                       126 T.C. No. 14



                   UNITED STATES TAX COURT



   PEABODY NATURAL RESOURCES COMPANY, f.k.a. HANSON NATURAL
RESOURCES COMPANY, CAVENHAM FOREST INDUSTRIES, INC., A PARTNER
       OTHER THAN THE TAX MATTERS PARTNER, Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



   Docket Nos. 20328-04, 6899-05.    Filed May 8, 2006.



        A partnership exchanged operating gold mines,
   including realty, for operating coal mines. The coal
   mines were subject to two coal supply contracts that
   obligated the mine owner to provide electric utilities
   with coal. The benefits and obligations under the
   contracts were governed by New Mexico law. The gold
   mines were not subject to supply contracts. The
   partnership treated the entire exchange as “tax free”
   under sec. 1031, I.R.C. R determined that the coal
   supply contracts were not real property and/or like-
   kind property and constituted “boot” so that the value
   of the supply contracts would be taxable in the year of
   the exchange.

        Held: The coal supply contracts were covenants
   running with and appurtenant to the real property under
                                - 2 -

     New Mexico law. Held, further, amplifying the holding
     in Koch v. Commissioner, 71 T.C. 54 (1978), the coal
     supply contracts are “like-kind” property within the
     meaning of sec. 1031, I.R.C., and are not taxable as
     part of the exchange.



     Martin D. Ginsburg, Alan S. Kaden, and Richard A. Wolfe, for

petitioner.

     Alan M. Jacobson and Donald L. Wells, for respondent.



                               OPINION


     GERBER, Chief Judge:    The parties filed motions for summary

judgment1 under Rule 1212 at docket No. 20328-04 with respect to

the issue of whether coal supply contracts that burdened coal

mine property received by a partnership, as part of an exchange

under section 1031, are like-kind property to the gold mining

property transferred by the partnership.

                             Background

         On June 25, 1993, Peabody Natural Resources Co. (a

partnership then known as Hanson Natural Resources Co.) (Peabody)


     1
      Respondent filed a cross-motion for partial summary
judgment, as his position, if correct, would not have resolved
all controversy between the parties. However, the partnership’s
position, if correct, would be dispositive of all matters in
controversy.
     2
      All Rule   references are to the Tax Court Rules of Practice
and Procedure,   and all section references, unless otherwise
indicated, are   to the Internal Revenue Code as amended and in
effect for the   years in issue.
                               - 3 -

transferred the assets of its gold mining business to Santa Fe

Pacific Mining Corp. (Santa Fe), an unrelated corporation, in

exchange for the assets of Santa Fe’s coal mining business.    The

parties to the exchange agreed that the mining assets exchanged

by each had a total value of approximately $550 million.    Peabody

treated the transaction as a like-kind exchange under section

1031.

     The transfer by Peabody to Santa Fe was of gold mines and

other gold mining property (including buildings and other

improvements, machinery and equipment, and mine exploration and

development rights).   In exchange, among other things, Peabody

(1) received from Santa Fe the Lee Ranch coal mine in New Mexico

(which included fee simple land and coal leases to other land

giving the leaseholder rights to the coal in place) and (2)

assumed all obligations of Santa Fe under two long-term coal

supply contracts entered into in the early 1980s by Santa Fe with

Tucson Electric Power Co. (TEPCO) and Western Fuels (WEF),

respectively.   The Lee Ranch was in a remote part of New Mexico

and consisted of 13,594 acres of fee simple land and 1,800 acres

of leased coal land.   During the early 1990s, the annual coal

output of the Lee Ranch mine was approximately 3.2 million to 5.0

million tons.   At the time of the June 25, 1993, exchange, the

Lee Ranch mine contained coal reserves of approximately 200
                               - 4 -

million tons.   The gold mines received by Santa Fe were not

burdened by gold supply contracts.

     The TEPCO supply contract began during 1983.   In connection

with TEPCO’s 1991 bankruptcy, however, the contract was

renegotiated resulting in a coal price reduction from the

original 1983 contract.   The renegotiated contract was for a

period ending December 31, 2009.   Either party, however, could

extend the contract for additional 5-year periods if the parties

were able to negotiate a good faith price that reflected the

then-current market price for coal.    Under the contract, Santa Fe

was the exclusive supplier of the coal required for the operation

of Units 1 and 2 of TEPCO’s Springerville Station power plant,

and TEPCO was obligated to purchase a specified annual minimum

amount of coal.   There was no maximum limit on the amount of coal

that Santa Fe could sell to TEPCO under the contract.   The

contract, however, did contain estimates that the combined

requirements of Springerville Station Units 1 and 2 would range

from .6 million to 2.34 million tons per year during the term of

the contract.   The quality of the coal was defined in the

contract, and the type of coal specified in the contract was the

type of coal produced in the Lee Ranch mine.   Under the contract,

Santa Fe committed to use its best efforts to mine the Lee Ranch

mine’s coal reserves and to sell TEPCO the amount of coal needed

for operation of the Springerville Station power plant.
                                 - 5 -

     The per-ton price of coal under the TEPCO contract was a

base price adjusted by Santa Fe’s actual mining costs.       The

contract was to run through December 31, 2009, or until the

retirement of the power station but could be reopened for

contract price renegotiation during July 2008 and at 5-year

intervals after 2010.   Specifically, the contract term was to

extend until the earlier of either:      (1) The date when

Springerville Station Units 1 and/or 2 were retired from

commercial operation; or (2) sometime after December 31, 2009, if

the parties were unsuccessful in their good faith price

renegotiations for any contract extension period.      During the

contract term Santa Fe was not permitted to sell coal to others

if such sales would impair its ability to satisfy the supply

contract obligations to TEPCO.

