Prohibition against use of replacement cost by LIFO taxpayers clarified.

• Author: Conjura, Carol
• Position: Last-in-first-out inventory accounting

In Mountain State Ford Truck Sales, Inc., 112 TC No. 7 (1999), the Tax Court held that the taxpayer was not allowed to use replacement cost in valuing its LIFO inventory, because it (1) violated elections made by the taxpayer on Form 970, Application to use LIFO Inventory Method, and (2) is an improper method of valuing current-year inventory for dollar-value LIFO taxpayers. This decision affects all LIFO taxpayers to the extent they use (or are considering the use of) replacement cost, as the options for determining current-year inventory value are the same under both the specific goods and dollar-value LIFO methods. Further, this decision provides the first unambiguous rejection of the use of the replacement cost valuation method by a LIFO taxpayer. Prior to this decision, the courts had not addressed the issue; the only authority was provided by a series of conflicting letter rulings.

Background

Sec. 472(b) (2) requires taxpayers using the LIFO method to "inventory [goods] at cost." Regs. Sec. 1.4728 (e) (2) (ii) allows dollar-value LIFO taxpayers to select one of four optional methods for determining the costs to be assigned to any current-year inventory increment:

1. Most recent purchases or production;

2. Earliest purchases or production during the tax year in order of acquisition;

3. Average of all goods purchased or produced during the tax year; or

4. Any other proper method that, in the IRS's opinion, clearly reflects income.

While these options are specifically provided to dollar-value LIFO taxpayers using the double-extension method, they are generally held also to be available to dollar-value taxpayers using the link-chain method. Virtually identical provisions are found in Regs. Sec. 1.472-2(d)(1)(i), addressing the determination of current-year inventory value by a specific-goods LIFO taxpayer.

In Letter Ruling 750313035013, the taxpayer requested permission to use the current replacement cost in computing its parts and accessories LIFO inventory, in lieu of actual invoice price. The Service allowed the use of current replacement cost, finding that it was an "other proper method" within the meaning of Regs. Sec. 1.4728(e) (2)(ii)(d). Subsequently, the IRS issued several rulings addressing the use of current replacement cost, but declined in each of them to specifically state that such use constituted an improper LIFO method.

In Letter Ruling (TAM) 8906001, the Service limited itself to determining that use of current replacement...