Final Regs Change Capitalization Rules for 'Pick and Pack' Costs

 [4830-01-u]

 ACTION: Final and temporary regulations.

 SUMMARY: This document contains final and temporary regulations under section 263A of the Internal Revenue Code of 1986 relating to accounting for costs incurred in producing property and acquiring property for resale. Section 263A was enacted as part of the Tax Reform Act of 1986. Changes to the applicable law were made by the Omnibus Budget Reconciliation Act of 1987, the Technical and Miscellaneous Revenue Act of 1988, and the Omnibus Budget Reconciliation Act of 1989. These final regulations primarily affect taxpayers subject to section 263A that acquire property for resale.

 EFFECTIVE DATE: August 5, 1994.

FOR FURTHER INFORMATION CONTACT: Rosemary DeLeone or Harry-Todd Astroy of the Office of the Assistant Chief Counsel, Income Tax and Accounting, (202) 622-4970 (not a toll-free number).

 SUPPLEMENTARY INFORMATION:

BACKGROUND

On March 30, 1987, and August 7, 1987, temporary regulations under section 263A were published in the Federal Register (TD 8131, 52 FR 10052 and TD 8148, 52 FR 29375). A public hearing was held on December 7, 1987. On August 9, 1993, final regulations under section 263A were published in the Federal Register (TD 8482, 58 FR 42198). In addition, a notice of proposed rulemaking was published on August 9, 1993, (58 FR 42263) regarding certain provisions that were reserved in the final regulations. A public hearing was held on November 30, 1993, on these provisions. After consideration of the public comments regarding the proposed regulations, the regulations are adopted as revised by this Treasury decision.

EXPLANATION OF STATUTORY PROVISIONS

 Section 263A (the uniform capitalization rules) was enacted as part of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 1986-3 C.B. (Vol. 1) (the 1986 Act). The statute was amended as part of the Omnibus Budget Reconciliation Act of 1987, Pub. L. 100-203, 101 Stat. 1330, 1987-3 C.B. 1 (the 1987 Act), the Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100-647, 102 Stat. 3342, 1988-3 C.B. 1 (the 1988 Act), and the Omnibus Budget Reconciliation Act of 1989, Pub. L. 101-239, 103 Stat. 2106 (the 1989 Act), 1990-1 C.B. 210.

 Section 263A provides a uniform set of rules that govern the capitalization of direct and indirect costs associated with property produced and property acquired for resale. Specifically, section 263A requires taxpayers to capitalize the direct and indirect costs properly allocable to real property and tangible personal property that they produce. Section 263A also requires taxpayers to capitalize the direct and indirect costs (including purchasing, handling, and storage costs) properly allocable to real property and personal property acquired for resale.

 The final regulations under section 263A that were published on August 9, 1993, generally require handling costs to be capitalized. Handling costs include costs attributable to processing, assembling, repackaging, transporting, and other similar activities, provided these activities do not come within the meaning of the term "produce" as defined in section 1.263A-2(a)(1). However, the final regulations under section 263A also provide that certain handling costs are not required to be capitalized. For instance, handling costs incurred at a retail sales facility with respect to property sold to retail customers at the facility are not required to be capitalized. In addition, handling costs incurred at a dual-function storage facility with respect to property sold to customers from the facility are not required to be capitalized to the extent that the costs are incurred with respect to property sold in on-site sales.

 The final regulations under section 263A that were published on August 9, 1993, reserve several provisions previously contained in the temporary regulations relating to certain other costs that were not considered handling costs. In particular, the regulations reserve provisions relating to distribution costs, custom-order delivery costs, and repackaging costs. After publishing a Notice of Proposed Rulemaking and considering public comments, these final regulations provide rules concerning such costs. In addition, these final regulations provide rules that permit the District Director to require appropriate adjustments to the valuation of inventories and other property subject to section 263A if a transfer of property is made to another person for a principal purpose of avoiding the application of section 263A.

PUBLIC COMMENTS

THE SCOPE OF DISTRIBUTION COSTS

 The proposed regulations provide that distribution costs are not required to be capitalized. The proposed regulations define distribution costs as any transportation costs incurred outside a storage facility in delivering goods to an unrelated customer. For this purpose, the proposed regulations state that any costs incurred on a loading dock are treated as incurred outside a storage facility.

 Several commentators argued that, in addition to transportation costs incurred outside a storage facility, distribution costs should also include all costs (i.e., labor equipment, and occupancy costs) incurred after a sales order has been received, regardless of whether these costs are incurred inside or outside a storage facility. They stated that the costs of retrieving the goods and readying them for shipment are more in the nature of deductible selling and distribution costs and do not relate to the production, acquisition, or holding of property.

 The preamble to the proposed regulations cites the Blue Book to the 1986 Act which states that deductible "distribution expenses are intended to include only external distribution costs, that is, those costs incurred in transporting goods from the taxpayer's warehouse or retail outlet to the customer, or to the customer's agent, a common carrier, or some other intermediary. Distribution expenses do not include costs of moving inventory from a taxpayer's warehouse to its retail store or other internal transportation costs." Joint Committee on Taxation Staff, General Explanation of the Tax Reform Act of 1986, 99th Cong., JCS-10-87, 510 n.61. Commentators contended that this reference was taken out of context and suggested that it should be used to define the nature of an activity (e.g., shipment to a customer vs. internal transfers) rather than the location of an activity (e.g., inside an off-site storage facility vs. the loading dock).

 These final regulations retain the definition of distribution costs contained in the proposed regulations. The Service and Treasury continue to believe that this definition of distribution costs provides for a better matching of income and related expenses because gross income is not typically recognized from the sale of an item when an order is placed, but rather when the item is shipped, delivered, or accepted, or when title to the item passes to the purchaser. Since costs incurred inside a storage facility are typically incurred prior to an item being shipped, delivered, or accepted, or when title passes, these costs should be capitalized until income is recognized.

 Furthermore, the Conference Report to the 1986 Act specifically states that "processing, assembly, rePackaging, and similar costs, including labor costs attributable to unloading goods (but not including labor costs attributable to loading of goods for final shipment to customers, or labor at a retail facility)" should be capitalized. H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II-306 (1986), 1986-3 (Vol. 4) C.B. 306. Thus, because Congress intended that costs incurred prior to loading goods for shipment be capitalized, distribution activities should not be construed to begin any earlier than at the loading dock.

PICK AND PACK COSTS AND REPACKAGING COSTS

 Several commentators have expressed concern that the definition of distribution costs contained in the proposed regulations may result in some taxpayers abandoning the use of the simplified resale method. In response, these final regulations except "pick and pack" costs from the scope of capitalizable handling costs incurred inside a storage facility. These final regulations define pick and pack costs as those casts incurred inside a storage facility in preparing specific goods for imminent shipment to a particular customer after the customer has ordered those goods. Examples of pick and pack costs include costs incurred to move specific goods from a storage location in preparation for shipment to the customer, pack or repack those goods for shipment to the customer, and stage those goods for shipment to the customer.

 Pick and pack costs, however, do not include occupancy costs, such as rent, depreciation, insurance, taxes, utilities, and maintenance. The Service and Treasury believe that the exclusion of these costs from the scope of pick and pack costs is consistent with Congressional intent that all off-site storage and warehousing costs be capitalized. See H. R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II-306 (1986), 1986-3 (Vol. 4) C.B. 306. Furthermore, this position is supported by the Conference Report to the 1986 Act. In a footnote to the Conference Report the conferees state that "[o]ffsite storage and warehousing costs generally include the cost of a facility whose primary function is the storage or warehousing of goods." H. R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II-306 (1986), 1986-3 (Vol. 4) C.B. 306. Thus, because the primary function of an off-site storage facility is the storage or warehousing of goods, all occupancy costs incurred at an off-site storage facility must be capitalized.

 Because the above rule for pick and pack costs essentially replaces the exception for repackaging costs contained in the proposed regulations, the separate exception for repackaging costs is unnecessary and has been eliminated.

