[Code of Federal Regulations]
[Title 26, Volume 4]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.381(c)(5)-1]

[Page 396-405]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.381(c)(5)-1  Inventories.

    (a) Carryover requirement--(1) General rule. Section 381(c)(5) 
provides that in a transaction to which section 381(a) applies and in 
which inventories are received by the acquiring corporation (as defined 
in Sec. 1.381(a)-1(b)(2)) such inventories shall be taken by the 
acquiring corporation (in determining its income) on the same basis on 
which such inventories were taken by the distributor or transferor 
corporation on the date of distribution or transfer unless different 
inventory methods were used on that date by several distributor or 
transferor corporations or by a distributor or transferor corporation 
and the acquiring corporation. If different methods were used, the 
acquiring corporation shall use the method or combination of methods of 
taking inventories adopted pursuant to the provisions of this section.
    (2) Rules of application. Reference in this section to a method or 
methods of taking inventories are to be construed as referring to both 
the method or methods of identifying the goods and the method or methods 
of valuing the goods. The method or methods of taking inventories shall 
be determined on the date of distribution or transfer, and any 
corporation, a party to a section 381(a) transaction whose taxable year 
does not end on such date shall be considered as using the method or 
methods of taking inventories that it would have employed had its 
taxable year ended on such date. The amount of the adjustments necessary 
to reflect the change in method of taking inventories pursuant to this 
section, the manner in which they are to be taken into account by the 
acquiring corporation, and the tax attributable thereto shall be 
determined and computed under section 481 and the regulations 
thereunder, subject to the rules provided in paragraphs (c) and (d) of 
this section. However, in the case of any party to a section 381(a) 
transaction which changes its method of taking inventories to the last-
in, first-out method of identification, the adjustments required by 
section 472(d) shall be applicable. See paragraph (e) of this section. 
This section shall not be construed as preventing any party to a section 
381(a) transaction from adopting an inventory method which, under the 
provisions of section 471 or 472, and the regulations thereunder, may be 
adopted without the consent of the Commissioner. For provisions defining 
the date of distribution or transfer, see paragraph (b) of Sec. 
1.381(b)-1.
    (b) Conditions for continuation of methods of taking inventories--
(1) No difference in method of taking inventories. (i) If all the 
parties to a section 381(a) transaction used the same method of taking 
inventories on the date of distribution or transfer, the acquiring 
corporation, whether or not immediately after the date of distribution 
or transfer it operates separate or integrated trades or businesses, 
shall continue to use such method of taking inventories, unless the 
acquiring corporation has, in accordance with paragraph (e) of Sec. 
1.446-1, obtained the consent of the Commissioner to use a different 
method of taking inventories. For purposes of this determination, a 
corporation shall be deemed to be using the last-in, first-out method of 
taking inventories with respect to a particular

[[Page 397]]

type of goods on the date of the distribution or transfer, if such 
corporation elects, under the provisions of section 472, to adopt the 
last-in, first-out method with respect to such goods for its taxable 
year within which or with which the date of distribution or transfer 
occurs.
    (ii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. O and P corporations are manufacturing companies which 
compute their entire inventories by the use of the last-in, first-out 
method of identification and the cost basis of valuation. In applying 
the last-in, first-out method both corporations use the dollar-value 
method, use the double-extension method, pool under the natural business 
unit method, and value annual inventory increases by reference to the 
actual cost of goods most recently purchased. P corporation acquires the 
assets of O corporation in a transaction to which section 381(a) 
applies. Under the provisions of this subparagraph, on and after the 
date of distribution or transfer P corporation must continue to use the 
last-in, first-out method of identification, the cost basis of 
valuation, and, in applying the last-in, first-out method, must continue 
to use the dollar-value method, use the double-extension method, pool 
under the natural business unit method, and value annual inventory 
increases by reference to the actual cost of goods most recently 
purchased, unless, in accordance with paragraph (e) of Sec. 1.446-1, 
consent of the Commissioner is obtained to change the method of taking 
inventories.

