[Code of Federal Regulations] [Title 26, Volume 6] [Revised as of April 1, 2004] From the U.S. Government Printing Office via GPO Access [CITE: 26CFR1.472-8] [Page 523-553] TITLE 26--INTERNAL REVENUE CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY (CONTINUED) PART 1_INCOME TAXES--Table of Contents Sec. 1.472-8 Dollar-value method of pricing LIFO inventories. (a) Election to use dollar-value method. Any taxpayer may elect to determine the cost of his LIFO inventories under the so-called ``dollar- value'' LIFO method, provided such method is used consistently and clearly reflects the income of the taxpayer in accordance with the rules of this section. The dollar-value method of valuing LIFO inventories is a method of determining cost by using ``base-year'' cost expressed in terms of total dollars rather than the quantity and price of specific goods as the unit of measurement. Under such method the goods contained in the inventory are grouped into a pool or pools as described in paragraphs (b) and (c) of this section. The term ``base-year cost'' is the aggregate of the cost (determined as of the beginning of the taxable year for which the LIFO method is first adopted, i.e., the base date) of all items in a pool. The taxable year for which the LIFO method is first adopted with respect to any item in the pool is the ``base year'' for that pool, except as provided in paragraph (g)(3) of this section. Liquidations and increments of items contained in the pool shall be reflected only in terms of a net liquidation or increment for the pool as a whole. Fluctuations may occur in quantities of various items within the pool, new items which properly fall within the pool may be added, and old items may disappear from the pool, all without necessarily effecting a change in the dollar value of the pool as a whole. An increment in the LIFO inventory occurs when the end of the year inventory for any pool expressed in terms of base-year cost is in excess of the beginning of the year inventory for that pool expressed in terms of base-year cost. In determining the inventory value for a pool, the increment, if any, is adjusted for changing unit costs or values by reference to a percentage, relative to base-year-cost, determined for the pool as a whole. See paragraph (e) of this section. See also paragraph (f) of this section for rules relating to the change to the dollar-value LIFO method from another LIFO method. (b) Principles for establishing pools of manufacturers and processors--(1) Natural business unit pools. A pool shall consist of all items entering into the entire inventory investment for a natural business unit of a business enterprise, unless the taxpayer elects to use the multiple pooling method provided in subparagraph (3) of this paragraph. Thus, if a business enterprise is composed of only one natural business unit, one pool shall be used for all of its inventories, including raw materials, goods in process, and finished [[Page 524]] goods. If, however, a business enterprise is actually composed of more than one natural business unit, more than one pool is required. