Rev. Rul. 76-282

Advice has been requested whether the adjustment required under section 472(d) of the Internal Revenue Code of 1954 is applicable to the taxpayer's goods under the circumstances described below.

The taxpayer seeks to adopt and use the last-in, first-out (LIFO) inventory method in taxable year 1975. Currently, all of the taxpayer's goods are includible in inventory under section 1.471-1 of the Income Tax Regulations. The taxpayer proposes to apply the adjustment required under section 472(d) of the Code to normal goods, but not to those goods described in section 1.471-2(c) that are unsalable at normal prices or unusable in the normal ways because of damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes. For purposes of this Revenue Ruling, the type of goods written down under section 1.471-2(c) shall be referred to collectively as "subnormal goods."

The specific issue is whether the adjustment required by section 472(d) of the Code applies to goods in inventory that are unsalable at normal prices or unusable in the normal way whose carrying value has been reduced pursuant to section 1.471-2(c) of the regulations.

Section 1.471-2(c) of the regulations deals with the valuation of inventories. It states that the bases of valuation most commonly used to meet the requirements of section 471 of the Code are (1) cost and (2) cost or market, whichever is lower. However, any goods in an inventory that are unsalable at normal prices or unusable in the normal way because of damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes, including secondhand goods taken in exchange, should be valued at bona fide selling prices less direct cost of disposition, whether cost or cost or market, whichever is lower, is used.

Section 472, of the Code allows a taxpayer to elect, subject to approval by the Commissioner of Internal Revenue, to use the LIFO method of identifying items in the closing inventory.

Section 472(d) of the Code provides, in part, with respect to an application to change to the LIFO inventory method, that in determining income for the taxable year preceding the taxable year for which the LIFO method is first used, the closing inventory of such preceding year of the goods specified in the application shall be at cost.

Section 1.472-2 of the regulations states the requirements incident to the adoption and use of the LIFO inventory method.

Section 1.472-2(b) of the regulations provides that under the LIFO inventory method the inventory shall be taken at cost regardless of its market value.

Section 1.472-2(c) of the regulations provides that goods of the specified type included in the opening inventory of the taxable year for which the method is first used shall be considered as having been acquired at the same time and at a unit cost equal to the actual cost of the aggregate divided by the number of units on hand. The actual cost of the aggregate shall be determined pursuant to the inventory method employed by the taxpayer under the regulations applicable to the prior taxable year with the exception that restoration shall be made with respect to any write-down to market value resulting from the pricing of former inventories.

Rev. Proc. 76-6, 1976-1 C.B. 545, sets forth procedures relating to the proper adoption and use of the LIFO-inventory method and the required restoration of any write-down to market value resulting from the pricing of former inventories under section 472(d) of the Code.

Accordingly, for purposes of section 1.472-2 of the regulations, the taxpayer's right to select the class or classes of goods to be covered by the LIFO election (or extension) goes to the nature of the goods and not to their condition, salability or other characteristics. Therefore, when the LIFO method is elected (or extended) for a particular class of goods, the election must include all goods within that class regardless of whether they are normal goods or goods that are unsalable at normal prices or unusable in the normal way. It is further held that the adjustment required under section 472(d) of the Code must include any write-down from actual cost with respect to goods that are unsalable at normal prices or unusable in the normal way, as well as normal goods that have been written down to market value under section 1.471-4.

With respect to a taxpayer that has a LIFO election in effect for a taxable year(s) prior to the effective date of this ruling, (taxable years beginning on and after 60 days from July 26, 1976, the date of publication of this ruling in Internal Revenue Bulletin 1976-30), under the authority contained in section 7805(b) of the Code, this Revenue Ruling will not apply to goods disposed of prior to the effective date of this Revenue Ruling, whose carrying value has been determined by reference to section 1.471-2(c) of the regulations. If a taxpayer has on hand at the beginning of the first taxable year commencing on and after the effective date of this Revenue Ruling, goods whose carrying value has been determined by reference to section 1.471-2(c), such goods must be valued at cost as of the end of the preceding taxable year to the extent such restoration has not been previously made. Any restoration of a write-down to market value for purposes of section 472(d) must be made in accordance with the provisions of Rev. Proc. 76-6, as revised, with respect to any goods whose carrying value has been determined under section 1.471-4. See Rev. Proc. 76-28, page 645, this Bulletin, for further implementation of this ruling.

¹ Also released as News Release IR-1630, dated July 2, 1976.