COSTS OF DELIVERING CUSTOM-ORDERED ITEMS

 The proposed regulations provide that, notwithstanding the general requirement that costs incurred in transporting goods from a taxpayer's storage facility to its retail sales facility are required to be capitalized, costs incurred outside a storage facility in delivering custom-ordered items to a retail sales facility are not required to be capitalized. For this purpose, the proposed regulations provide that any costs incurred on a loading dock are treated as incurred outside a storage facility. The preamble to the proposed regulations also states that the Service is considering eliminating this exception altogether.

 Commentators contended that the custom-order exception should not be eliminated because these delivery costs are more appropriately characterized as costs incurred to ship goods directly to a customer rather than as costs incurred to internally move inventory. In addition, commentators asserted that the custom-order exception should not be limited to costs incurred outside a storage facility in delivering custom-ordered items to a retail sales facility. These commentators believe that all costs incurred in delivering custom-ordered items to a retail sales facility should be deductible, regardless of whether they are incurred inside or outside a storage facility.

 These final regulations retain the custom-order exception. The Service and Treasury believe that limiting this exception to costs incurred outside a storage facility in delivering custom-ordered items to a retail sales facility provides for a better matching of income and related expenses.

COSTS OF TRANSPORTING GOODS TO A RELATED PERSON

 The proposed regulations provide that distribution costs do not include costs incurred by a taxpayer in delivering goods to a related person. The proposed regulations further provide that when a taxpayer sells goods to a related person, the costs of transporting the goods are included in determining the basis of the goods that are sold, and hence in determining the resulting gain or loss from such sale, for all purposes of the Internal Revenue Code and the regulations thereunder. For purposes of this provision, the proposed regulation states that persons are related if they are described in section 267(b) or section 707(b).

 One commentator argued that the requirement to capitalize costs incurred by a taxpayer in delivering goods to a related person is contrary to the purported purpose of section 263A and can result in the permanent disallowance of the capitalized costs. The commentator noted that if the capitalization of costs incurred in transporting property between related parties produces or increases a loss, the loss disallowance rules in sections 267(a)(1) and 707(b)(1) may in some instances permanently disallow the loss. Thus, the commentator argued that the requirement to capitalize costs incurred by a taxpayer in delivering goods to a related person is unfair because it results in harsher treatment than the treatment of internal transportation costs carried on within a single entity.

 These final regulations retain the rule contained in the proposed regulations. The Service and Treasury continue to believe that the cost of transporting goods between related parties is properly treated as a capitalizable handling cost for all purposes (i.e., not just for timing purposes, but also for character purposes). In addition, the very limited potential for loss disallowance under sections 267(a)(1) and 707(b)(1) could result from any one of a number of properly capitalizable costs (e.g., storage costs, production costs, etc.) other than handling costs associated with transporting goods to a related party. Moreover, the fact that sections 267(a)(1) and 707(b)(1) will result in loss disallowance only in unusual circumstances does not justify the additional complexity that would result to all taxpayers from the series of rules that would be necessary to accommodate the treatment requested by the commentator.

TRANSFERS FOR TAX AVOIDANCE PURPOSES

 The proposed regulations provide that the District Director may require appropriate adjustments to valuations of inventory and other property subject to section 263A if the transfer of property is made to another person for a principal purpose of tax avoidance. The example provided in the proposed regulations states that the District Director may require a taxpayer using the simplified production method (as described in section 1.263A-2(b)) to apply that method to transferred inventories immediately prior to a transfer under section 351 if a principal purpose of the transfer is tax avoidance. The Service and Treasury continue to believe that the Secretary has the authority to prescribe regulations to prevent taxpayers from using related parties, pass-thru entities, or intermediaries to avoid the application of section 263A. Therefore, the final regulations retain the anti-abuse rule contained in the proposed regulations with one clarifying modification that substitutes "a principal purpose to avoid the application of section 263A" for "a principal purpose of tax avoidance."

EFFECTIVE DATES

 These final regulations are applicable to costs incurred in taxable years beginning after December 31, 1993. In the case of property that is inventory in the hands of the taxpayer, however, these regulations are effective for taxable years beginning after December 31, 1993.

