Rev. Rul. 77-326

Advice has been requested whether a taxpayer using an accrual method of accounting and the farm-price method of valuing inventory may exclude raised breeding animals from its inventory and capitalize and depreciate such animals.

The taxpayer, a corporation organized in 1974, purchased certain breeding animals and raised certain other animals to be breeding animals during its first taxable year ended December 31, 1974. The taxpayer elected to use an accrual method of accounting and to value its inventory under the farm-price method.

Under section 61(a)(2) of the Internal Revenue Code of 1954 and section 1.61-4(b) of the Income Tax Regulations a farmer using an accrual method of accounting must use inventories to determine gross income derived from business. Under section 471, which authorizes the Secretary to determine whether inventories are necessary to clearly reflect income and to prescribe rules for their handling to conform with the best accounting practice in the trade or business, rules have been developed to determine the inventories of farmers using an accrual method.

Under section 1.471-6(d) of the regulations, a taxpayer using the farm-price method values inventories at market price less direct disposition costs.

Section 1.61-4(b) of the regulations prescribes the items to be included in inventory. Under section 1.61-4 livestock raised or purchased for sale must be included in inventory. Livestock acquired for draft, breeding, or dairy purposes and not held for sale may be included in inventory instead of being treated as capital assets subject to depreciation.

For purposes of section 1.61-4 of the regulations, "acquired" livestock includes both purchased and raised breeding livestock. See Rev. Rul. 55-736, 1955-2 C.B. 522.

Accordingly, an accrual-basis taxpayer using the farm-price inventory method may exclude raised breeding animals from its inventory and capitalize and depreciate the cost of such animals.

A taxpayer wishing to change its method of accounting for raised breeding animals must obtain the approval of the Commissioner of Internal Revenue in accordance with the provisions of section 446 of the Code and section 1.446-1(e) of the regulations.