     The TEPCO supply contract “[inured] to the benefit of and

[was] binding upon the Parties and their respective successors

and assigns.”   The original 1983 contract allowed each party to

assign its rights and duties so long as the assignee or delegatee

“assumes” the rights and duties of the assignor and so long as

the assignee or delegatee is “capable of performing this

Agreement.”   The 1983 contract also required any assumption by an

assignee to be accomplished in a written document entered into

with the other parties to the 1983 contract.
                               - 6 -

     The WEF supply contract, also entered into in 1983, was

between Santa Fe and WEF, a nonprofit cooperative comprising a

group of relatively small electric utilities.    WEF, in turn,

would sell the coal to another cooperative, Plains Electric

Generation & Transmission Cooperative, Inc. (Plains), for use in

its Escalante Power Plant.   Although the WEF supply contract is

primarily between Santa Fe, as the seller, and WEF, as the buyer,

that supply contract identified Plains as the guarantor of WEF’s

performance under that contract.   That contract contained the

recitation that WEF and Plains “desire to secure a reliable and

reasonably priced supply of coal of the quality and quantities as

set forth herein for use in the generation of electricity in Unit

I, and potentially in an additional Unit II, of the [Escalante]

Station.”   That contract also contained a price renegotiation

provision that took effect in 1993 under which WEF could

terminate the contract if a new long-term coal price were not

negotiated.

     On account of WEF’s deteriorating financial condition, it

sought to renegotiate its contract.    During 1990 the pricing

provisions were modified resulting in coal price reductions and

changes in other contract provisions.    The renegotiated WEF

contract ran until December 31, 2004, and could be extended for

up to three 10-year periods by either party.    Each 10-year

extension depended on the parties’ ability to renegotiate and
                               - 7 -

agree to a new coal price which, in the parties’ views, reflected

the then market price for coal.

     Santa Fe was required to maintain coal reserves adequate to

supply the quantity of coal called for under the WEF contract.

The WEF contract provided that any party subsequently acquiring

an interest in the Lee Ranch mine coal reserves “shall take such

interest subject to the dedication and reservation” of said

reserves.   The contract also provided that the “dedication” was

not intended to be construed as a transfer to WEF of an interest

in the coal in place, but that it was “imposed as and * * *

[constituted] both an equitable servitude binding upon * * *

[Santa Fe] and * * * [its] successors and assigns and a covenant

running with * * * [Santa Fe’s] interest”.

     The contract price was based on a complex formula that, to

some extent, was based on the variable and fixed costs incurred

by Lee Ranch mine in supplying coal under the contract.   Under

the WEF contract, Santa Fe was the exclusive supplier of the

Escalante Station’s coal needs within minimum quantity and

quality standards, on an annual basis, with no limit on the

amount of coal that could be sold to WEF.    The contract, however,

did contain an estimate of the Escalante Station’s requirements

as being .5 million to 2.3 million tons per year.   Under the WEF

contract, Santa Fe had “the right to supply all of the Usage *     *

* for each Year.”   Santa Fe could not sell coal from the Lee
                                - 8 -

Ranch mine to others if doing so would impair its ability to

satisfy its coal supply contract obligations to WEF.

     The WEF contract terms were to be interpreted under the laws

of New Mexico.    Under the WEF contract, Santa Fe would be allowed

to supply coal from mines other than Lee Ranch mine if it were

unable to remove coal from Lee Ranch mine on account of a force

majeure.   The WEF supply contract provided that it would “inure

to the benefit of and be binding upon the Parties and their

respective successors and assigns.”

     Peabody and Santa Fe determined that the mining assets each

exchanged had a total value of approximately $550 million.    In

accordance with section 1.1031(j)-1(a)(2), Income Tax Regs.,

Peabody separated into exchange groups the assets it transferred

and received.    Peabody treated the gold mines, coal mine

reserves, and appurtenant supply contracts as real property.    It

valued the Lee Ranch mine coal reserves at $272.1 million.     On

its income tax returns for the years in issue, Peabody treated

its exchange of the gold mining assets for coal mining assets as

a like-kind exchange under section 1031.
                                - 9 -

     In the notices of final partnership administrative

adjustment for Peabody’s taxable years ended March 31, 1994

through 1996, and its short taxable year ended June 30, 1996,

respondent determined that the supply contracts were not like-

kind property as to which Peabody was entitled to nonrecognition

treatment under section 1031.

