Rev. Proc. 76-28

Section 1. Purpose.

The purpose of this Revenue Procedure is to set forth the application of section 1.471-2 of the Income Tax Regulations, concerning inventory write-downs, including subnormal goods under section 1.471-2(c), to the use of the last-in, first-out ("LIFO") inventory method as described in section 472 of the Internal Revenue Code of 1954.

Sec. 2. Scope.

This Revenue Procedure applies to taxpayers who have elected (or extended) the LIFO inventory method and either excluded "goods written down" under section 1.471-2 of the regulations from their LIFO election (or extensions) or included such goods in their election (or extensions) at a value less than cost. In addition, this Revenue Procedure applies to taxpayers, who after electing (or extending) the LIFO inventory method, have written down the carrying value of such goods in their closing LIFO inventory to less than cost for any year subsequent to the year of the LIFO election (or extension). For these purposes, cost means actual cost. This procedure also provides guidelines for the treatment of goods written down by taxpayers who elect (or extend) the LIFO inventory method in the future.

Sec. 3. Background.

.01 Section 471 of the Code provides general rules for the use of inventories. Section 1.471-2(a) of the regulations provides that each inventory: (1) must conform as nearly as may be to the best accounting practice in the trade or business, and (2) must clearly reflect income. Section 1.471-2(b) provides, in part, that inventory rules cannot be uniform but must give effect to trade customs that come within the scope of the best accounting practice in the particular trade or business. Further, in order to clearly reflect income, the inventory practice should be consistent from year to year. Section 1.471-2(c) deals with the valuation of inventories, and states that the bases of valuation most commonly used to meet the requirements of section 471 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 market, whichever is lower, is used.

.02 Subject to approval by the Commissioner of Internal Revenue, section 472 of the Code allows a taxpayer to elect to use the LIFO method of identifying items in the closing inventory for goods specified in the application for such approval.

.03 Section 472(b)(2) of the Code states that in inventorying goods specified in the application to elect LIFO, the taxpayer shall inventory such goods at cost.

.04 Section 472(d) of the Code provides, in part, 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.

.05 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 values resulting from the pricing of former inventories.

.06 Section 1.472-4 of the regulations states that a taxpayer may not change to the LIFO method unless, at the time the taxpayer files its application for the adoption of such method, it agrees to such adjustments incident to the change to or use of such method, in the inventories of prior taxable years or otherwise, as the district director, upon examination of the taxpayer's returns, deems necessary in order to clearly reflect income.

.07 Rev. Rul. 76-282, page 137, this Bulletin, holds that 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 further holds 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.

Sec. 4. Application.

.01 The provisions of section 1.471-2 of the regulations, as they would relate to inventory write-downs, are not applicable for purposes of section 472 of the Code. Furthermore, a write-down in inventory valuation under section 1.471-2(c) relating to the valuation of subnormal goods does not create a separate class of goods.

.02 Solely for purposes of this Revenue Procedure so-called "excess stock" write-downs and percentage write-downs applied to a class or type of goods will be considered as coming within the write-down restoration rules contained herein pertaining to section 1.471-2 of the regulations.

.03 When the LIFO inventory method is elected for a particular class of goods, the LIFO method is to be applied to all goods within that class of goods, including those that may be unsalable at normal prices or unsalable in the normal way. Within a given class of goods the LIFO method makes no distinction between goods that have been written down and those that have not been written down.

.04 Section 472(b) of the Code requires that under the LIFO inventory method, the inventory shall be taken at cost for the year of the LIFO election, as well as subsequent taxable years.

.05 In order to properly satisfy the requirements of section 472(d) of the Code, regarding the value of the closing inventory of the year preceding the year of the LIFO election (or extension), such closing inventory must be valued at actual cost. In order to value such closing inventory at actual cost, any write-down in inventory value determined under section 1.471-2 of the regulations including those made to reflect unsalability at normal prices or unusability in the normal way that was reflected in the closing inventory of the year preceding the year of the LIFO election (or extension) must be restored when the LIFO method is elected (or extended).

.06 If the closing inventory of the year preceding the year of the LIFO election (or extension) is not valued at cost, an amended Federal income tax return must be filed for such preceding year to properly state such inventory at cost. The amended return, with respect to the taxable year preceding the taxable year for which the LIFO inventory method is elected (or extended) must be filed with the Federal income tax return for the taxable year for which the LIFO inventory method is elected (or extended). Any adjustment necessary in order to restate the preceding year's ending inventory at cost as required by section 472(d) of the Code, to the full extent thereof, must be taken into account and reflected in the income of the amended return for the preceding taxable year. See Rev. Proc. 76-6, 1976-1 C.B. 545, as revised by Announcement 76-38, 1976-13 I.R.B. 21 (IR-1576), Announcement 76-78, 1976-24 I.R.B. 44 (IR-1613), and Announcement 76-95, I.R.B. 1976-30.

.07 Once the LIFO election has been made with respect to a particular class of goods, inventories of like goods shall be taken at cost regardless of market value, any determination as to unsalability at normal prices or unusability in the normal way or any other write-down made pursuant to section 1.471-2 of the regulations.

.08 With respect to a taxpayer that has a LIFO election in effect for a taxable year(s) prior to the effective date contained in section 6, this Revenue Procedure will not apply to goods disposed of prior to the beginning of the first taxable year commencing on and after 60 days from July 26, 1976, the date of publication of this Revenue Procedure in Internal Revenue Bulletin 1976-30, whose carrying value has been determined by reference to section 1.471-2 of the regulations. If a taxpayer has on hand at the beginning of the first taxable year commencing 60 days after July 26, 1976, goods whose carrying value has been determined by reference to section 1.471-2, 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.

.09 Any restoration of a write-down to market value for purposes of section 472(d) of the Code 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 of the regulations.

.10 If a taxpayer has elected (or extended) the LIFO inventory method and fails to comply with the provisions of this Revenue Procedure, the Service, upon examination of such taxpayer's Federal income tax return, may require the taxpayer to discontinue the LIFO inventory method.

Sec. 5. Inquiries.

Inquiries regarding this Revenue Procedure may be addressed to the Commissioner of Internal Revenue, Attention: T:C:C, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.

Sec. 6. Effective Date.

This Revenue Procedure, except for the provisions of section 4.09, is applicable for taxable years beginning on and after 60 days from July 26, 1976, the date of the publication of this Revenue Procedure in Internal Revenue Bulletin 1976-30.

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