Uniform Capitalization Rules: Inventory; Self-Constructed Assets; Real Estate (Portfolio 576)

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Description

Uniform Capitalization Rules: Inventory; Self-Constructed Assets; Real Estate analyzes the cost capitalization rules applicable to manufactured inventories, inventories of wholesalers and retailers, self-constructed assets, and real property produced for sale.

The 1986 Tax Reform Act overhauled these costing rules, essentially creating a uniform set of rules. Costs related to a particular category of produced or acquired property must be associated with that property and deducted either when the property is sold or through depreciation deductions.

The Worksheets include certain relevant IRS pronouncements and related materials, such as legislative history and checklists. To aid in researching a particular matter, a Bibliography is provided.

Authors

Richard Garrett

Richard Garrett obtained his M.S.T. from Southeastern University. He is a member of the American Institute of Certified Public Accountants—Tax Division, Tax Accounting Subcommittee, and Corporate Tax Division of the Internal Revenue Service.

 

Credentials /

 

Richard Garrett, B.A., Benjamin Franklin University; M.S.T., Southeastern University; member, American Institute of Certified Public Accountants—Tax Division, Tax Accounting Subcommittee; and Corporate Tax Division of the Internal Revenue Service (1974-80).

 

 

James E. Connor

James E. Connor, B.A., obtained his J.D. from University of Pennsylvania Law School and his LL.M. in Taxation from Georgetown University Law Center. He was an adjunct professor for Georgetown University Law Center (LL.M. program) from 1985-1990 and a formerly of Office of Chief Counsel, Internal Revenue Service from 1977-85. He served as Technical Assistant to Director of Legislation & Regulations Division in 1985.

 

Credentials / 

James E. Connor, B.A., Cornell University; J.D., University of Pennsylvania Law School; LL.M. in Taxation, Georgetown University Law Center; adjunct professor, Georgetown University Law Center (LL.M. program) (1985-90); formerly of Office of Chief Counsel, Internal Revenue Service (1977-85); served as Technical Assistant to Director of Legislation & Regulations Division (1985).

 

 

 

Table of Contents

Detailed Analysis

I. Introduction

A. Basic Concepts Underlying the Uniform Capitalization Rules

1. In General

2. Analysis of Whether Transactions Are Subject to the Uniform Capitalization Rules

a. Inventories

(1) General

(2) Materials and Supplies

(3) Products Furnished in Connection with Services

b. Self-Constructed Assets

c. Long-Term Contracts

d. Summary

B. Organization of Issues

C. History of Uniform Capitalization

D. Significant Issues Under the Uniform Capitalization Rules

1. Determining Whether Certain Activities Constitute a Separate Trade or Business

2. Status of UCR Methods as Accounting Methods

a. Adopting Accounting Methods

b. Changing Accounting Methods

3. Financial Accounting Issues

4. Definition of “Production” Activities

a. Significance of the Issue

b. What Are Production Activities?

