Rev. Rul. 60-244

Advice has been requested whether a taxpayer, who elects to treat the cutting of timber as a sale or exchange under section 631(a) of the Internal Revenue Code of 1954 and adopts the last-in, first-out, inventory method under section 472 of the Code, may use, in financial statements to shareholders and for credit purposes, an inventory reserve reflecting the difference between the fair market value of the timber cut and the adjusted cost basis of such timber, determined without reference to such fair market value.

The taxpayer has extensive timber holdings from which substantial quantities of timber are cut each year for use in its manufacturing operations. It elected to treat the cutting of timber as a sale or exchange under section 631(a) of the Code. It also adopted the last-in, first-out (LIFO), inventory method described in section 472 of the Code.

Section 631(a) of the Code provides that a taxpayer may elect on its return for a taxable year to treat the cutting of timber during the taxable year as a sale or exchange. If such an election is made, gain or loss to the taxpayer is recognized in an amount equal to the difference between the fair market value of the timber cut during the taxable year and the adjusted basis for depletion of such timber in the hands of the taxpayer. For this purpose, the fair market value is the fair market value as of the first day of the taxable year in which the timber is cut and shall be treated as the cost of such timber to the taxpayer for all purposes for which such cost is a necessary factor.

Section 472(b) of the Code provides that in inventorying goods specified in an application to use the LIFO method, the taxpayer shall:

(1) Treat those remaining on hand at the close of the taxable year as being: First, those included in the opening inventory of the taxable year (in the order of acquisition) to the extent thereof; and second, those acquired in the taxable year;

(2) Inventory them at cost; and

(3) Treat those included in the opening inventory of the taxable year in which such method is first used as having been acquired at the same time and determine their cost by the average cost method.

Section 472(c) of the Code provides that the elective method shall apply only if the taxpayer establishes to the satisfaction of the Secretary of the Treasury or his delegate that the taxpayer has used no procedure other than that specified in paragraphs (1) and (3) of subsection (b) in inventorying such goods to ascertain the income, profit, or loss of the first taxable year for which the method described in subsection (b) is to be used, for the purpose of a report or statement covering such taxable year (1) to shareholders, partners, or other proprietors, or to beneficiaries, or (2) for credit purposes. Also see section 1.472-2(e) of the Income Tax Regulations. Section 472(e)(2) of the Code contains similar provisions for subsequent taxable years under which the Secretary or his delegate may determine that the taxpayer has used some procedure other than that specified in paragraph (1) of subsection (b). Also see section 1.472-2(g) of the regulations.

The taxpayer keeps its books, records, and accounts in conformity with the last-in, first-out, inventory method, using cost for timber cut as distinguished from section 631(a) fair market value, and reflecting such cost in the LIFO inventories shown on financial statements. For both Federal income tax returns and financial statements, inventories of cut timber (logs, pulpwood, etc.) are treated as being, first, the cut timber included in the opening inventory of the taxable year to the extent thereof and, second, the timber cut during the taxable year. The fair market value as of the beginning of the taxable year of the standing timber cut during the year is used in lieu of the actual cost of such timber in computing the closing inventory of cut timber for such year and the opening inventory for the succeeding year.

In financial statements to shareholders and for credit purposes, the taxpayer reflects in its inventory the fair market value of the timber cut to which section 631(a) applies but provides an inventory reserve to eliminate the excess of such fair market value over the adjusted cost basis of the cut timber included in inventory. The reserve is shown on the balance sheet as a deduction from inventories, but is not an allowable deduction for Federal income tax purposes. The net effect of such treatment is to reflect, in the inventory of timber cut under the provisions of section 631(a) on the financial statements and credit reports, the adjusted cost basis of such timber.

The specific question is whether such treatment of inventories in the taxpayer's financial reports to shareholders and for credit purposes is consistent with the provisions of sections 472(c) and 472(e) of the Code.

Under the circumstances described in the instant case, it is held that the indicated treatment of LIFO inventories in reports to shareholders and for credit purposes is consistent with the provisions of and the principles underlying sections 472(c) and 472(e) of the Code. Accordingly, a taxpayer, who elects to treat the cutting of timber in a taxable year as a sale or exchange under section 631(a) of the Code, and who adopts the last-in, first-out, inventory method may, in financial statements to shareholders and for credit purposes, use an inventory reserve reflecting the difference between the fair market value of the timber cut and its adjusted cost basis, determined without reference to such fair market value.