Subpart D - Inventories

26 USC 471 - General rule for inventories

(a) General rule 
Whenever in the opinion of the Secretary the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer on such basis as the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.
(b) Estimates of inventory shrinkage permitted 
A method of determining inventories shall not be treated as failing to clearly reflect income solely because it utilizes estimates of inventory shrinkage that are confirmed by a physical count only after the last day of the taxable year if
(1) the taxpayer normally does a physical count of inventories at each location on a regular and consistent basis, and
(2) the taxpayer makes proper adjustments to such inventories and to its estimating methods to the extent such estimates are greater than or less than the actual shrinkage.
(c) Cross reference 
For rules relating to capitalization of direct and indirect costs of property, see section 263A.

26 USC 472 - Last-in, first-out inventories

(a) Authorization 
A taxpayer may use the method provided in subsection (b) (whether or not such method has been prescribed under section 471) in inventorying goods specified in an application to use such method filed at such time and in such manner as the Secretary may prescribe. The change to, and the use of, such method shall be in accordance with such regulations as the Secretary may prescribe as necessary in order that the use of such method may clearly reflect income.
(b) Method applicable 
In inventorying goods specified in the application described in subsection (a), the taxpayer shall:
(1) Treat those remaining on hand at the close of the taxable year as being: First, those included in the opening inventory of the taxable year (in the order of acquisition) to the extent thereof; and second, those acquired in the taxable year;
(2) Inventory them at cost; and
(3) Treat those included in the opening inventory of the taxable year in which such method is first used as having been acquired at the same time and determine their cost by the average cost method.
(c) Condition 
Subsection (a) shall apply only if the taxpayer establishes to the satisfaction of the Secretary that the taxpayer has used no procedure other than that specified in paragraphs (1) and (3) of subsection (b) in inventorying such goods to ascertain the income, profit, or loss of the first taxable year for which the method described in subsection (b) is to be used, for the purpose of a report or statement covering such taxable year
(1) to shareholders, partners, or other proprietors, or to beneficiaries, or
(2) for credit purposes.
(d) 3-year averaging for increases in inventory value 
The beginning inventory for the first taxable year for which the method described in subsection (b) is used shall be valued at cost. Any change in the inventory amount resulting from the application of the preceding sentence shall be taken into account ratably in each of the 3 taxable years beginning with the first taxable year for which the method described in subsection (b) is first used.
(e) Subsequent inventories 
If a taxpayer, having complied with subsection (a), uses the method described in subsection (b) for any taxable year, then such method shall be used in all subsequent taxable years unless
(1) with the approval of the Secretary a change to a different method is authorized; or,
(2) the Secretary determines that the taxpayer has used for any such subsequent taxable year some procedure other than that specified in paragraph (1) of subsection (b) in inventorying the goods specified in the application to ascertain the income, profit, or loss of such subsequent taxable year for the purpose of a report or statement covering such taxable year
(A)  to shareholders, partners, or other proprietors, or beneficiaries, or
(B)  for credit purposes; and requires a change to a method different from that prescribed in subsection (b) beginning with such subsequent taxable year or any taxable year thereafter.

If paragraph (1) or (2) of this subsection applies, the change to, and the use of, the different method shall be in accordance with such regulations as the Secretary may prescribe as necessary in order that the use of such method may clearly reflect income.

(f) Use of government price indexes in pricing inventory 
The Secretary shall prescribe regulations permitting the use of suitable published governmental indexes in such manner and circumstances as determined by the Secretary for purposes of the method described in subsection (b).
(g) Conformity rules applied on controlled group basis 

(1) In general 
Except as otherwise provided in regulations, all members of the same group of financially related corporations shall be treated as 1 taxpayer for purposes of subsections (c) and (e)(2).
(2) Group of financially related corporations 
For purposes of paragraph (1), the term group of financially related corporations means
(A) any affiliated group as defined in section 1504 determined by substituting 50 percent for 80 percent each place it appears in section 1504 (a) and without regard to section 1504 (b), and
(B) any other group of corporations which consolidate or combine for purposes of financial statements.

26 USC 473 - Qualified liquidations of LIFO inventories

(a) General rule 
If, for any liquidation year
(1) there is a qualified liquidation of goods which the taxpayer inventories under the LIFO method, and
(2) the taxpayer elects to have the provisions of this section apply with respect to such liquidation,

then the gross income of the taxpayer for such taxable year shall be adjusted as provided in subsection (b).