                            Discussion

     The focus of this case concerns a section 1031 like-kind

exchange of gold mines for coal mines.   Respondent acknowledges

that the coal mines and gold mines are like-kind property as to

which Peabody is entitled to nonrecognition treatment under

section 1031(a).   In petitioner’s motion for summary judgment and

respondent’s cross-motion for partial summary judgment, the

parties disagree about whether two coal supply contracts are real

property and/or like-kind property within the meaning of section

1031 (i.e., whether the coal supply contracts are boot).

     Initially, we must decide whether the coal supply contracts

are considered or treated as real property under New Mexico law.

We must also decide whether those contracts, in the setting of

this case, constitute “like-kind” property within the meaning of

section 1031.

     Summary judgment is intended to expedite litigation and

avoid unnecessary and expensive trial.   Fla. Peach Corp. v.

Commissioner, 90 T.C. 678, 681 (1988).   Summary judgment may be
                                - 10 -

granted with respect to a legal issue, if there is “no genuine

issue as to any material fact and * * * a decision may be

rendered as a matter of law.”    Rule 121(a) and (b); Craig v.

Commissioner, 119 T.C. 252, 259-260 (2002); Sundstrand Corp. v.

Commissioner, 98 T.C. 518, 520 (1992), affd. 17 F.3d 965 (7th

Cir. 1994).    There is no disagreement between the parties as to a

material fact, and therefore this matter is ripe for summary

judgment.

I.   New Mexico Law:   Are the Supply Contracts Real Property?

     Petitioner argues that the supply contracts are real property

under New Mexico law, whereas respondent argues the contracts are

not real property but some type of intangible right.

      A.   Petitioner’s Arguments

      Petitioner contends that the supply contracts are real

property under New Mexico law.      Petitioner asserts that each

contract established a servitude under which Santa Fe and

successive owners of the Lee Ranch mine land have the obligation

to mine and supply the coal needed pursuant to that contract to

operate the utility’s power plant.       This servitude, petitioner

maintains, is a real property interest under New Mexico law.

      B.   Respondent’s Arguments

      Respondent contends that the supply contracts are not real

property under New Mexico law, relying on the fact that the

contracts did not result in a transfer of ownership of the coal
                                 - 11 -

to the buyer/utility.      Respondent also points out that under

neither contract did the utility have the right to go onto the

Lee Ranch land and extract coal.      Instead, respondent contends

Peabody had to mine and supply the coal required by the utility’s

power plant.      Accordingly, respondent concludes that the supply

contracts are not real property but contracts to sell personal

property.    See Townsend v. State ex rel. State Highway Dept., 871

P.2d 958, 959 (N.M. 1994) (observing that though mineral-in-place

interests constitute real property, the underlying minerals are

transformed into personal property when the mineral or physical

substance is severed from the land).

     C.     Analysis of Coal Supply Contracts Under New Mexico Law

     We begin our analysis by noting that the supply contracts

are contracts for the sale of goods under New Mexico law.      In

addition, each contract created a servitude obligating Santa Fe

and subsequent owners of the Lee Ranch mine to extract and supply

coal to the power plant.      We conclude that under New Mexico law,

the supply contract servitudes constitute real property

interests, for reasons we will discuss.

             1.   Status as Contracts for the Sale of Goods

     Minerals in place (i.e., minerals lying unworked beneath or

on the surface of the land) are considered part of that land, and

an interest in minerals in place is real property for purposes of

New Mexico law.      Interests in minerals in place can be separately
                              - 12 -

conveyed to and held by someone other than the owner of the

surface estate.   After the minerals are severed and removed from

the land, they become personal property.    See generally id. at

959; 58 C.J.S., Mines and Minerals, sec. 141 (1998).

     As pertinent to this case, New Mexico has adopted section 2-

107 of the Uniform Commercial Code, which addresses minerals to

be severed from realty by the seller.   In pertinent part, N.M.

Stat. Ann. section 55-2-107 (Michie 1993) provides:

     Sec. 55-2-107.   Goods to be Severed from Realty;
     Recording

     (1)   A contract for the sale of minerals or the like
           (including oil and gas) * * * to be removed from
           realty is a contract for the sale of goods within
           this article if they are to be severed by the
           seller but until severance a purported present
           sale thereof which is not effective as a transfer
           of an interest in land is effective only as a
           contract to sell.

           *      *    *      *     *      *    *

     (3)   The provisions of this section are subject to any
           third party rights provided by the law relating to
           realty records, and the contract for sale may be
           executed and recorded as a document transferring
           an interest in land and shall then constitute
           notice to third parties of the buyer’s rights
           under the contract for sale.

Accordingly, the TEPCO and WEF coal supply contracts are

contracts for the sale of goods under New Mexico law.3



     3
      N.M. Stat. Ann. sec. 55-2-106(1) (Michie 1993) and sec.
2-106(1) of the Uniform Commercial Code each define a “contract
for sale” to include both a present sale of goods and a contract
to sell goods in the future.
                               - 13 -

     Even though coal supply contracts are contracts for the sale

of goods covered by article 2 of the Uniform Commercial Code, the

obligation of Santa Fe or its successors to sell unsevered coal

in the future may also qualify to be treated as the transfer of

an interest in land.    See N.M. Stat. Ann. sec. 55-2-107(1).   In

other words, classification of the two supply contracts as

contracts for the sale of goods in the future by N.M. Stat. Ann.

section 55-2-107(1), does not preclude those contracts from also

effecting a transfer of an interest in real property under New

Mexico law.    See also 1 Restatement, Contracts 2d, sec. 127, cmt.

b & c (1981).

