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Washington Tax Alert March 22, 2007 (writedown of excess inventory parts)

Washington Tax Alert from Don Barnes, dbarnes@washingtontaxlaw.com
March 22, 2007

A field attorney for the Large & Mid-Size Business division (who formerly worked in the IRS National Office) recently issued field attorney advice (FAA 20071101F) to the Inventory Technical Advisor regarding the costing of certain excess inventory parts used to maintain and repair equipment that is no longer being produced.

The taxpayer valued its excess parts inventory at lower of cost or market (LCM) under Treas. Reg. § 1.471-4(a). The field attorney advice explains that for normal goods in inventory, "market" for purposes of LCM is the current bid price of the basic elements of cost to purchase or manufacture each item of inventory at year end. In this case, the taxpayer conceded that there was no market write-down from cost because "there has been no diminution in the replacement and/or reproduction costs [at year end]."

Instead, the taxpayer argued that its excess parts were "subnormal" goods under Treas. Reg. § 1.471-2(c) and should be valued at bona fide selling prices less costs of disposition. The field attorney advice concludes that the excess parts were not subnormal goods, even though the taxpayer's parts were obsolete, technologically dated, and physically separated from taxpayer's other inventory. As a result, the parts could not be valued at bona fide selling prices less costs of disposition. The IRS' position in the FAA is that inventory items are not subnormal for purposes of Treas. Reg. § 1.471-2(c) unless the items are physically defective. This position does not appear to be consistent with the regulations, which provide that subnormal goods include goods that are not salable at normal prices because of "changes of style, odd or broken lots, or other similar causes."