    (2) Separate businesses. (i) If, immediately after the date of 
distribution or transfer, any of the trades or businesses of the parties 
to a section 381(a) transaction are operated as separate and distinct 
trades or businesses within the meaning of paragraph (d) of Sec. 1.446-
1, then the method or methods of taking inventories employed by such 
parties to the transaction on the date of distribution or transfer with 
respect to such trades or businesses shall be used by the acquiring 
corporation, unless the acquiring corporation has, in accordance with 
paragraph (e) of Sec. 1.446-1, obtained the consent of the Commissioner 
to use a different method of taking inventories. This subparagraph shall 
not be construed as precluding the Commissioner under section 471 or 
472, and the regulations thereunder, from requiring that the method of 
taking inventories used in a particular trade or business be used in 
another trade or business with respect to similar types of goods, if, in 
the opinion of the Commissioner, the use of such method of taking 
inventories is necessary for a clear reflection of income.
    (ii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. R Corporation is engaged in the production of radios and 
television sets and S Corporation is engaged in the production of 
washers and driers. In computing their inventories both corporations use 
the cost basis of valuation. R corporation uses the last-in, first-out 
method of identification, whereas S corporation uses the first-in, 
first-out method. T corporation acquires the assets of R corporation and 
S corporation in a transaction to which section 381(a) applies. T 
corporation operates as a separate and distinct trade or business, 
within the meaning of paragraph (d) of Sec. 1.446-1, each of the 
businesses formerly operated by R corporation and S corporation. Under 
the provisions of this subparagraph, T corporation is required to 
continue to use the method of taking inventories previously used by R 
corporation and S corporation, respectively, with respect to each trade 
or business, unless, in accordance with paragraph (e) of Sec. 1.446-1, 
consent of the Commissioner is obtained to change the methods of taking 
inventories, on and after the dates of transfer. However, the 
Commissioner may require T corporation, in accordance with Sec. 1.472-
2, to use the last-in, first-out method with respect to that portion of 
the goods in the trades or businesses formerly operated by S corporation 
and T corporation which are similar to goods in the trade or business 
formerly operated by R corporation, if, in his opinion, the use of the 
last-in, first-out method with respect to such similar goods is 
necessary for a clear reflection of income.

    (3) Integrated businesses--(i) Same inventory method. If, 
immediately after the date of distribution or transfer, any of the 
trades or businesses of the parties to a section 381(a) transaction are 
not operated as separate and distinct trades or businesses within the 
meaning of paragraph (d) of Sec. 1.446-1, then, to the extent that the 
same methods of taking inventories for particular types of goods were 
employed on the date of distribution or transfer by the parties to the 
transaction with respect to any trades or businesses which are 
integrated or are required to

[[Page 398]]

be integrated in accordance with paragraph (d) of Sec. 1.446-1, the 
acquiring corporation shall continue to employ such methods of taking 
inventories for such types of goods, unless, in accordance with 
paragraph (e) of Sec. 1.446-1, the acquiring corporation has obtained 
the consent of the Commissioner to use a different method of taking 
inventories. This subdivision shall not be construed as precluding the 
Commissioner under section 471 or 472, and the regulations thereunder, 
from requiring that the method of taking inventories used with respect 
to particular types of goods in a particular trade or business operated 
by the acquiring corporation after the date of distribution or transfer 
be used with respect to similar types of goods in another trade or 
business operated by it after such date if, in the opinion of the 
Commissioner, the use of such method of taking inventories is necessary 
for a clear reflection of income.
    (ii) Different inventory methods. If, immediately after the date of 
distribution or transfer, any of the trades or businesses of the parties 
to a section 381(a) transaction are not operated as separate and 
distinct trades or businesses within the meaning of paragraph (d) of 
Sec. 1.446-1, then, to the extent that different methods of taking 
inventories for particular types of goods were employed on the date of 
distribution or transfer by the parties to the transaction with respect 
to any trades or businesses which are integrated or required to be 
integrated in accordance with paragraph (d) of Sec. 1.446-1, the 
acquiring corporation shall not be permitted to continue to use such 
different methods of taking inventories, and shall adopt the method of 
taking inventories described in paragraph (c) of this section for such 
types of goods unless, in accordance with paragraph (d) of this section, 
consent of the Commissioner is obtained to use a different method of 
taking inventories.
    (iii) Examples. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example (1). O and P corporations are manufacturing companies which 
compute their entire inventories by the use of the last-in, first-out 
method of identification and the cost basis of valuation. In applying 
the last-in, first-out method both corporations use the dollar-value 
method and the double-extension method. However, O corporation pools 
under the natural business unit method while P corporation pools under 
the multiple pool method. In addition, O corporation determines the cost 
of its annual inventory increase by reference to the actual cost of 
goods most recently purchased, whereas P corporation determines the cost 
of such increase by reference to the actual cost of the goods purchased 
during the taxable year in the order of acquisition. P corporation 
acquires the assets of O corporation in a transaction to which section 
381(a) applies and integrates the business formerly operated by O 
corporation into the business which was operated by P corporation before 
the date of distribution or transfer. Under the provisions of 
subdivision (i) of this subparagraph (relating to the same inventory 
methods in an integrated trade or business), P corporation shall 
continue to use the last-in, first-out method of identification, the 
cost basis of valuation, and in applying the last-in, first-out method, 
shall continue to use the dollar-value method and the double-extension 
method, unless, in accordance with paragraph (e) of Sec. 1.446-1, 
consent of the Commissioner is obtained to change the method of taking 
inventories. However, under the provisions of subdivision (ii) of this 
subparagraph (relating to different inventory methods in an integrated 
trade or business), P corporation shall use the method of taking 
inventories described in paragraph (c) of this section with respect to 
the method of pooling and the method of determining the cost of annual 
inventory increases, unless, in accordance with paragraph (d) of this 
section, consent of the Commissioner is obtained to use a different 
method of taking inventories.
    Example (2). Y and Z corporations are engaged in the manufacture of 
cereal products. Y corporation uses the first-in, first-out method of 
identification and the cost or market, whichever is lower, method of 
valuing its inventories, including oats. Z corporation uses the first-
in, first-out method of identification and the cost or market, whichever 
is lower, method of valuing its inventories, except oats which are 
valued on the cost method. Y corporation acquires all of the assets of Z 
corporation in a transaction to which section 381(a) applies and 
integrates the business formerly operated by Z corporation into the 
business which was operated by Y corporation before the date of 
distribution or transfer. Under the provisions of subdivision (i) of 
this subparagraph (relating to the same inventory methods in an 
integrated trade or business), Y corporation must continue to use the 
first-in, first-out method with respect to all of its inventories and 
must continue to use the cost or market, whichever is