          2.    Creation of Servitudes

     The TEPCO and WEF coal supply contracts created servitudes

under New Mexico law.    The modern view is that servitudes may be

created by contract.    See Cafeteria Operators, L.P. v. Coronado-

Santa Fe Associates, L.P., 952 P.2d 435, 441 (N.M. Ct. App.

1997); 1 Restatement, Property 3d (Servitudes), sec. 2.1(1)(a),

reporter’s note (2000).

     Although he disputes that the supply contracts created

servitudes under New Mexico law, respondent acknowledges that the

servitudes (stemming from the seller’s obligation to mine and

supply coal from the Lee Ranch mine property to the

buyer/utility) involve affirmative covenants.    See 1 Restatement,
                                - 14 -

Property 3d (Servitudes), sec. 1.3(1) & (2), cmt. d, illus. 1 &

2.4

       New Mexico law recognizes both “real covenants” and

“equitable servitudes”.5     E.g., Pollock v. Ramirez, 870 P.2d 149,

153 (N.M. Ct. App. 1994).     In Pollock, a restrictive covenant was

not enforceable because the instrument creating it did not meet

the requirements for recordation in real property records.     The

court in Pollock, however, noted that the restriction could still

be enforced as an equitable servitude assuming the requirements

for establishing and enforcing such an equitable servitude were

met.       See id. at 153.

       Under New Mexico law, there are three requirements for a

covenant to be an equitable servitude:     (1) The covenant must

touch and concern the land; (2) the original “covenanting”


       4
      Vol. 1 Restatement, Property 3d (Servitudes), sec. 1.1
(2000) defines a “servitude” as a legal device that creates a
right or an obligation that runs with land or an interest in
land. “Running with land” means that the right or obligation
passes automatically to successive owners or occupiers of the
land or the interest in land with which the right or obligation
runs. Id. sec. 1.1(1)(a). Servitudes covered by the Restatement
include easements, profits, and covenants. Id. sec. 1.1(2). As
defined by the Restatement, an “easement” creates a nonpossessory
right to enter and use land in the possession of another and
obligates the possessor not to interfere with the uses authorized
by the easement, whereas a “profit” is an easement that confers
the right to enter and remove timber, minerals, oil, gas, game,
or other substances from land in possession of another. Id. sec.
1.2(1) & (2).
       5
      Vol. 1 Restatement, supra sec. 1.4 has dropped the terms
“real covenant” and “equitable servitude” to describe servitudes
encompassed within covenants that run with the land.
                              - 15 -

parties must intend that covenant to run with the land; and (3)

any successor against whom enforcement is sought must have

actual, constructive, or inquiry notice of that covenant.     Lex

Pro Corp. v. Snyder Enters., Inc., 671 P.2d 637, 639 (N.M. 1983);

Pollock v. Ramirez, supra at 153.

     In Lex Pro Corp. v. Snyder Enters., Inc., 100 N.M. at 391,

the New Mexico Supreme Court observed that a covenant touches and

concerns the land if either (1) the burden of that covenant

renders the covenantor’s interest in land less valuable or (2)

the benefit of that covenant renders the covenantee’s interest in

land more valuable.   The New Mexico courts have also held that a

covenant meets the “touch and concern” requirement if it calls

for either doing physical things to the land such as building a

wall, or refraining from doing physical things to the land.

Cypress Gardens, Ltd. v. Platt, 952 P.2d 467, 470 (N.M. Ct. App.

1997).   The TEPCO and WEF supply contract obligations of Santa Fe

and its successors to mine and supply coal from the Lee Ranch

mine property do touch and concern that land.6

     As to the second requirement that the original covenanting

parties intend that the covenant run with the land, the WEF

supply contract specifically expresses an intent to effect a


     6
      Although 1 Restatement, supra sec. 3.2, now requires
neither the benefit nor the burden of a covenant to touch and
concern land in order for the covenant to be valid as a
servitude, we need not here decide whether this requirement has
been superseded under New Mexico law.
                               - 16 -

dedication of the Lee Ranch mine coal reserves to fulfilling that

contract and to establish a servitude upon Santa Fe and its

successors running with the Lee Ranch mine property.   Although

the TEPCO supply contract contains no specific provision, it

provides that the agreement is to inure to the benefit of and be

binding upon respective successors to and assigns of the original

parties to the TEPCO contract.   Where the original instrument

creating a covenant involving land provided that successors

should be bound by the covenant and where only successive owners

of the land were capable of performing the obligation pertaining

to that covenant, that covenant has been held to run with the

land.    Murphy v. Kerr, 5 F.2d 908, 910 (8th Cir. 1925); Bolles v.

