shall not apply for any 
taxable year for purposes of determining the amount of any deduction for 
cost or percentage depletion allowable under section 611 or the 
limitation on any foreign tax credit under section 904.
    (3) The application of this paragraph may be illustrated by the 
following examples:

    Example 1. (a) A, a calendar-year taxpayer who does not make the 
election provided in section 503(c)(2) of the Tax Reform Act of 1969, 
carves out and sells on December 31, 1968, a $500,000 production 
payment. Further, A carves out and sells on March 4, 1969, a $300,000 
production payment, and on November 14, 1969, a $150,000 production 
payment. None of the production payments are carved out for exploration 
or development. During 1969, A has gross income of $600,000 (determined 
initially for this purpose by treating the $150,000 production payment 
carved out on November 14, 1969, as a loan) and allowable deductions of 
$700,000.
    (b) The provisions of section 636 do not apply to a portion of the 
November 14, 1969, production payment for purposes other than section 
611 and section 904 of the Code, determined as follows:

(1) Amount of production payment carved out in 1969 on or       $150,000
 after August 7, 1969........................................
(2) Amount of production payment carved out during 1968......    500,000
(3) Amount of production payment carved out during 1969          300,000
 taxable year before August 7, 1969..........................
                                                              ----------
(4) Item (2) minus item (3)..................................    200,000
(5) Excess of allowable deductions over gross income for 1969    100,000
(6) Amount of production payment carved out in 1969 on or        100,000
 after August 7, 1969, to which section 636 does not apply
 (lesser of items (1), (4), and (5)).........................



Thus, A will not treat $100,000 of the consideration received for the 
production payment carved out on November 14, 1969, as a loan and as a 
result his gross income for 1969 will be $700,000. However, in computing 
percentage depletion, A will not include the $100,000 in gross income 
from property and in computing cost depletion A will not include the 
mineral units attributable thereto. Nor, will A include the $100,000 in 
determining the limitation on foreign tax credit under section 904.
    Example 2. Assume the same facts as in example 1 except that for 
taxable year 1969 A's gross income (determined initially for this 
purpose by treating the November 14, 1969, production payment as a loan) 
exceeds the amount of his allowable deductions under chapter 1 of 
subtitle A of the Code. The entire amount of the November 14, 1969, 
production payment is treated as a mortgage loan under section 636(a).

[T.D. 7261, 38 FR 5465, Mar. 1, 1973, as amended by T.D. 8435, 57 FR 
43896, Sept. 23, 1992]

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