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RECENTLY, THE IRS HAS BEEN WILLING TO GUIDE TAXPAYERS COMPLIANCE WITH THE COMPLEX UNICAP REQUIREMENTS UNDER SECTION 263A FOR VALUING INVENTORY
In several recent rulings, the IRS has clarified and expanded the inventory valuation methods under the Uniform Capitalization (UNICAP) rules of Section 263A. Section 263A is perhaps one of the most complex Code provisions that tax practitioners and their clients have to comply with on a day-to-day basis. This is particularly true when the client has both inventory and non-inventory items that are produced or purchased for resale. Taxpayers and practitioners should be aware of how these recent rulings affect their reporting under Section 263A and related provisions, such as accounting changes under Section 481.
Overview of Section 263A
Manufacturers, certain retailers, and wholesalers must use the UNICAP method to account for property they produce and for property they purchase for resale.1 Under this method, the taxpayer must capitalize all direct and indirect costs properly allocable to such property. The regulations provide complex rules for determining which direct and indirect costs are allocable to particular items of property. Once the total capitalized costs of items of property subject to the rules are calculated, the taxpayer must allocate those costs between: (1) ending inventory and other property on hand at the end of the year; and (2) property sold during the year.
There are many special rules and exceptions to the UNICAP inventory computations. For example, taxpayers that acquire personal property for resale are generally exempt from the UNICAP rules if their average annual gross receipts were less than $10 million for the three previous years.2 Another rule specifies that tangible personal property under the UNICAP provision includes a film, sound recording, videotape, book, or similar property.3
Exclusions from section 263A. Many costs are not subject to the UNICAP rules.4 The excluded costs include those related to:
1. Property produced for personal use.
2. Timber (including certain ornamental trees).
3. Property produced under long-term contracts.
4. Costs deductible as research and experimental expenditures.5
5. Certain oil, gas, and other mineral property, foreign drilling, amortizable, or developmental expenditures.
6. Expenditures (other than circulation expenditures) subject to the ten-year amortization rule for tax preferences.
In addition, certain costs incurred by an individual or personal service...