[[Page 399]]

lower, method of valuing all inventories except oats, unless, in 
accordance with paragraph (e) of Sec. 1.446-1, consent of the 
Commissioner is obtained to change the method of taking inventories. In 
addition, under the provisions of subdivision (ii) of this subparagraph 
(relating to different inventory methods in an integrated trade or 
business), Y corporation shall use the method described in paragraph (c) 
of this section in valuing its inventory of oats, unless, in accordance 
with paragraph (d) of this section, consent of the Commissioner is 
obtained to use a different method of valuing its oats.

    (4) Rules of application. (i) In any case where the method of taking 
inventories employed on the date of distribution or transfer is 
continued, it will be unnecessary for the acquiring corporation to renew 
any election previously made by it or by any distributor or transferor 
corporation with respect to such method of taking inventories, and the 
acquiring corporation is bound by any such elections. If, on the date of 
distribution or transfer, any party to a section 381(a) transaction had 
no inventories of a particular type of goods, or such party came into 
existence as a result of the transaction, such party shall not be 
considered to be using a method of taking inventories for the particular 
type of goods different from that used by the other parties to the 
transaction. If, on the date of distribution or transfer, any one of the 
parties to the transaction is using the cash receipts and disbursements 
method of accounting and is not required to take inventories, the 
determination as to whether such method of accounting is to be continued 
by the acquiring corporation shall be made in accordance with section 
381(c)(4) and the regulations thereunder.
    (ii) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example (1). M corporation is engaged in manufacturing and computes 
its inventories under the first-in, first-out method of identification 
and the cost or market, whichever is lower, method of valuation. N 
corporation is also engaged in manufacturing and computes its 
inventories under the first-in, first-out method of identification and 
the cost method of valuation. M corporation acquires the assets of N 
corporation in a transaction to which section 381(a) applies and M 
corporation integrates the business formerly operated by N corporation 
into the business which was operated by M corporation before the date of 
distribution or transfer. On the date of distribution or transfer, N 
corporation has inventories of sheet steel while M corporation has no 
inventories of this particular type of goods. In all other respects the 
inventories of the two corporations consist of similar types of goods. 
Under the provisions of this subparagraph, M corporation must use the 
first-in, first-out method of identification and the cost method of 
valuation of inventories of sheet steel, unless, in accordance with 
paragraph (e) of Sec. 1.446-1, consent of the Commissioner is obtained 
to change the method of taking such inventories. For other goods in its 
inventories M corporation must use the first-in, first-out method of 
identification (as required by subparagraph (3)(i) of this paragraph), 
and with respect to the method of valuation, must use the method of 
taking inventories described in paragraph (c) of this section, unless, 
in accordance with paragraph (d) of this section, consent of the 
Commissioner is obtained to use a different method of taking 
inventories.
    Example (2). W corporation is engaged in the business of raising 
cattle and uses the cash receipts and disbursements method of computing 
taxable income. Inventories, therefore, are not required. X corporation 
is also engaged in the business of raising cattle and uses the accrual 
method of computing taxable income under which it has elected to use the 
``farm-price method'' of valuing inventories. The assets of W 
corporation are acquired by X corporation in a transaction to which 
section 381(a) applies and X corporation integrates the business 
formerly operated by W corporation into the business which was operated 
by X corporation before the date of distribution or transfer. Under the 
provisions of this subparagraph, whether X corporation is required to 
take inventories will depend upon which method of accounting is used by 
X corporation after the date of distribution or transfer, in accordance 
with the provisions of section 381(c)(4) and the regulations thereunder. 
Therefore, if X corporation uses the cash receipts and disbursements 
method, it will not be required to take inventories into account in 
computing its taxable income. However, if X corporation uses the accrual 
method, it must use the ``farm-price method'' of taking inventories, 
unless, in accordance with paragraph (d) of this section, consent of the 
Commissioner is obtained to use a different method of taking 
inventories.

    (c) Change of method of taking inventories without consent of 
Commissioner--(1) General rule. If, under the provisions of paragraph 
(b) of this section, the acquiring corporation is not permitted to 
continue to use the method of taking

[[Page 400]]

inventories used by it or by the distributor or transferor corporation 
or corporations on the date of distribution or transfer, the acquiring 
corporation shall use the principal method of taking inventories for 
each particular type of goods of such corporations, as determined under 
subparagraph (2) of this paragraph: Provided, That:
    (i) Such method clearly reflects the income of the acquiring 
corporation after the distribution or transfer as provided by sections 
446(a) and 471 and the regulations thereunder, and
    (ii) The use of such method is not inconsistent with the provisions 
of any closing agreement entered into under section 7121 and the 
regulations thereunder.

If the principal method does not satisfy the requirements of 
subdivisions (i) and (ii) of this subparagraph, or if the acquiring 
corporation wishes to use a method other than the principal method, see 
paragraph (d)(1) of this section. If the principal method of taking 
inventories is adopted under this paragraph, it will not be necessary 
for the acquiring corporation or corporations to renew any election 
previously made by it or by the distributor or transferor corporation 
with respect to such principal method of taking inventories, and the 
acquiring corporation is bound by any such election.
    (2) Principal method of taking inventories. The determination of the 
principal method of taking inventories shall be made with respect to 
each particular type of goods of each integrated trade or business 
operated by the acquiring corporation immediately after the date of 
distribution or transfer. Such determination for each integrated trade 
or business shall be made by reference to the methods of taking 
inventories previously used in the component trades or businesses for 
such types of goods which constitute the subsequent integrated trade or 
business of the acquiring corporation. For purposes of this 
determination, a corporation shall be deemed to be using the last-in, 
first-out method of taking inventories with respect to a particular type 
of goods on the date of the distribution or transfer, if such 
corporation elects, under the provisions of section 472, to adopt the 
last-in, first-out method with respect to such goods for its taxable 
year within which or with which the date of distribution or transfer 
occurs. The fair market value of the particular types of goods of each 
group of component trades or businesses with respect to which one method 
of taking inventories common to all was employed shall be compared with 
the fair market value of comparable types of goods of other groups of 
component trades or businesses with respect to which another method of 
taking inventories common to all was employed. For purposes of the above 
comparison and to the extent that particular types of goods are included 
in inventory by grouping or pooling, then such group or pool shall be 
considered as a single unit. The total fair market value of such group 
or pool shall be the basis for comparison in determining the principal 
method of taking inventories. The method of taking inventories of the 
group of component trades or businesses having the largest fair market 
value of such inventories shall be the principal method of taking 
inventories. For purposes of this subparagraph, the fair market value of 
the inventories of a component trade or business shall be determined 
immediately after the date of distribution or transfer.
    (3) Examples. The provisions of this paragraph may be illustrated by 
the following examples:

    Example (1). (i) X, Y, and Z corporations are all engaged in the 
manufacture of sheet metal. In addition, Y and Z corporations are 
engaged in the manufacture of paper containers. X and Y corporations use 
the first-in, first-out method of identifying goods and the cost method 
of valuing all inventories, while Z corporation uses the first-in, 
first-out method of identifying goods and the cost or market, whichever 
is lower, method of valuing all inventories. X, Y, and Z corporations 
enter into a transaction to which section 381(a) applies, and the 
acquiring corporation integrates the sheet metal businesses formerly 
operated by X, Y, and Z corporations and also integrates the paper 
container businesses formerly operated by Y and Z corporations. Each 
corporation has the same types of goods in the inventories of its sheet 
metal business and Y and Z corporations have the same types of goods in 
the inventories of their paper container businesses. Immediately after 
the date of distribution or transfer the fair market values of the 
respective inventories are as follows:

[[Page 401]]



------------------------------------------------------------------------
                                            X          Y           Z
------------------------------------------------------------------------
Sheet metal..........................     $10,000     $7,000     $15,000
Paper container......................  ..........      6,000       7,000
------------------------------------------------------------------------