5. Can Companies Decide to Treat Period Costs as Inventory or Capitalized Costs?

a. In General

b. Change in Treatment of Period Costs

6. Treatment of Otherwise Non-Deductible Costs Under the UCR

7. Interplay with Other Deferral Provisions

8. Relationship of the Uniform Capitalization Rules to the Determination of “Market”

9. Treatment of Environmental Clean-Up Costs and Asbestos Removal Costs

a. Relationship to the Uniform Capitalization Rules

b. Environmental Cleanup Costs

(1) Qualified Environmental Remediation Expenditures

(2) Other Environmental Clean-Up Expenditures

c. Asbestos Removal Costs

10. Treatment of Related Party UCR Costs

II. Manufacturers

A. General Discussion

1. Introduction

2. Pre-UCR

B. Uniform Capitalization Rules

1. Taxes

2. Tax Depreciation/Depletion

3. Rework Labor, Scrap and Spoilage

4. Factory Administrative Costs

5. Administrative Service and Support Costs

6. Production Officers’ Salaries

7. Production Insurance

8. Production Employee Benefits

9. Bidding Costs on Awarded Contracts

10. Off-Site Storage and Warehousing Costs

11. Handling Costs

12. Interest

13. Materials and Supplies

14. Engineering and Design Costs

15. Licensing and Franchise Costs

16. Purchasing Costs

C. Non-Inventoriable Costs

1. In General

2. General and Administrative Expenses

3. Depreciation, Amortization, and Cost Recovery Allowances on Equipment and Facilities That Are Temporarily Idle

D. Practical Capacity Method

1. UCR Repeal of the Practical Capacity Method

2. Validity of Repeal

3. Planning Ideas

E. Steps Necessary to Compute Inventory

1. Step 1 - Identify Full Absorption Inventory Costs

2. Step 2 - Identify Additional UCR Inventory Costs

a. In General

b. Allocation Methods

c. Illustrations of Allocation Methods

(1) Property Taxes, Depreciation, and Insurance

(2) Officers’ Salaries

d. Allocating Costs of Mixed Service Departments

(1) Departments Which Support More Than One Business

(2) Self-Developed Allocation Methods

(3) Direct, Step, and Linear Algebra Methods

(4) Simplified Allocation Methods

(a) Background

(b) Simplified Service Cost Method

(i) In General

(ii) Allocation Formula

(iii) Production Cost Allocation Ratio

(iv) Labor-Based Allocation Ratio

(v) De Minimis Rule

(vi) Separate Method of Accounting

3. Step 3 - Allocating Additional Costs to Inventory

a. Self-Developed Allocation Methods

b. Simplified Production Method

(1) In General

(2) Simplified Production Method Without Historic Absorption Ratio Election

(a) Example of FIFO Inventory Calculation Under the Simplified Production Method

(b) Example of LIFO Inventory Calculation Under the Simplified Production Method - Multiple Pool(s)

(c) Example of LIFO Inventory Calculation Under the Simplified Production Method - Raw Material Content Pool

(d) De Minimis Rule for Producers with Total Indirect Costs of $200,000 or Less

(e) When Should the Simplified Production Method Be Used?

(3) Simplified Production Method with Historical Absorption Ratio Election

(a) In General

(b) Operating Rules and Definitions

(i) Historic Absorption Ratio

(ii) Test Period and Updated Test Period

(iii) Qualifying Period

(A) In General

(B) Extension of Qualifying Period

(c) Method of Accounting

(i) Adoption and Use

(ii) Revocation of Election

(d) Reporting and Recordkeeping Requirements

(i) Reporting

(ii) Recordkeeping

(e) Example

F. Other Code Sections That Restrict Deductions

G. Manufacturers May Have Long-Term Contracts

III. Retailers and Wholesalers

A. Introduction

B. Application of the UCR Rules to Resale Activities

1. Production Versus Resale Activities

2. Intangible Property Acquired for Resale

3. Real Estate Acquired for Resale

C. Indirect Costs Required to Be Inventoried

1. In General

2. Off-Site Storage and Warehousing

a. General Rules

b. Definition of On-Site Storage

(1) Definition of “Retail Sales Facility”

(2) “Physically Attached to, and an Integral Part of”

c. Dual Function Facilities

d. Storage of Non-Inventory Property

e. Costs Associated with Storage

3. Purchasing

a. Definition of Purchasing Costs

b. Allocation of Labor Costs Between Purchasing and Non-Purchasing Activities

c. Costs Related to Purchasing Activities

4. Handling Costs (i.e., Processing, Assembling, Repackaging, Transporting, and Similar Activities)

a. General Rules

b. Transportation Costs

c. Pick and Pack Costs

d. Costs Attributable to Handling Activities

5. General and Administrative Costs (G& A)

D. Costs Not Required to Be Inventoried

E. Application of the Resale-Related Indirect Costing Rules

1. Steps Required to Apply Rules

2. Allocation of G& A Between Resale Activities and Other Activities

3. Allocation of Inventoriable Resale Costs Between Ending Inventory and Cost of Goods Sold

a. In General

b. The Simplified Resale Method

(1) In General

(2) Mechanics of the Simplified Resale Method

(3) Permissible Variations of the Simplified Resale Method

(a) In General

(b) Variation #1 - Exclusion of Beginning Inventories from Denominator of Storage and Handling Ratio

(c) Variation #2 - Multiplication of Storage and Handling Ratio by Total  Costs in Ending Inventory