ACCOUNTING METHOD CHANGES

 If a taxpayer must change its method of accounting as a result of these regulations, the taxpayer generally must file a Form 3115, Application for Change in Accounting Method, with the Commissioner in accordance with the requirements of section 1.446-1(e)(3)(i) and Rev. Proc. 92-20, 1992-1 C.B. 685. If, however, as a result of these regulations a taxpayer changes its method of accounting in its first taxable year beginning on or after January 1, 1994, then the change must be made pursuant to Rev. Proc. 94-49, 1994-30 I.R.B., dated July 25, 1994.

SPECIAL ANALYSIS

 It has been determined that these regulations are not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations. Therefore, a Regulatory Impact Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, a copy of the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

DRAFTING INFORMATION

 The principal authors of these regulations are Rosemary DeLeone and Harry-Todd Astroy of the Office of Assistant Chief Counsel, Income Tax and Accounting, IRS. However, other personnel from the IRS and the Treasury Department assisted in developing these regulations on matters of both substance and style.

Treasury Decision 8559

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by removing the entry for "Section 1.263A-1T" and adding new entries in numerical order to read as follows:

Authority: Authority: 26 U.S.C. 7805. * * *

Section 1.263A-4T also issued under 26 U.S.C. 263A. * * *

Section 1.263A-7T also issued under 26 U.S.C. 263A. * * *

Section 1.263A-1 also issued under 26 U.S.C. 263A. * * *

Section 1.263A-3 also issued under 26 U.S.C. 263A. * * *

Par. 2 Section 1.263A-4T is added to read as follows:

SECTION 1.263A-4T RULES RELATING TO PROPERTY PRODUCED IN A FARMING BUSINESS.

(a) through (c) [Reserved]

(d) This section is effective for costs incurred after December 31, 1986, in taxable years ending after such date. In the case of property that is inventory in the hands of the taxpayer, this section is effective for taxable years beginning after December 31, 1986.

SECTION 1.263A-1T [AMENDED]

Par. 3. Paragraph (c) of section 1.263A-1T is redesignated as paragraph (c) of 1.263A-4T.

Par. 4. Section 1.263A-7T is added to read as follows:

SECTION 1.263A-7T RULES RELATING TO CHANGES IN METHODS OF ACCOUNTING.

(a) through (e) [Reserved]

(f) This section is effective for costs incurred after December 31, 1986, in taxable years ending after such date. In the case of property that is inventory in the hands of the taxpayer, this section is effective for taxable years beginning after December 31, 1986.

SECTION 1.263A-1T [AMENDED]

Par. 5. Paragraph (e) of 1.263A-1T is redesignated as paragraph (e) of 1.263A-7T.

Par. 6. section 1.263A-7T(e) is amended as follows:

1. The first and fourth sentences of paragraph (e)(1)(i) are amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

2. The third sentence of paragraph (e)(1)(i) is amended by removing the phrase "this section" and replacing it with "the regulations thereunder".

3. Paragraph (e)(1)(ii) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder" every place that it appears.

4. The first sentence of paragraph (e)(1)(iii)(B) is amended by removing the phrase "this section" the first time it appears and replacing it with "section 263A and the regulations thereunder" and by removing "of this section".

5. The second sentence of paragraph (e)(1)(iii)(B) is amended by removing the phrase "of this section".

6. The first sentence of paragraph (e)(1)(iv) is amended by removing the phrase "this section" the first, second, and third time it appears and replacing it with "section 263A and the regulations thereunder".

7. The first sentence of paragraph (e)(2) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

8. Paragraph (e)(3)(i) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

9. The first sentence of paragraph (e)(4)(i) is amended by removing the phrase "this section" the first time it appears and replacing it with "section 263A and the regulations thereunder".