    (ii) Since X, Y, and Z corporations all used the first-in, first-out 
method of identifying their inventories as of the date of distribution 
or transfer, then, under the provisions of paragraph (b)(3)(i) of this 
section, the acquiring corporation shall continue to use the first-in, 
first-out method of identifying all goods unless, in accordance with 
paragraph (e) of Sec. 1.446-1, consent of the Commissioner is obtained 
to change the method of accounting.
    (iii) Since the acquired corporations used different methods of 
valuing inventories in their sheet metal business and their paper 
container business, when the businesses were integrated the acquiring 
corporation must, under the provisions of this paragraph, determine 
which method of inventory valuation used by the acquired corporations on 
the date of distribution or transfer is the principal method of 
inventory valuation for each of such businesses.
    (a) In determining which is the principal method of valuing 
inventories for the sheet metal business pursuant to subparagraph (2) of 
this paragraph, the total fair market value of the sheet metal 
inventories of X and Y corporations, $17,000 (i.e., $10,000 
+$7,000=$17,000), is compared with the fair market value of the sheet 
metal inventory of Z corporation, $15,000. Since the total fair market 
value of the sheet metal inventories of X and Y corporations ($17,000) 
exceeds the fair market value of the sheet metal inventory of Z 
corporation ($15,000), the cost method of valuation used by X and Y 
corporations is the principal method of taking such inventories, and 
must be used by the acquiring corporation in valuing such inventories, 
if the conditions set forth in subparagraph (1) of this paragraph are 
satisfied.
    (b) In determining which is the principal method of valuing 
inventories for the paper container business pursuant to subparagraph 
(2) of this paragraph, the fair market value of the paper container 
inventory of Y corporation ($6,000) is compared with the fair market 
value of the paper container inventory of Z corporation ($7,000). Since 
the fair market value of the paper container inventory of Z corporation 
($7,000) exceeds the fair market value of the paper container inventory 
of Y corporation ($6,000), the cost or market, whichever is lower, 
method of valuation used by Z corporation is the principal method of 
taking such inventories, and must be used by the acquiring corporation 
in valuing such inventories, if the conditions set forth in subparagraph 
(1) of this paragraph are satisfied.
    Example (2). (i) X, Y, and Z corporations are all engaged in the 
manufacture of electrical appliances. In addition, X and Z corporations 
are engaged in the manufacture of plastic containers. X corporation uses 
the first-in, first-out method of identifying goods and the cost method 
of valuing all inventories. Y and Z corporations use the last-in, first-
out method of identifying goods and the cost method of valuing all 
inventories. In applying the last-in, first-out method, Y corporation 
uses the dollar value method, the double-extension method, and pools 
under the natural business unit method, while Z corporation uses the 
dollar value method, the double-extension method, and pools under the 
multiple pooling method for all inventories. X, Y, and Z corporations 
enter into a transaction to which section 381(a) applies, and the 
acquiring corporation integrates the electric appliance businesses 
formerly operated by X, Y, and Z corporations and also integrates the 
plastic container businesses formerly operated by X and Z corporations. 
Each corporation has the same types of goods in the inventories of its 
electric appliance business and X and Z corporations have the same types 
of goods in the inventories of their plastic container businesses. 
Immediately after the date of distribution or transfer, the fair market 
values of the respective inventories are as follows:

------------------------------------------------------------------------
                                              X           Y         Z
------------------------------------------------------------------------
Electric appliance.....................     $13,000     $10,000   $5,000
Plastic container......................       7,000  ..........    6,000
------------------------------------------------------------------------

    (ii) Since X, Y, and Z corporations all used the cost method of 
valuing their inventories as of the date of distribution or transfer, 
then, under the provisions of paragraph (b)(3)(i) of this section, the 
acquiring corporation shall continue to use the cost method of valuing 
all goods unless, in accordance with paragraph (e) of Sec. 1.446-1, 
consent of the Commissioner is obtained to change the method of 
accounting.
    (iii) Since the acquired corporations used different methods of 
identifying inventories in their electric appliance business and their 
plastic container business, when the businesses were integrated the 
acquiring corporation must, under the provisions of this paragraph, 
determine which method of inventory identification used by the acquired 
corporations on the date of distribution or transfer is the principal 
method of inventory identification for each of such businesses.
    (a)(1) In determining which is the principal method of identifying 
inventories for the electric appliance business pursuant to subparagraph 
(2) of this paragraph, the fair market value of the electric appliance 
inventory of X corporation, $13,000, is compared with the total fair 
market value of the electric appliance inventories of Y and Z 
corporations, $15,000 (i.e., $10,000+$5,000 =$15,000).