(b) Adjustment for replacements 
If the liquidated goods are replaced (in whole or in part) during any replacement year and such replacement is reflected in the closing inventory for such year, then the gross income for the liquidation year shall be
(1) decreased by an amount equal to the excess of
(A) the aggregate replacement cost of the liquidated goods so replaced during such year, over
(B) the aggregate cost of such goods reflected in the opening inventory of the liquidation year, or
(2) increased by an amount equal to the excess of
(A) the aggregate cost reflected in such opening inventory of the liquidated goods so replaced during such year, over
(B) such aggregate replacement cost.
(c) Qualified liquidation defined 
For purposes of this section
(1) In general 
The term qualified liquidation means
(A) a decrease in the closing inventory of the liquidation year from the opening inventory of such year, but only if
(B) the taxpayer establishes to the satisfaction of the Secretary that such decrease is directly and primarily attributable to a qualified inventory interruption.
(2) Qualified inventory interruption defined 

(A) In general 
The term qualified inventory interruption means a regulation, request, or interruption described in subparagraph (B) but only to the extent provided in the notice published pursuant to subparagraph (B).
(B) Determination by Secretary 
Whenever the Secretary, after consultation with the appropriate Federal officers, determines
(i) that
(I) any Department of Energy regulation or request with respect to energy supplies, or
(II) any embargo, international boycott, or other major foreign trade interruption,

has made difficult or impossible the replacement during the liquidation year of any class of goods for any class of taxpayers, and

(ii) that the application of this section to that class of goods and taxpayers is necessary to carry out the purposes of this section,

he shall publish a notice of such determinations in the Federal Register, together with the period to be affected by such notice.

(d) Other definitions and special rules 
For purposes of this section
(1) Liquidation year 
The term liquidation year means the taxable year in which occurs the qualified liquidation to which this section applies.
(2) Replacement year 
The term replacement year means any taxable year in the replacement period; except that such term shall not include any taxable year after the taxable year in which replacement of the liquidated goods is completed.
(3) Replacement period 
The term replacement period means the shorter of
(A) the period of the 3 taxable years following the liquidation year, or
(B) the period specified by the Secretary in a notice published in the Federal Register with respect to that qualified inventory interruption.

Any period specified by the Secretary under subparagraph (B) may be modified by the Secretary in a subsequent notice published in the Federal Register.

(4) LIFO method 
The term LIFO method means the method of inventorying goods described in section 472.
(5) Election 

(A) In general 
An election under subsection (a) shall be made subject to such conditions, and in such manner and form and at such time, as the Secretary may prescribe by regulation.
(B) Irrevocable election 
An election under this section shall be irrevocable and shall be binding for the liquidation year and for all determinations for prior and subsequent taxable years insofar as such determinations are affected by the adjustments under this section.
(e) Replacement; inventory basis 
For purposes of this chapter
(1) Replacements 
If the closing inventory of the taxpayer for any replacement year reflects an increase over the opening inventory of such goods for such year, the goods reflecting such increase shall be considered, in the order of their acquisition, as having been acquired in replacement of the goods most recently liquidated (whether or not in a qualified liquidation) and not previously replaced.
(2) Amount at which replacement goods taken into account 
In the case of any qualified liquidation, any goods considered under paragraph (1) as having been acquired in replacement of the goods liquidated in such liquidation shall be taken into purchases and included in the closing inventory of the taxpayer for the replacement year at the inventory cost basis of the goods replaced.
(f) Special rules for application of adjustments 

(1) Period of limitations 
If
(A) an adjustment is required under this section for any taxable year by reason of the replacement of liquidated goods during any replacement year, and
(B) the assessment of a deficiency, or the allowance of a credit or refund of an overpayment of tax attributable to such adjustment, for any taxable year, is otherwise prevented by the operation of any law or rule of law (other than section 7122, relating to compromises),

then such deficiency may be assessed, or credit or refund allowed, within the period prescribed for assessing a deficiency or allowing a credit or refund for the replacement year if a notice for deficiency is mailed, or claim for refund is filed, within such period.

