Rev. Rul. 79-149

ISSUE

Are livestock raised and purchased for breeding purposes "inventory assets" as defined in section 312(b) of the Internal Revenue Code of 1954 when the cost of raising and purchasing the breeding stock is properly capitalized and depreciated, rather than included in inventory, for federal income tax purposes?

FACTS

The taxpayer, a corporation, raises and purchases livestock. Some are held for sale and some for breeding purposes. Taxpayer uses the accrual method of accounting and values its inventory under the farm-price method. Taxpayer excludes from its inventory the cost of both raised and purchased breeding animals. These costs are capitalized and depreciated in accordance with sections 1.471-6 and 1.61-4 of the Income Tax Regulations. See Rev. Rul. 77-326, 1977-2 C.B. 184.

Under section 333 of the Code, taxpayer adopted a plan of liquidation and distributed to its shareholders within the same month all of its property, including the breeding animals. With regard to the distribution of the breeding animals, taxpayer reported as ordinary income under section 1245(a) of the Code the amount by which the lower of the recomputed basis of the breeding animals or their fair market value exceeded the taxpayer's adjusted basis in the breeding animals. Taxpayer increased its earnings and profits by the amount of this section 1245(a) gain and decreased its earnings and profits by the amount of its adjusted basis in the breeding animals pursuant to section 312(a) of the Code.

LAW AND ANALYSIS

Section 312(a) of the Code provides that except as otherwise provided in this section, on the distribution of property by a corporation with respect to its stock, the earnings and profits of the corporation shall be decreased by the sum of--(1) the amount of money, (2) the principal amount of the obligations of such corporation, and (3) the adjusted basis of the other property so distributed.

Section 312(b)(1) of the Code provides that on the distribution by a corporation, with respect to its stock, of inventory assets the fair market value of which exceeds the adjusted basis thereof, the earnings and profits of the corporation (A) shall be increased by the amount of such excess; and (B) shall be decreased by the lesser of (i) the fair market value of the inventory assets distributed, or (ii) the earnings and profits (as increased under subparagraph (A)).

Section 312(b)(2)(A) of the Code provides that the term "inventory assets" means--(i) stock in trade of the corporation, or other property of a kind which would properly be included in the inventory of the corporation if on hand at the close of the taxable year; (ii) property held by the corporation primarily for sale to customers in the ordinary course of its trade or business; and (iii) unrealized receivables or fees, except receivables from sales or exchanges of assets other than assets described in this subparagraph.

Section 1.312-2 of the regulations provides, in part, that the rules provided in section 312(b) shall be applicable without regard to the method used in computing inventories for the purpose of the computation of taxable income.

Under section 312(b)(2)(A) of the Code and section 1.312-2 of the regulations, taxpayer's breeding livestock is not stock in trade which would properly be included in its inventory if on hand at the close of the taxable year or property held primarily for sale to customers in the ordinary course of its business; nor, in light of taxpayer's income tax treatment, do the breeding animals represent other property which would properly be included in the inventory of taxpayer if on hand at the close of the taxable year. Consequently, in computing its earnings and profits upon the distribution of the breeding animals, taxpayer is governed by the provisions of section 312(a) of the Code.

HOLDING

Livestock raised and purchased for breeding purposes are not "inventory assets" as defined in section 312(b) of the Code when the cost of raising and purchasing the breeding stock is properly capitalized and depreciated, rather than included in inventory, for federal income tax purposes.