10. The third sentence of the Example of paragraph (e)(4)(ii) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

11. The first sentences of Example (1) and Example (3) of paragraph (e)(5) are amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

12. The first and last sentences of paragraph (e)(6)(i) are amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

13. The first and second sentences of paragraph (e)(6)(ii)(A) are amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

14. Paragraph (e)(6)(ii)(A)(1) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

15. In paragraph (e)(6)(ii)(C), the second sentence of Example (1), the third sentence of Example (3), and the first sentence of Example (5) are amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

16. The third sentence of paragraph (e)(6)(iii)(A) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

17. The second sentence of paragraph (e)(6)(iii)(B)(1) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

18. The fourth sentence of the Example of paragraph (e)(6)(iii)(B)(2) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

19. The second sentence of paragraph (e)(6)(iii)(C)(1) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

20. The eighth sentence of the Example of paragraph (e)(6)(iii)(C)(2) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

21. The third and fifth sentences of the Example of paragraph (e)(6)(iv)(C) are amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

22. The second sentence of paragraph (e)(7)(iii)(B) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

23. The fourth sentence of the Example of paragraph (e)(7)(v) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

24. Paragraph (e)(9)(i) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder" every place that it appears.

25. The third and sixth sentences of Example 1, the third sentence of Example 2, the fifth sentence of Example 3, the seventh sentence of Example 4, and the third sentence of Example 5 of paragraph (e)(9)(ii) are amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

26. The first sentence of paragraph (e)(10)(i) is amended by removing "this section" and replacing it with "section 263A and the regulations thereunder."

27. The second sentence of paragraph (e)(10)(i) is amended by removing the phrase "this section" the first time it appears and replacing it with "the regulations thereunder" and removing the phrase "this section" the second time it appears and replacing it with "section 263A and the regulations thereunder".

28. Paragraph (e)(10)(ii)(A) is amended by removing the phrase "this section" and replacing it with "the regulations thereunder" every place that it appears.

29. The third sentence of paragraph (e)(10)(iii) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

30. The first sentence of paragraph (e)(11)(i) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

31. The first sentence of paragraph (e)(11)(ii) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

32. The first and second sentences of paragraph (e)(11)(iii) are amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

33. Paragraph (e)(11)(iv) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder".

34. Paragraph (e)(11)(v) is amended by removing the phrase "this section" and replacing it with "section 263A and the regulations thereunder" every place that it appears.

SECTION 1.263A-1T [REMOVED]

Par 7. Section 1.263A-1T is removed.

Par. 8. Section 1.263A-1 is amended as follows:

1. The last sentence of paragraph (a)(2)(i) is amended by removing "1.263A-1T(e)" and replacing it with "1.263A-7T(e)".

2. Paragraph (a)(3)(v) is amended by removing "1.263A-1T(c)" and replacing it with "1.263A-4T(c)".

3. The second sentence of paragraph (b)(3) is amended by removing "1.263A-1T(c)" and replacing it with "1.263A-4T(c)".

4. The second sentence of paragraph (b)(4) is amended by removing "1.263A-1T(c)" and replacing it with "1.263A-4T(c)".

5. Paragraph (b)(10) is amended by removing the second sentence and by adding paragraphs (b)(1)(i) and (ii).

6. The text of paragraph (j)(4) is added.

7. The added text reads as follows:

SECTION 1.263A-1 UNIFORM CAPITALIZATION OF COSTS.

* * * * *

(b) * * *

(10) * * *

(i) For purposes of this section, substantial construction is deemed to have occurred if the lesser of --

(A) 10 percent of the total estimated costs of construction; or

(B) The greater of $10 million or 2 percent of the total estimated costs of construction, was incurred before March 1, 1986.

(ii) For purposes of the provision in paragraph (b)(10)(i) of this section, the total estimated costs of construction shall be determined by reference to a reasonable estimate, on or before March 1, 1986, of such amount. Assume, for example, that on March 1, 1986, the estimated costs of constructing a facility were $150 million. Assume that before March 1, 1986, $12 million of construction costs had been incurred. Based on the above facts, substantial construction would be deemed to have occurred before March 1, 1986, because $12 million (the costs of construction incurred before such date) is greater than $10 million (the lesser of $15 million; or the greater of $10 million or $3 million). For purposes of this provision, construction costs are defined as those costs incurred after construction has commenced at the site of the property being constructed (unless the property will not be located on land and, therefore, the initial construction of the property must begin at a location other than the intended site). For example, in the case of a building, construction commences when work begins on the building, such as the excavation of the site, the pouring of pads for the building, or the driving of foundation pilings into the ground. Preliminary activities such as project engineering and architectural design do not constitute the commencement of construction, nor are such costs considered construction costs, for purposes of this paragraph (b)(10).

