Rev. Rul. 70-564

Advice has been requested whether, under the circumstances described below, a new corporation which acquires inventories in a nontaxable exchange under section 351(a) of the Internal Revenue Code of 1954 must file Form 970, Application for the Adoption and Use of the Elective Inventory Method, in order to adopt the last-in, first-out (LIFO) inventory method, and whether, if such corporation properly adopts the LIFO method, its opening LIFO inventory costs for the year of change must be determined by the average cost method.

X corporation transferred certain of its assets to Y, a newly organized corporation, solely in exchange for the stock of Y, in a transaction in which no gain or loss was recognized by reason of the application of section 351(a) of the Code. Under section 362(a)(1) of the Code, the assets retained the same basis in the hands of Y as they had in the hands of X. Included in the assets acquired by Y were inventories with respect to which X used the LIFO inventory method. Transactions under section 351 of the Code do not meet the requirements of section 381(a) of the Code. Therefore, the provisions of section 381(c)(5) of the Code, relating to carryovers of inventories in certain corporate acquisitions, are not applicable.

Section 472(a) of the Code provides that a taxpayer may elect to use the last-in, first-out (LIFO) method of inventorying goods specified in an application to use such method filed at such time and in such manner as the Secretary or his delegate may prescribe. The change to, and the use of, such method shall be in accordance with such regulations as the Secretary or his delegate may prescribe as necessary in order that the use of such method may clearly reflect income.

As far as here pertinent, section 472(b)(3) of the Code provides that in inventorying goods specified in the application to use the LIFO method the taxpayer shall treat those goods included in opening inventory of the taxable year in which such method (LIFO) is first used as having been acquired at the same time and determine their cost by the average cost method.

Section 1.472-2 of the Income Tax Regulations sets forth requirements incident to the adoption and use of the LIFO inventory method, including compliance with the requirements of section 472 of the Code and sections 1.472-1 through 1.472-7 of the regulations.

Section 1.472-3(a) of the regulations provides, in part, that the LIFO inventory method may be adopted and used only if the taxpayer files with his income tax return a Form 970, and pursuant to the instructions printed thereon and to the requirements of this section of the regulations, a statement of his election to use such inventory method.

It is held that, in order to adopt the LIFO inventory method, Y must file Form 970 and otherwise comply with the provisions of section 472 of the Code and the regulations thereunder. The cost of Y's opening inventory for the year of change is determined by the average cost method as provided by section 472(b)(3) of the Code. See Textile Apron Company, Inc. v. Commissioner, 21 T.C. 147 (1953), acquiescence, C.B. 1954-1, 7, in which a corporation was created to succeed to the business of three sole proprietorships in a non-taxable exchange under section 112(b)(5) of the Internal Revenue Code of 1939 (section 351 of the 1954 Code). The corporation was held to be a new taxpayer and was denied the right to use the LIFO method as used by the proprietorships because of its failure to file Form 970 with the return for its first taxable year.

The above holding is equally applicable where such a transferee is an existing corporation not using the LIFO method of valuing inventories. Thus, such transferee, if it desires to change to the LIFO method, must file Form 970 and determine opening inventory for the year of change by the average cost method.

For a situation where both transferor and transferee, in a nontaxable exchange under section 351 of the Code, use the LIFO method of inventory valuation, see Revenue Ruling 70-565, below.