Pecos Irr. Co., 167 P. 280, 282-283 (N.M. 1917).7

     As to the requirement that the successor against whom

enforcement of that covenant is sought have actual, constructive,

or inquiry notice, Peabody had actual notice of the TEPCO and WEF

coal supply contract obligations, as it assumed those contracts.

In addition, a memorandum of dedication concerning the WEF

contract was recorded in 1985 with the County Clerk for McKinley

County, New Mexico, the county in which the Lee Ranch mine is



     7
      See also 1 Restatement, supra sec. 2.2, cmt. i (“If the
contract calls for a performance that can only be rendered by
someone who owns or occupies a particular parcel of land, and if
it would have little value to the other party if it could be
terminated by a conveyance of that land, the burden was probably
intended to run with the land of the promisor.”).
                                - 17 -

located.

       We hold that the TEPCO and WEF coal supply contracts created

servitudes obligating Santa Fe and successive owners of the Lee

Ranch mine to mine and supply coal to the buyer/utility and that

those servitudes are real property interests under New Mexico

law.    See 1 Restatement, Property 3d (Servitudes), sec. 2.1 cmt.

b, illus. 4.

II.    Like-Kind Status of the Supply Contracts Under Section 1031

       A.   Petitioner’s Arguments

       Petitioner contends that the real property status of the

supply contracts under New Mexico law should be determinative of

the like-kind issue; i.e., should automatically qualify the

contracts as like-kind property to the gold mining property under

section 1031(a).     In support of this argument, petitioner, among

other things, relies on this Court’s holding in Or. Lumber Co. v.

Commissioner, 20 T.C. 192, 196-197 (1953).    Petitioner notes that

this Court held in Or. Lumber Co. that the rights to harvest

standing timber were personal property under Oregon law and

therefore were not like-kind property to land (real property)

received in exchange.

       If the status of the supply contracts as real property is

held not in and of itself to be dispositive, petitioner

alternatively argues the supply contracts are like-kind property

to the gold mining property because the contracts (including
                               - 18 -

potential renewals) could have a duration or term lasting 30 or

more years.   Petitioner’s argument is based on section 1.1031(a)-

1(c), Income Tax Regs., which provides a safe harbor for a 30-

year or greater leasehold of a fee to qualify as “like kind” to a

fee interest in real property.

     Finally, petitioner places reliance in Koch v. Commissioner,

71 T.C. 54, 65-70 (1978), a case which petitioner contends is

indistinguishable from the circumstances we consider here.    In

that case, this Court held that two parcels of fee simple real

property were like kind, under section 1031(a), even though one

parcel was subject to 99-year condominium leases.   In Koch, it

was reasoned that the leases did not constitute boot because they

were not separable from the fee simple real property interest.

     B.   Respondent’s Arguments

     Conversely, respondent contends that the fact that the

supply contracts are treated as real property interests under New

Mexico law does not conclusively establish that they are like

kind to the gold mining property Peabody transferred.   Respondent

argues that like kind status of the supply contracts, for

purposes of section 1031, is a question of Federal tax law.

Respondent also notes that section 1031 case precedent does not

support the axiom that exchanges of real property are ipso facto

like kind.    On this point, see Koch v. Commissioner, supra at 64-

65 (citing Fleming v. Commissioner, 24 T.C. 818, 823-824 (1955),
                               - 19 -

affd. in part and revd. in part 241 F.2d 78 (5th Cir. 1957),

affd. sub nom. Commissioner v. P.G. Lake, Inc., 356 U.S. 260

(1958)).    Respondent contends that the supply contracts

constitute property of a different kind and class and are not

like-kind property to the gold mining property Peabody

transferred, because the contracts are of an intrinsically

different nature and character from gold mining property.    See

sec. 1.1031(a)-1(b), Income Tax Regs.

     Finally, respondent argues that Koch is distinguishable from

and inapplicable to this case because the condominium leases in

Koch were 99-year (long-term) land leases, whereas the coal

supply contracts we consider are only interests in coal to be

removed from the ground.8   Respondent also attempts to

distinguish Koch, where condominium leaseholders had the primary

right directly to use the land, from this case, where the coal

buyers have no direct and substantially similar right to use the

Lee Ranch mine land.

     C.    Analysis

     We agree with respondent that exchanges of real property

interests are not, ipso facto, like-kind exchanges under section

1031.    Koch v. Commissioner, supra at 64-65; see also Smalley v.



     8
      We note that respondent does not carry this reasoning into
the question of whether the Lee Ranch mine (land in fee and coal
leases) is like-kind property to the two gold mine properties
received in exchange.
                               - 20 -

Commissioner, 116 T.C. 450, 463-464 (2001).   For example, carved-

out oil payments, although characterized as real property under

State law, were found not to be like kind to a fee interest in

real estate.   Fleming v. Commissioner, supra at 823-824.    See

also Wiechens v. United States, 228 F. Supp. 2d 1080, 1085 (D.

Ariz. 2002), where 50-year water rights were not like kind to a

fee interest in real estate, and Clemente, Inc. v. Commissioner,

T.C. Memo. 1985-367, where an 8-acre parcel of land was not like

kind to gravel extraction rights in another parcel of land.

