Coal supply contracts were not taxed when transferred as part of a swap of mining properties.

Peabody Natural Resources Company exchanged its gold mining business with Santa Fe Pacific Mining Co. for a coal mine in New Mexico and two long-term contracts to supply coal from the mine to Tucson Electric Power Company and Western Fuels.

Ordinarily when two companies exchange properties, the exchange triggers an income tax. Each company must compare the fair market value of what it received to the “tax basis” it had in the property it exchanged. The difference is taxable gain.

However, no tax is triggered if the properties being swapped are of a “like kind.” The IRS does not allow like-kind treatment for exchanges of most contracts. Peabody argued that it was exchanging real property — one mine for another — and the coal supply contracts were a kind of real property right tied to the mine.

The US Tax Court agreed in early May. The court said the key was New Mexico law treats the supply contracts as a “servitude,” or right to receive the coal dug out of the mine for the full terms of the contracts. The contracts burden what any owner can do with the mine. The case is Peabody Natural Resources Company v. Commissioner.

By Keith Martin