[[Page 402]]

Since the total fair market value of the electric appliance inventories 
of Y and Z corporations ($15,000) exceeds the fair market value of the 
electric appliance inventory of X corporation ($13,000), the last-in, 
first-out method of identification is the principal method of taking the 
electric appliance inventories and must be used by the acquiring 
corporation, if the conditions set forth in subparagraph (1) of this 
paragraph are satisfied.
    (2) Since Y and Z corporations used different pooling methods, in 
applying the last-in, first-out method, the acquiring corporation must, 
under the provisions of this paragraph, determine which pooling method 
as used by Y and Z corporations on the date of distribution or transfer 
is the principal method. In making such determination pursuant to 
subparagraph (2) of this paragraph, the fair market value of the 
electric appliance inventory of Y corporation ($10,000) is compared with 
the fair market value of the electric appliance inventory of Z 
corporation ($5,000). Since the fair market value of the electric 
appliance inventory of Y corporation ($10,000) exceeds the fair market 
value of the electric appliance inventory of Z corporation ($5,000), the 
natural business unit method is the principal method of pooling and must 
be used by the acquiring corporation in applying the last-in, first-out 
method with respect to the electric appliance business, if the 
conditions set forth in subparagraph (1) of this paragraph are 
satisfied.


In addition, under the provisions of paragraph (b)(3)(i) of this 
section, the acquiring corporation must use the dollar value method and 
the double-extension method for valuing goods in its electric appliance 
inventory since Y and Z corporations both used such methods in valuing 
their electric appliance inventories as of the date of distribution or 
transfer, unless, in accordance with paragraph (e) of Sec. 1.446-1, 
consent of the Commissioner is obtained to change the method of 
accounting.
    (b) In determining which is the principal method of identifying 
inventories for the plastic container business pursuant to subparagraph 
(2) of this paragraph, the fair market value of the plastic container 
inventory of X corporation ($7,000) is compared with the fair market 
value of the plastic container inventory of Z corporation ($6,000). 
Since the fair market value of the plastic container inventory of X 
corporation. ($7,000) exceeds the fair market value of the plastic 
container inventory of Z corporation ($6,000) the first-in, first-out 
method of identification, as used by X corporation, is the principal 
method of taking the plastic container inventories and must be used by 
the acquiring corporation, if the conditions set forth in subparagraph 
(1) of this paragraph are satisfied.

    (d) Change of method of taking inventories with consent of the 
Commissioner--(1) General rule--(i) Carryover and principal method not 
permitted. If the acquiring corporation is not permitted, under 
paragraph (b) of this section, to continue to use the method of taking 
inventories used by it or the distributor or transferor corporation or 
corporations on the date of distribution or transfer, and is not 
permitted, under paragraph (c) of this section, to use the principal 
method of taking inventories, then such acquiring corporation must 
request the Commissioner to determine the appropriate method of taking 
inventories.
    (ii) Principal method required. If the acquiring corporation wishes 
to use a method of taking inventories other than the principal method of 
taking inventories which is required to be used under paragraph (c) of 
this section, it shall apply to the Commissioner for permission to use 
such other method of taking inventories. Permission to use such other 
method of taking inventories will not be granted unless the acquiring 
corporation and the Commissioner agree to the terms, conditions, and 
adjustments under which the change to such method will be effected.
    (2) Time and manner of making application. Request for a 
determination of the method of taking inventories to be used under 
subparagraph (1)(i) of this paragraph or applications for permission to 
use a method of taking inventories under subparagraph (1)(ii) of this 
paragraph shall be filed with the Commissioner of Internal Revenue, 
Attention: T:I:C, Washington, DC 20224, not later than 90 days after the 
date of distribution or transfer, except that in cases where the date of 
distribution or transfer occurs before January 15, 1975, such 
applications or requests shall be filed not later than 90 days after 
such date. The application shall be accompanied by a copy of the 
statement described in paragraph (b)(3) of Sec. 1.381(b)-1, and by a 
statement specifying the nature of the transaction which causes section 
381 to apply; the differences in methods of taking inventories used by 
the corporations concerned; the method of taking inventories proposed to 
be used by the acquiring corporations; and the amount of adjustments 
necessary

[[Page 403]]