     To decide whether an exchange is like kind within the

meaning of section 1031(a), we must compare the exchanged

properties to ascertain whether the nature and character of the

transferred rights in and to the respective properties are

substantially alike.    Koch v. Commissioner, supra at 64-65; sec.

1.1031(a)-1(b), Income Tax Regs.   See generally the discussion in

Smalley v. Commissioner, supra at 461-464.    We conclude that the

real property interest status under New Mexico law of the TEPCO

and WEF supply contracts is not determinative of whether those

supply contracts constitute like-kind property as opposed to boot

under section 1031.    See Koch v. Commissioner, supra at 64-65.

In making this comparison, consideration is to be given to the

respective interests in the physical properties, the nature of

the title conveyed, the rights of the parties, the duration of

the interests, and any other factor bearing on the nature or
                               - 21 -

character of the properties as distinguished from their grade or

quality.    Id.; sec. 1.1031(a)-1(b), Income Tax Regs.

     In Commissioner v. Crichton, 122 F.2d 181, 182 (5th Cir.

1941), affg. 42 B.T.A. 490 (1940), the Court of Appeals for the

Fifth Circuit held that the exchange of an overriding royalty

interest in minerals for a city lot qualified as a like-kind

exchange.   See also Rev. Rul 68-331, 1968-1 C.B. 352, in which it

was ruled that the exchange of an oil producing lease for a fee

simple title to a ranch qualified as a like-kind exchange.

     Conversely, in Fleming v. Commissioner, 24 T.C. at 823-824,

we held that the exchange of an assignment of carved-out oil

payment rights for a fee interest in real estate failed to

qualify because they were not like-kind properties, even though

applicable State law characterized the oil payment rights as an

interest in real estate.

     In Koch v. Commissioner, 71 T.C. at 65, we reconciled the

difference in the holdings of Crichton and Fleming as follows:

     The main distinction between the two transactions is
     the duration of the interests--an overriding royalty
     interest continues until the mineral deposit is
     exhausted whereas a carved-out oil payment right
     terminates usually when a specified quantity of
     minerals has been produced or a stated amount of
     proceeds from the sale of minerals has been received.

     Petitioner attempts to distinguish the coal supply contracts

here from the carved-out production payment rights in Fleming, on

the basis that the supply contracts are more extensive in scope
                               - 22 -

and duration.   Petitioner argues that the contracts involve

“essentially perpetual and unlimited rights” and meet the 30-

year-leasehold safe harbor of section 1.1031(a)-1(c), Income Tax

Regs., because each contract, with renewals, had 30 or more years

to run at the time of the exchange.

     Peabody’s right to mine and extract coal from the Lee Ranch

mine land derives solely from its ownership of the land in fee

and the coal leases making up that coal mine property, not from

the TEPCO and WEF contracts.   As previously discussed, the supply

contracts created servitudes obligating Peabody to mine and

supply coal from the Lee Ranch mine to the utility/buyers

pursuant to those contracts.   Those contracts themselves,

however, did not give Peabody the right to mine coal from the Lee

Ranch land.

     The supply contracts obligate each utility/buyer to pay a

specified price for Lee Ranch mine coal.   In other words, the

contracts afford Peabody specified payment rights with respect to

the coal supplied.   In that respect, Peabody’s supply contract

payment rights are incident to, derive almost exclusively from,

and cannot be separated from its ownership of the Lee Ranch mine

land.   It is Peabody’s ownership of that mine’s coal reserves

that gives Peabody the right to mine and extract coal from the
                                - 23 -

Lee Ranch mine land.9   In addition, unlike the overriding royalty

interests in Crichton, Peabody’s supply contract payment rights

do not necessarily last until coal on the Lee Ranch mine land has

been exhausted.   Without optional renewals, the TEPCO supply

contract lasts until December 31, 2009, and the WEF supply

contract lasts until December 31, 2004.   See, e.g., Clemente v.

Commissioner, T.C. Memo. 1985-367, where exchanged properties

were held not to be like kind because the gravel extraction right

the taxpayer received did not give that taxpayer the right to an

unlimited quantity of gravel.    By contrast, in Rev. Rul. 55-749,

1955-2 C.B. 295, the exchange of fee land for perpetual water

rights was ruled to be qualified as like kind.10


     9
      In his declaration, the Lee Ranch mine’s controller stated
that, to the best of his knowledge, all coal ever supplied under
the TEPCO and WEF supply contracts has come from the Lee Ranch
mine. In certain limited and/or remote circumstances, each
contract would permit the seller to furnish substitute coal from
a source other than the Lee Ranch mine. For instance, the seller
under the TEPCO contract commits to use its best efforts to mine
and supply to TEPCO such coal as is needed for operation of the
Springerville Station from the Lee Ranch mine’s coal reserves.
The TEPCO contract, however, provides that from “time to time”,
the seller may substitute coal from other mines owned by the
seller so long as the substituted coal delivered satisfies
prescribed quality requirements and does not cost more than coal
then being delivered to the Springerville Station from the Lee
Ranch mine. Similarly, during an event of force majeure, the WEF
supply contract would permit the seller, with the buyer’s
consent, to deliver substitute coal (i.e., coal obtained from a
source other than the Lee Ranch mine) to the Escalante Station.
     10
      In Rev. Rul. 55-749, 1955-2 C.B. 295, 296, the rationale
for the ruling included the following:

                                                     (continued...)
                              - 24 -

     However, Peabody seeks to come within the safe harbor of

section 1.1031(a)-1(c), Income Tax Regs., by relying on the

renewal terms of the supply contract that might cause the

contracts to last 30 years or more.11   In Century Elec. Co. v.

