Tax-free basis step-up for LIFO bargain purchases.

• Author: Kalis, Jr., Frank J.
• Position: Last-in-first-out inventory accounting

In LaCrosse Footwear, Inc. (1998), the Court of Federal Claims rendered an opinion with an interesting twist on the separate-item treatment for bargain-purchased LIFO inventory created by the decisions in Hamilton Industries, Inc., 97 TC 120 (1991), and Kohler Co., 124 F3d 1451 (Fed. Cir. 1997). The court held that a corporation adopting the dollar-value LIFO inventory method under Regs. Sec. 1.472-8(e)(2) must, consistent with Kohler and Hamilton, account for bargain-purchased goods as different LIFO items from subsequently acquired goods and treat them as sold first, but may get a tax-free basis step-up of the bargain-purchased inventory to its fair market value (FMV). This position enabled the Claims Court to adhere to the analysis in Kohler (to which the court was bound by precedent but disagreed), but allowed the taxpayer to permanently avoid taxation of the bargain element in the purchase. (The Service has appealed the decision.)

Background

Under Hamilton and Kohler, goods acquired at a substantial discount from current cost, even though physically identical to goods subsequently purchased or produced, must be accounted for as separate items under the dollar-value LIFO method, because of their substantially different cost characteristics. The result of treating subsequently purchased items as separate items results in triggering the discount into income to the extent the bargain-purchased items are sold first and do not remain physically on hand at year-end.

After purchasing substantially all the assets of another corporation (including inventory), LaCrosse adopted the double-extension, dollar-value LIFO inventory accounting method and the method Of earliest acquisitions during the year for valuing goods in closing inventory in excess of those in opening inventory, under Regs. Sec. 1.472-8(e)(2). LaCrosse allocated a portion of the purchase price to the inventory, resulting in an opening inventory value of approximately 33% of FMV.

Base-Year LIFO Items May Be Valued at FMV

The Claims Court dismissed the requirement under Regs. Sec. 1.472-2(c) that goods on LIFO must be valued at cost regardless of FMV, because the regulation specifically excepts computations otherwise provided under Regs. Sec. 1.472-8, with respect to the dollar-value method. Instead, the Claims Court superimposed on that regulation the underlying philosophy of the double-extension, dollar-value LIFO method--an item's base-year cost should approximate FMV, even when...