to prevent duplication or omission of items in the computation of 
taxable income under such proposed method. The Commissioner may also 
require such other information as may be necessary in order to determine 
the proper method of taking inventories to be used by the acquiring 
corporation.
    (e) Treatment of layers of inventories by the acquiring corporation 
and rules for making adjustments--(1) In general. This paragraph 
provides rules for treating layers of inventories by the acquiring 
corporation and rules for making adjustments, once the acquiring 
corporation's method of taking inventories for its taxable year 
including the date of distribution or transfer has been determined in 
accordance with the rules set forth in paragraphs (a) through (d) of 
this section. Thus, for example, if the acquiring corporation uses the 
last-in, first-out method of taking inventories for its taxable year 
including the date of distribution or transfer, either because such 
corporation elects the last-in, first-out method of taking inventories 
under the provisions of section 472 for such year or because such method 
is otherwise determined to be the principal method of taking inventories 
under paragraph (c)(2) of this section, then such corporation shall 
integrate its layers of inventories and make the necessary adjustments 
in accordance with the rules under paragraph (e)(2) of this section.
    (2) Acquiring corporation uses last-in, first-out method--(i) 
Dollar-value method--(a) Distributor or transferor corporation using 
last-in, first-out method. In any case where the acquiring corporation 
is required or permitted to use the dollar value method of pricing 
inventories on the last-in, first-out method for its taxable year 
including the date of distribution or transfer, the inventories of each 
distributor or transferor corporation which used the last-in, first-out 
method for its taxable year in which the distribution or transfer 
occurred shall be placed on the dollar value method pursuant to the 
rules contained in paragraph (f) of Sec. 1.472-8, and then such 
inventories shall be integrated with the inventories of the acquiring 
corporation. If pools of each corporation are permitted or required to 
be combined, they shall be combined in accordance with the principles 
set forth in paragraph (g)(2) of Sec. 1.472-8. For purposes of 
combining pools, all base-year inventories or layers of increment which 
occur in taxable years including the same December 31 shall be combined. 
A base-year inventory or layer of increment occurring in any short 
taxable year not including a December 31 or in the final taxable year of 
a distributor or transferor corporation shall be merged with and 
considered a layer of increment of its immediately preceding taxable 
year.
    (b) Distributor or transferor corporation not using last-in, first-
out method. In any case where the acquiring corporation is required or 
permitted to use the last-in, first-out method of taking inventories for 
its taxable year including the date of distribution or transfer, the 
inventories of each distributor or transferor corporation which did not 
use the last-in, first-out method for its taxable year in which the 
distribution or transfer occurred shall be treated by the acquiring 
corporation as having been acquired at their average unit cost in a 
single transaction on the date of distribution or transfer. Thus, where 
the acquiring corporation is required or permitted to use the dollar 
value method of pricing inventories, if an item of inventory is to be 
combined in an existing dollar value pool, such item shall be treated as 
if it were purchased at its average unit cost on the date of 
distribution or transfer with respect to such pool. On the other hand, 
if such item is not to be combined in an existing pool and the taxpayer 
otherwise uses LIFO with respect to such item, such item will be treated 
as if it were purchased at its average unit cost on the date of 
distribution or transfer with respect to a new pool (if any), with the 
base-year being the year of distribution or transfer. Adjustments 
resulting from a restoration to cost of any write-down to market value 
of such inventories of a distributor or transferor corporation shall be 
taken into account by such corporation in its final taxable year (where 
such year is closed by reason of section 381(b)). See section 472(d).
    (ii) Specific goods method--(a) Distributor or transferor 
corporation using last-in, first-out method. In any case

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where the acquiring corporation is required or permitted to use the 
specific goods method of pricing inventories on the last-in, first-out 
method for its taxable year including the date of distribution or 
transfer, the inventories of each distributor or transferor corporation 
which used the last-in, first-out method for its taxable year in which 
the distribution or transfer occurred shall be treated by the acquiring 
corporation as having the acquisition dates and costs of the distributor 
or transferor corporation.
    (b) Distributor or transferor not using last-in, first-out method. 
See paragraph (e)(1)(i)(b) of this section.
    (3) Acquiring corporation uses first-in, first-out method--(i) 
Distributor or transferor corporations not using first-in, first-out 
method. In any case where the acquiring corporation is permitted or 
required to use the first-in, first-out method of taking inventories for 
its taxable year including the date of distribution or transfer, the 
inventories of each distributor or transferor corporation which did not 
use the first-in, first-out method shall be treated by the acquiring 
corporation as having the same acquisition dates and costs which such 
inventory would have had if the distributor or transferor corporation 
had been using the first-in, first-out method for its taxable year in 
which the distribution or transfer occurred. However, if the acquiring 
corporation values its inventories at cost or market, whichever is 
lower, then the acquired inventories shall be treated as having been 
acquired at cost or market, whichever is lower.
    (ii) Distributor or transferor corporation using first-in, first-out 
method. In any case where the acquiring corporation is required or 
permitted to use the first-in, first-out method of taking inventories 
for its taxable year including the date of distribution or transfer, the 
inventories of each distributor or transferor corporation which used 
such method for its taxable year in which the distribution or transfer 
occurred shall be treated by the acquiring corporation as having the 
same acquisition dates and costs as the distributor or transferor 
corporations. However, where the acquiring corporation values its 
inventories at cost or market, whichever is lower, then the acquiring 
corporation shall treat the acquired inventories as having been acquired 
at cost or market, whichever is lower.
    (4) Adjustments. Except as provided in paragraph (e)(1) of this 
section with respect to any adjustments under section 472(d), the 
adjustments necessary to reflect the change from the method of taking 
inventories previously used by any of the corporations involved 
(including any adjustments required by section 481), shall be determined 
and computed in the same manner as if on the date of distribution or 
transfer, each of the several corporations that were not using the 
method of taking inventories used by the acquiring corporation for its 
taxable year including the date of distribution or transfer had 
initiated a change in the method of taking inventories. However, such 
adjustments (as an item of income or deduction, as the case may be) 
shall be taken into account solely by the acquiring corporation in 
computing its taxable income.
    (f) Basis of inventories received. The basis of inventories received 
by the acquiring corporation from a distributor or transferor 
corporation shall be determined in accordance with section 334(b)(1) or 
362(b), and the regulations thereunder. See also section 1013, and the 
regulations thereunder.
    (g) Additional rules applicable to distributions or transfers before 
January 15, 1975--(1) Statute of limitations bars assessment or refund. 
If the date of distribution or transfer was before January 15, 1975, and 
if the assessment of any deficiency or the refund or credit of any 
overpayment for the taxable year of the acquiring corporation which 
includes the date of distribution or transfer or any subsequent taxable 
year is prevented by the operation of any law or rule of law, then this 
section does not authorize the Commissioner or the acquiring corporation 
to change any method or methods of computing inventories in any taxable 
year of the acquiring corporation. However, the Commissioner or the 
acquiring corporation may change such method or methods of computing 
inventories under the provisions of section 446, 471, or 472 and the 
regulations thereunder.