* * * * *

(j) * * *

(4) * * * The District Director may require appropriate adjustments to valuations of inventory and other property subject to section 263A if a transfer of property is made to another person for a principal purpose of avoiding the application of section 263A. Thus, for example, the District Director may require a taxpayer using the simplified production method of section 1.263A-2(b) to apply that method to transferred inventories immediately prior to a transfer under section 351 if a principal purpose of the transfer is to avoid the application of section 263A.

Par. 9. Section 1.263A-3(c)(4)(vi) is amended as follows:

1. The heading is revised.

2. The text of paragraphs (A) and (B) is added.

3. The heading for paragraph (C) is revised and the text is added.

4. The revised and added provisions read as follows:

SECTION 1.263A-3 RULES RELATING TO PROPERTY ACQUIRED FOR RESALE.

* * * * *

(c) * * *

(4) * * *

(vi) COSTS NOT REQUIRED TO BE CAPITALIZED AS HANDLING COSTS -- (A) DISTRIBUTION COSTS -- (1) IN GENERAL. Distribution costs are not required to be capitalized. Distribution costs are any transportation costs incurred outside a storage facility in delivering goods to a customer. For this purpose, any costs incurred on a loading dock are treated as incurred outside a storage facility.

(2) COSTS INCURRED IN TRANSPORTING GOODS TO A RELATED PERSON. Distribution costs do not include costs incurred by a taxpayer in delivering goods to a related person. Thus, for example, when a taxpayer sells goods to a related person, the costs of transporting the goods are included in determining the basis of the goods that are sold, and hence in determining the resulting gain or loss from the sale, for all purposes of the Internal Revenue Code and the regulations thereunder. See, e.g., sections 267, 707, and 1502. For purposes of this provision, persons are related if they are described in section 267(b) or section 707(b).

(B) DELIVERY OF CUSTOM-ORDERED ITEMS. Generally, costs incurred in transporting goods from a taxpayer's storage facility to its retail sales facility must be capitalized. However, costs incurred outside a storage facility in delivering custom-ordered items to a retail sales facility are not required to be capitalized. For this purpose, any costs incurred on a loading dock are treated as incurred outside a storage facility. Delivery of custom-ordered items occurs when a taxpayer can demonstrate that a delivery to the taxpayer's retail sales facility is made to fill an identifiable order of a particular customer (placed by the customer before the delivery of the goods occurs) for the particular goods in question. Factors that may demonstrate the existence of a specific, identifiable delivery include the following --

(1) The customer has paid for the item in advance of the delivery;

(2) The customer has submitted a written order for the item;

(3) The item is not normally available at the retail sales facility for on-site customer purchases; and

(4) The item will be returned to the storage facility (and not held for sale at the retail sales facility) if the customer cancels an order.

(C) PICK AND PACK COSTS -- (1) IN GENERAL. Generally, handling costs incurred inside a storage or warehousing facility must be capitalized. However, costs attributable to pick and pack activities inside a storage or warehousing facility are not required to be capitalized. Pick and pack activities are activities undertaken in preparation for imminent shipment to a particular customer after the customer has ordered the specific goods in question. Examples of pick and pack activities include:

(i) Moving specific goods from a storage location in preparation for shipment to the customer;

(ii) Packing or repacking those goods for shipment to the customer; and

(iii) Staging those goods for shipment to the customer.

(2) ACTIVITIES THAT ARE NOT PICK AND PACK ACTIVITIES. Pick and pack activities do not include:

(i) Unloading goods that are received for storage;

(ii) Checking the quantity and quality of goods received;

(iii) Comparing the quantity of goods received to the amounts ordered and preparing the receiving documents;

(iv) Moving the goods to their storage location, e.g., bins, racks, containers, etc.; and

(v) Storing the goods.

(3) COSTS NOT ATTRIBUTABLE TO PICK AND PACK ACTIVITIES. Occupancy costs, such as rent, depreciation, insurance, security, taxes, utilities, and maintenance costs properly allocable to the storage or warehousing facility, are not costs attributable to pick and pack activities.