Commissioner, 15 T.C. 581, 591-592 (1950), affd. 192 F.2d 155

(8th Cir. 1951), we indicated that subsequent 10-year periods

were added to the initial term of a 25-year lease to meet the

requirements of a leasehold for 30 years or more under the

Treasury regulation safe harbor.   See also Rev. Rul. 78-72, 1978-

1 C.B. 258, which would allow the addition of optional renewal

periods to determine if a leasehold interest was for 30 years or

more.




     10
      (...continued)
     where the water right, whatever its size, is in
     perpetuity, as distinguished from a right to a specific
     total amount of water or to a specific amount of water
     for a limited period, the water rights and the land
     involved are regarded as sufficiently similar to
     constitute property of a like kind within the meaning
     of section 1031(a) of the Code. * * *
     11
      We previously have indicated that a short-term leasehold
of real property is not equivalent to a fee interest for purposes
of sec. 1031. Capri, Inc. v. Commissioner, 65 T.C. 162, 181-182
(1975); May Dept. Stores Co. v. Commissioner, 16 T.C. 547, 556
(1951); Standard Envelope Manufacturing Co. v. Commissioner, 15
T.C. 41, 48 (1950). As we observed in Smalley v. Commissioner,
116 T.C. 450, 464 n.11 (2001), this characterization of short-
term leasehold interests derives not from any particular State
law characterization but from negative implication of
longstanding regulations which provide that an exchange of a 30-
year lease for a fee interest qualifies as a like-kind exchange
under sec. 1031.
                               - 25 -

     Contrary to petitioner’s argument, the supply contract

payment rights are not a leasehold interest in a fee property.

As previously held, Peabody’s right to mine and extract coal from

that land comes solely from ownership of the coal mine.    We

therefore conclude that the 30-year safe harbor provisions of

section 1.1031(a)-1(c), Income Tax Regs., do not apply.    See

Wiechens v. United States, 228 F. Supp. 2d at 1085 (where it was

held that a taxpayer’s 50-year water rights were not equivalent

to a leasehold of a fee for 30 years or more so as to qualify for

the regulation safe harbor).

     The underlying rationale for allowing nonrecognition of gain

or loss under section 1031 is the concept that a taxpayer’s

economic situation following the exchange is essentially the same

as it had been before the transaction.   This is expressed in the

following quote from the committee report underlying the

predecessor statute to section 1031:    “if the taxpayer’s money is

still tied up in the same kind of property as that in which it

was originally invested, he is not allowed to compute and deduct

his theoretical loss on the exchange, nor is he charged with a

tax upon his theoretical profit”.   H. Rept. 704, 73d Cong., 2d

Sess. (1934), 1939-1 C.B. (Part 2) 554, 564; see also Biggs v.

Commissioner, 69 T.C. 905, 913 (1978), affd. 632 F.2d 1171 (5th

Cir. 1980).   The underpinning supporting section 1031(a) is that

the new property is substantially a continuation of the old
                                - 26 -

investment which remains unliquidated.      Commissioner v. P.G.

Lake, Inc., 356 U.S. at 268.

     In determining whether the like-kind requirement of section

1031 had been met, we found it significant in Koch v.

Commissioner, 71 T.C. at 65, that section 1031(a) refers to

property of a like, not an identical, kind.      The required

comparison of the old and new exchanged properties, we reasoned,

should be directed to whether the taxpayer, in making the

exchange, has used its property to acquire a new kind of asset or

has merely exchanged its property for an asset of like nature or

character.   Id.   Examining the exchanged properties in Koch with

those principles in mind, we held the taxpayer’s exchange of fee

simple land for other fee simple land subject to 99-year

condominium leases qualified for nonrecognition treatment under

section 1031(a) because those exchanged properties were property

of a like kind.    Id. at 65-70.

     In Koch, we rejected the Commissioner’s contention that the

taxpayer/lessor’s interests (primarily the right to condominium

rental payments) could be separated from the taxpayer’s fee

simple interest in that land.      We observed that:   (1) The

taxpayer’s right to rent was not a separate and distinct item of

property but part of the bundle of rights incident to ownership

of the fee; (2) the bundle of rights and its related obligations

were inextricably bound up with the fee simple interest; (3) the
                              - 27 -

condominium leases contained numerous provisions (some of which

we briefly summarized in our findings in Koch) not only securing

the payment of rent but also protecting the value of the

taxpayer’s reversionary interest; and (4) the right to rent was

merely an incident of ownership of the fee simple interest.      Id.

at 66-68.   We also acknowledged that the 99-year condominium

leases prevented the taxpayer from taking physical possession of

the land received and using it for other purposes.   We viewed

that leasehold restriction on the taxpayer’s use of the new land

as a distinction in the grade or quality of the exchanged old and

new properties as opposed to a difference in their kind or class.