[[Page 405]]

    (2) Statute of limitations does not bar assessment and refund. 
Except as provided in subparagraph (1) of this paragraph--
    (i) If the date of distribution or transfer was before January 15, 
1975, and the acquiring corporation has, for the taxable year which 
includes the date of distribution or transfer:
    (a) Adopted or continued a method or methods of taking inventories 
consistent with the rules of this section,
    (b) Been granted permission by the Commissioner, in accordance with 
section 446, 471, or 472 and the regulations thereunder, to use a method 
or methods of taking inventories, or
    (c) Adopted a method or methods of taking inventories that, under 
section 446, 471, or 472 and the regulations thereunder may be adopted 
without the consent of the Commissioner,

then the method or methods of taking inventories adopted or continued in 
the manner described in (a), (b), or (c) of this subdivision, shall not 
be changed, by reason of the rules contained in this section, by the 
Commissioner or by the acquiring corporation for any taxable year ending 
after the date of distribution or transfer. However, the Commissioner or 
the acquiring corporation may change such method or methods of taking 
inventories for any such taxable year under the provisions of, and to 
the extent permitted by, section 446, 471, or 472 and the regulations 
thereunder.
    (ii) If the date of distribution or transfer was before January 15, 
1975, and the acquiring corporation has, for the taxable year which 
includes the date of distribution or transfer, adopted or continued a 
method or methods of taking inventories other than in the manner 
described in (a), (b), or (c) of subdivision (i) of this subparagraph, 
then the acquiring corporation may--
    (a) Continue to use the method or methods of taking inventories so 
adopted or continued if such method or methods clearly reflect income 
and if proper adjustments were made to reflect the adoption of such 
method or methods, or
    (b) Adopt the method or methods of taking inventories prescribed by 
this section.

Such method or methods of taking inventories shall be adopted by filing 
an amended return (which includes the proper adjustments required by 
this section) for the taxable year of the acquiring corporation which 
includes the date of distribution or transfer, and by filing amended 
returns for all subsequent taxable years of the acquiring corporation 
for which returns have previously been filed. Such amended return or 
returns shall be accompanied by a copy of the statement described in 
paragraph (b)(3) of Sec. 1.381(b)-1, and by a statement specifying the 
nature of the transaction which causes section 381 to apply; the 
difference in methods of taking inventories used by the corporation 
concerned; the method or methods of taking inventories originally 
adopted by the acquiring corporation; the method or methods of taking 
inventories adopted on the amended return or returns; and the 
computation of the amount of the adjustments and the resulting increase 
or decrease in tax.
    (h) Effective date. This section is applicable with respect to 
taxable years beginning after January 15, 1975. However, if a taxpayer 
wishes to rely on the rules stated in this section for taxable years 
beginning before January 15, 1975 it may do so, subject to the 
provisions of paragraph (g) of this section.

(Sec. 381(c)(5) and 7805 of the Internal Revenue Code of 1954 (68A Stat. 
917; 26 U.S.C. 381(c)(5) and 7805))

[T.D. 7344, 40 FR 2684, Jan. 15, 1975]