(2) Interest 
Solely for purposes of determining interest on any overpayment or underpayment attributable to an adjustment made under this section, such overpayment or underpayment shall be treated as an overpayment or underpayment (as the case may be) for the replacement year.
(g) Coordination with section 472 
The Secretary shall prescribe such regulations as may be necessary to coordinate the provisions of this section with the provisions of section 472.

26 USC 474 - Simplified dollar-value LIFO method for certain small businesses

(a) General rule 
An eligible small business may elect to use the simplified dollar-value method of pricing inventories for purposes of the LIFO method.
(b) Simplified dollar-value method of pricing inventories 
For purposes of this section
(1) In general 
The simplified dollar-value method of pricing inventories is a dollar-value method of pricing inventories under which
(A) the taxpayer maintains a separate inventory pool for items in each major category in the applicable Government price index, and
(B) the adjustment for each such separate pool is based on the change from the preceding taxable year in the component of such index for the major category.
(2) Applicable Government price index 
The term applicable Government price index means
(A) except as provided in subparagraph (B), the Producer Price Index published by the Bureau of Labor Statistics, or
(B) in the case of a retailer using the retail method, the Consumer Price Index published by the Bureau of Labor Statistics.
(3) Major category 
The term major category means
(A) in the case of the Producer Price Index, any of the 2-digit standard industrial classifications in the Producer Prices Data Report, or
(B) in the case of the Consumer Price Index, any of the general expenditure categories in the Consumer Price Index Detailed Report.
(c) Eligible small business 
For purposes of this section, a taxpayer is an eligible small business for any taxable year if the average annual gross receipts of the taxpayer for the 3 preceding taxable years do not exceed $5,000,000. For purposes of the preceding sentence, rules similar to the rules of section 448 (c)(3) shall apply.
(d) Special rules 
For purposes of this section
(1) Controlled groups 

(A) In general 
In the case of a taxpayer which is a member of a controlled group, all persons which are component members of such group shall be treated as 1 taxpayer for purposes of determining the gross receipts of the taxpayer.
(B) Controlled group defined 
For purposes of subparagraph (A), persons shall be treated as being component members of a controlled group if such persons would be treated as a single employer under section 52.
(2) Election 

(A) In general 
The election under this section may be made without the consent of the Secretary.
(B) Period to which election applies 
The election under this section shall apply
(i) to the taxable year for which it is made, and
(ii) to all subsequent taxable years for which the taxpayer is an eligible small business,

unless the taxpayer secures the consent of the Secretary to the revocation of such election.

(3) LIFO method 
The term LIFO method means the method provided by section 472 (b).
(4) Transitional rules 

(A) In general 
In the case of a year of change under this section
(i) the inventory pools shall
(I) in the case of the 1st taxable year to which such an election applies, be established in accordance with the major categories in the applicable Government price index, or
(II) in the case of the 1st taxable year after such election ceases to apply, be established in the manner provided by regulations under section 472;
(ii) the aggregate dollar amount of the taxpayers inventory as of the beginning of the year of change shall be the same as the aggregate dollar value as of the close of the taxable year preceding the year of change, and
(iii) the year of change shall be treated as a new base year in accordance with procedures provided by regulations under section 472.
(B) Year of change 
For purposes of this paragraph, the year of change under this section is
(i) the 1st taxable year to which an election under this section applies, or
(ii) in the case of a cessation of such an election, the 1st taxable year after such election ceases to apply.

26 USC 475 - Mark to market accounting method for dealers in securities

(a) General rule 
Notwithstanding any other provision of this subpart, the following rules shall apply to securities held by a dealer in securities:
(1) Any security which is inventory in the hands of the dealer shall be included in inventory at its fair market value.
(2) In the case of any security which is not inventory in the hands of the dealer and which is held at the close of any taxable year
(A) the dealer shall recognize gain or loss as if such security were sold for its fair market value on the last business day of such taxable year, and
(B) any gain or loss shall be taken into account for such taxable year.

Proper adjustment shall be made in the amount of any gain or loss subsequently realized for gain or loss taken into account under the preceding sentence. The Secretary may provide by regulations for the application of this paragraph at times other than the times provided in this paragraph.