(4) Impact of the Simplified Resale Method on LIFO Taxpayers

(5) Adoption of Simplified Resale Method and Special Rules

(a) Adoption of Simplified Resale Method

(b) Simplified Resale Method - Special Rules

(c) The Historic Absorption Ratio

(i) General Discussion

(ii) Operating Rules and Definitions

(A) Historic Absorption Ratio

(B) Test Period and Updated Test Period

(C) Qualifying Period

(iii) Method of Accounting

4. Whether to Use the Simplified Resale Method and/or the Simplified Service Cost Method

F. Small Retailers/Wholesalers Exemption from Uniform Capitalization Rules

1. In General

2. Method Changes Resulting From Increasing (or Decreasing) Gross Receipts

3. Testing Gross Receipts

a. General Rule

b. How to Determine Gross Receipts

IV. Self-Constructed Assets

A. In General

B. Pre-UCR Law

1. Introduction

2. The Idaho Power Case

3. Specific Cost Areas

a. Direct Materials

b. Direct Labor

c. Construction-Related Employee Benefits

d. Payroll Taxes

e. Overhead Expenses

C. UCR for Self-Constructed Assets

1. Scope of Rules

a. In General

b. Application to Intellectual Property

c. Property Produced for Taxpayer by a Contractor

d. Construction of Property That Will Produce Inventoriable Goods

e. Package Design Costs

2. Costs Required to Be Capitalized

a. Direct Labor and Direct Materials

b. Indirect Costs

(1) Labor-Related Indirect Costs

(2) Costs Related to Construction Equipment and Facilities

(3) Administrative and Support Costs

(4) Taxes

(5) Engineering and Design Expenses

(6) Other Costs Required to Be Capitalized

c. Interest: Pre-UCR Law

d. Interest: Post-UCR Law

(1) IRS Guidance on Interest Capitalization

(2) Situations Subject to Interest Capitalization

(3) General Rules

(4) Interest Incurred by Related C Corporations

(5) Consolidated Return Implications

(6) Flow-Through Entities

(7) Safe Harbor Sale and Leaseback Transactions

3. Recovery of Capitalized Costs

4. Costs Not Required to Be Capitalized

5. Effective Dates

V. Real Property Produced for Sale

A. In General

B. Non-Inventory Treatment

C. Capitalization Rules

1. In General

2. Allocation Rules

3. Costs Relating to Future Improvements

D. Interplay with Long-Term Contract Rules

E. Effective Date

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Conference Report to Accompany H.R. 3838 H.R. Rep. No. 841, 99th Cong., 2d Sess. II-302-313 (1986) (Tax Reform Act of 1986)

Worksheet 2 General Explanation of the Tax Reform Act of 1986 (Staff of the Joint Committee on Taxation) 501-530 (May 4, 1987)

Worksheet 3 Conference Report to Accompany H.R. 3545 H.R. Rep. No. 495, 100th Cong., 1st Sess. 922-924 (1987) (Omnibus Budget Reconciliation Act of 1987)

Worksheet 4 Conference Report to Accompany H.R. 4333 H.R. Rep. No. 1104, 100th Cong., 2d Sess. 116-120 and 145-146 (1988) (Technical and Miscellaneous Revenue Act of 1988)

Worksheet 5 Conference Report to Accompany H.R. 3299 H.R. Rep. No. 386, 101st Cong., 1st Sess. 614-616 (1989) (Omnibus Budget Reconciliation Act of 1989)

Worksheet 6 Preamble to Regs. -1T T.D. 8131, 52 Fed. Reg. 10052 (March 30, 1987)

Worksheet 7 Preamble to Regs. -1T T.D. 8148, 52 Fed. Reg. 29375 (August 7, 1987)

Worksheet 8 Preamble to Regs.  T.D. 8482, 58 Fed. Reg. 42198 (August 9, 1993)

Worksheet 9 Preamble to T.D. 8559, 59 Fed. Reg. 39958 (August 5, 1994)

Worksheet 10 Preamble to T.D. 8584, 59 Fed. Reg. 67187 (December 29, 1994), Capitalization of Interest, and Regulations Table of Contents

Worksheet 11 Internal Revenue Service Coordinated Issue Paper on Capitalization of Unclassified Labor Costs for Utilities Industry, Issued April 1, 1996

Worksheet 12 Sample Election Statements - Manufacturers

Worksheet 13 Sample Election Statements - Retailers/Wholesalers

Worksheet 14 Sample Election Statements - Self-Constructed Assets

Worksheet 15 Sample Election Statements - Interest Capitalization

Worksheet 16 Sample Statements to be Used by Producers of Real Property for Sale Adopting Simplified Methods

Worksheet 17 Manufacturing Inventory Costs

Worksheet 18 Wholesalers/Retailers Inventory Costs

Worksheet 19 Self-Constructed Assets Capitalization Costs

Worksheet 20 Administrative, Service or Support Costs

Worksheet 21 Examples of Methods Used to Allocate Support Costs 1

Worksheet 22 List of Elections and Options

Worksheet 23 Relative Benefits/Detriments of the Simplified Production Method

Worksheet 24 Comparison of Direct Reallocation, Step-Allocation and Linear Algebra Method

Worksheet 25 Modifying Existing Burden Rate to Comply with 

Worksheet 26 Formulas and Definitions for Interest Capitalization

Bibliography

OFFICIAL

Statutes:

Regulations:

Legislative History:

Revenue Rulings and Procedures:

Cases:

UNOFFICIAL

Texts and Treatises:

Periodicals:

1986

1987

1988

1989

1990

1991

1993

1995

2000

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