Sec. 351 transfers as "bargain purchases."

• Author: Kalis, Frank J., Jr.

In its continuing attempt to extend l the application of the decisions in: Hamilton Industries, Inc., 97 TC 120 (1991), and Kohler Co., 34 Ct. Fed. Cls. 379 (11/3/95), the IRS has raised the issue of whether the receipt of low-basis inventory in a Sec. 351 transfer can be equated to a bargain purchase of inventory, causing the acquired items to be treated as different LIFO items from goods subsequently purchased or produced at regular prices. Hamilton Industries and Kohler Co. each purchased inventory at prices significantly lower than normal cost; both companies then elected to use the LIFO method to retain the low-basis goods in their inventories. The courts, however, ruled that inventory subsequently produced, albeit similar in all respects except cost, should not be treated as the same LIFO items as the bargain goods for LIFO calculation purposes. This had the effect of causing the low-basis bargain purchase inventory to be treated as sold, thus subjecting the bargain element of that inventory to tax.

The Service is now extending the theory of Hamilton Industries and Kohler to Sec. 351 transactions. In situations in which the transferee receives low-basis inventory (usually LIFO inventory of the transferor), the IRS is contending that the inventory items received by the transferee are of a different nature and have different cost characteristics than similar items purchased or produced during the year. These "new" inventory items, although physically similar to the transferred inventory, are not, in the Service's view, comparable for purposes of LIFO computations, and should be treated as different LIFO items in...