(b) Exceptions 

(1) In general 
Subsection (a) shall not apply to
(A) any security held for investment,
(B) 
(i) any security described in subsection (c)(2)(C) which is acquired (including originated) by the taxpayer in the ordinary course of a trade or business of the taxpayer and which is not held for sale, and
(ii)  any obligation to acquire a security described in clause (i) if such obligation is entered into in the ordinary course of such trade or business and is not held for sale, and
(C) any security which is a hedge with respect to
(i) a security to which subsection (a) does not apply, or
(ii) a position, right to income, or a liability which is not a security in the hands of the taxpayer.

To the extent provided in regulations, subparagraph (C) shall not apply to any security held by a person in its capacity as a dealer in securities.

(2) Identification required 
A security shall not be treated as described in subparagraph (A), (B), or (C) of paragraph (1), as the case may be, unless such security is clearly identified in the dealers records as being described in such subparagraph before the close of the day on which it was acquired, originated, or entered into (or such other time as the Secretary may by regulations prescribe).
(3) Securities subsequently not exempt 
If a security ceases to be described in paragraph (1) at any time after it was identified as such under paragraph (2), subsection (a) shall apply to any changes in value of the security occurring after the cessation.
(4) Special rule for property held for investment 
To the extent provided in regulations, subparagraph (A) of paragraph (1) shall not apply to any security described in subparagraph (D) or (E) of subsection (c)(2) which is held by a dealer in such securities.
(c) Definitions 
For purposes of this section
(1) Dealer in securities defined 
The term dealer in securities means a taxpayer who
(A) regularly purchases securities from or sells securities to customers in the ordinary course of a trade or business; or
(B) regularly offers to enter into, assume, offset, assign or otherwise terminate positions in securities with customers in the ordinary course of a trade or business.
(2) Security defined 
The term security means any
(A) share of stock in a corporation;
(B) partnership or beneficial ownership interest in a widely held or publicly traded partnership or trust;
(C) note, bond, debenture, or other evidence of indebtedness;
(D) interest rate, currency, or equity notional principal contract;
(E) evidence of an interest in, or a derivative financial instrument in, any security described in subparagraph (A), (B), (C), or (D), or any currency, including any option, forward contract, short position, and any similar financial instrument in such a security or currency; and
(F) position which
(i) is not a security described in subparagraph (A), (B), (C), (D), or (E),
(ii) is a hedge with respect to such a security, and
(iii) is clearly identified in the dealers records as being described in this subparagraph before the close of the day on which it was acquired or entered into (or such other time as the Secretary may by regulations prescribe).

Subparagraph (E) shall not include any contract to which section 1256 (a) applies.

(3) Hedge 
The term hedge means any position which manages the dealers risk of interest rate or price changes or currency fluctuations, including any position which is reasonably expected to become a hedge within 60 days after the acquisition of the position.
(4) Special rules for certain receivables 

(A) In general 
Paragraph (2)(C) shall not include any nonfinancial customer paper.
(B) Nonfinancial customer paper 
For purposes of subparagraph (A), the term nonfinancial customer paper means any receivable which
(i) is a note, bond, debenture, or other evidence of indebtedness;
(ii) arises out of the sale of nonfinancial goods or services by a person the principal activity of which is the selling or providing of nonfinancial goods or services; and
(iii) is held by such person (or a person who bears a relationship to such person described in section 267 (b) or 707 (b)) at all times since issue.
(d) Special rules 
For purposes of this section
(1) Coordination with certain rules 
The rules of sections 263 (g), 263A, and 1256 (a) shall not apply to securities to which subsection (a) applies, and section 1091 shall not apply (and section 1092 shall apply) to any loss recognized under subsection (a).
(2) Improper identification 
If a taxpayer
(A) identifies any security under subsection (b)(2) as being described in subsection (b)(1) and such security is not so described, or
(B) fails under subsection (c)(2)(F)(iii) to identify any position which is described in subsection (c)(2)(F) (without regard to clause (iii) thereof) at the time such identification is required,

the provisions of subsection (a) shall apply to such security or position, except that any loss under this section prior to the disposition of the security or position shall be recognized only to the extent of gain previously recognized under this section (and not previously taken into account under this paragraph) with respect to such security or position.

(3) Character of gain or loss 

(A) In general 
Except as provided in subparagraph (B) or section 1236 (b)
(i) In general Any gain or loss with respect to a security under subsection (a)(2) shall be treated as ordinary income or loss.
(ii) Special rule for dispositions If
(I) gain or loss is recognized with respect to a security before the close of the taxable year, and
(II) subsection (a)(2) would have applied if the security were held as of the close of the taxable year,

such gain or loss shall be treated as ordinary income or loss.