We observed that section 1031(a) “‘was not intended to draw any

distinction between parcels of real property however dissimilar

they may be in location, in attributes, and in capacities for

profitable use.’”   Koch v. Commissioner, 71 T.C. at 68 (quoting

Commissioner v. Crichton, 122 F.2d at 182).12   Finally, in Koch

v. Commissioner, supra at 70, we held that the value of the

taxpayer’s condominium lease interests did not constitute taxable




     12
      Sec. 1.1031(a)-1(b), Income Tax Regs., contains the
explanation that the “like-kind” requirement concerns the nature
or character of property and not its grade or quality. As we
observed in Commissioner v. Crichton, 42 B.T.A. 490, 492 (1940),
affd. 122 F.2d 181 (5th Cir. 1941), substantially similar
interpretations of the term “like kind” have appeared in all
applicable regulations beginning with those issued under the
Revenue Act of 1921.
                               - 28 -

other property or boot under section 1031(b), because the

“lessor’s fee simple interest cannot be so fragmented.”

     In return for the gold mining property Peabody, among other

things, received the Lee Ranch coal mine, which was subject to

two coal supply contracts.    Respondent acknowledges that the Lee

Ranch mine (consisting of fee simple land and coal leases) is

like kind to the gold mining property and qualifies for

nonrecognition treatment under section 1031(a).13   Respondent,

however, contends this case is distinguishable from Koch.

Respondent argues that the coal supply contracts are separable

from the Lee Ranch mine and constitute taxable other property or

boot under section 1031(b).   In other words, respondent argues

those two supply contracts can be fragmented and are not

inextricably bound up with Peabody’s ownership of the Lee Ranch

mine’s coal reserves.   We disagree.

     Although each supply contract is also a contract for the

sale of goods under New Mexico law and does not give the

utility/buyer a right to extract coal from the Lee Ranch mine

land, in the context of this case we do not find those

distinctions to be significant nor to sufficiently distinguish

this case from Koch.    Peabody’s right to mine and extract coal


     13
      Apparently, respondent does not dispute that the exchange
of leasehold for fee interest here is all right. In addition
Peabody’s right to mine and extract coal from the Lee Ranch mine
is obviously substantially alike to the right to mine and extract
gold from the two gold mines.
                                - 29 -

from the Lee Ranch mine land and its supply contracts payment

rights for the coal cannot be separated from its ownership of the

Lee Ranch mine coal reserves.    Those rights are part of the

bundle of rights incident to Peabody’s ownership of the Lee Ranch

mine land coal reserves.   Indeed, those supply contracts give

Peabody no right to mine and extract coal from that land.

Instead, Peabody’s right to mine and extract coal from that land

comes solely from its ownership of that land and coal reserves.

     As to the right to payment under the contracts for coal

furnished, those rights are ancillary to Peabody’s ownership of

the coal reserves.   Accordingly, the question of whether the

supply contracts afford an advantageous or detrimental coal price

to Peabody is immaterial in that setting.    See Koch v.

Commissioner, 71 T.C. at 68.    Because we hold that the right to

receive income from the tenant is part of the bundle of rights

ancillary to and inherent in the ownership of the realty, the

question of whether the lease was advantageous or detrimental to

the fee owner is immaterial.

     It is true Peabody is obligated to mine and supply coal to

meet the operating needs of power stations and that Peabody is

prohibited from impairing the contracted-for supply by selling

coal to other buyers.   In our view those contract obligations and

restrictions constitute a distinction in the grade or quality of

the old and new mining properties rather than a difference in
                               - 30 -

their kind or class.   The new coal mine property is of a like

nature or character to the gold mining property Peabody

exchanged.   By exchanging the gold mining property for the coal

mining property subject to the supply contracts, Peabody is

essentially continuing the original investment which remains

fully unliquidated.    See Commissioner v. P.G. Lake, Inc., 356

U.S. at 268.   Respondent, contrary to our holding in Koch, is

attempting to fragment and currently tax Peabody on the supply

contracts before their actual realization.

     We hold that the coal mine subject to the TEPCO and WEF

supply contracts Peabody received is like kind to the gold mining

property transferred and that Peabody’s exchange qualifies for

nonrecognition treatment under section 1031(a).   See Koch v.

Commissioner, 71 T.C. 54 (1978).    In the light of that holding

and because the supply contracts cannot be separated from

Peabody’s ownership of the Lee Ranch mine coal reserves, it

follows that those contracts are not taxable as other property or

boot under section 1031(b).   See id.
                               - 31 -

     D.   Conclusion

     On the basis of the forgoing, we conclude, as a matter of

law, that petitioner is entitled to summary judgment and

respondent is not so entitled.


                                 An appropriate order will be issued

                          at docket Nos. 20328-04 and 6899-05.




[Reporter’s Note: This Opinion was modified by Order dated July 13,

2006.]