(B) Exception 
Subparagraph (A) shall not apply to any gain or loss which is allocable to a period during which
(i) the security is described in subsection (b)(1)(C) (without regard to subsection (b)(2)),
(ii) the security is held by a person other than in connection with its activities as a dealer in securities, or
(iii) the security is improperly identified (within the meaning of subparagraph (A) or (B) of paragraph (2)).
(e) Election of mark to market for dealers in commodities 

(1) In general 
In the case of a dealer in commodities who elects the application of this subsection, this section shall apply to commodities held by such dealer in the same manner as this section applies to securities held by a dealer in securities.
(2) Commodity 
For purposes of this subsection and subsection (f), the term commodity means
(A) any commodity which is actively traded (within the meaning of section 1092 (d)(1));
(B) any notional principal contract with respect to any commodity described in subparagraph (A);
(C) any evidence of an interest in, or a derivative instrument in, any commodity described in subparagraph (A) or (B), including any option, forward contract, futures contract, short position, and any similar instrument in such a commodity; and
(D) any position which
(i) is not a commodity described in subparagraph (A), (B), or (C),
(ii) is a hedge with respect to such a commodity, and
(iii) is clearly identified in the taxpayers records as being described in this subparagraph before the close of the day on which it was acquired or entered into (or such other time as the Secretary may by regulations prescribe).
(3) Election 
An election under this subsection may be made without the consent of the Secretary. Such an election, once made, shall apply to the taxable year for which made and all subsequent taxable years unless revoked with the consent of the Secretary.
(f) Election of mark to market for traders in securities or commodities 

(1) Traders in securities 

(A) In general 
In the case of a person who is engaged in a trade or business as a trader in securities and who elects to have this paragraph apply to such trade or business
(i) such person shall recognize gain or loss on any security held in connection with such trade or business at the close of any taxable year as if such security were sold for its fair market value on the last business day of such taxable year, and
(ii) any gain or loss shall be taken into account for such taxable year.

Proper adjustment shall be made in the amount of any gain or loss subsequently realized for gain or loss taken into account under the preceding sentence. The Secretary may provide by regulations for the application of this subparagraph at times other than the times provided in this subparagraph.

(B) Exception 
Subparagraph (A) shall not apply to any security
(i) which is established to the satisfaction of the Secretary as having no connection to the activities of such person as a trader, and
(ii) which is clearly identified in such persons records as being described in clause (i) before the close of the day on which it was acquired, originated, or entered into (or such other time as the Secretary may by regulations prescribe).

If a security ceases to be described in clause (i) at any time after it was identified as such under clause (ii), subparagraph (A) shall apply to any changes in value of the security occurring after the cessation.

(C) Coordination with section 1259 
Any security to which subparagraph (A) applies and which was acquired in the normal course of the taxpayers activities as a trader in securities shall not be taken into account in applying section 1259 to any position to which subparagraph (A) does not apply.
(D) Other rules to apply 
Rules similar to the rules of subsections (b)(4) and (d) shall apply to securities held by a person in any trade or business with respect to which an election under this paragraph is in effect. Subsection (d)(3) shall not apply under the preceding sentence for purposes of applying sections 1402 and 7704.
(2) Traders in commodities 
In the case of a person who is engaged in a trade or business as a trader in commodities and who elects to have this paragraph apply to such trade or business, paragraph (1) shall apply to commodities held by such trader in connection with such trade or business in the same manner as paragraph (1) applies to securities held by a trader in securities.
(3) Election 
The elections under paragraphs (1) and (2) may be made separately for each trade or business and without the consent of the Secretary. Such an election, once made, shall apply to the taxable year for which made and all subsequent taxable years unless revoked with the consent of the Secretary.
(g) Regulatory authority 
The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section, including rules
(1) to prevent the use of year-end transfers, related parties, or other arrangements to avoid the provisions of this section,
(2) to provide for the application of this section to any security which is a hedge which cannot be identified with a specific security, position, right to income, or liability, and
(3) to prevent the use by taxpayers of subsection (c)(4) to avoid the application of this section to a receivable that is inventory in the hands of the taxpayer (or a person who bears a relationship to the taxpayer described in section 267 (b) or 707 (b)).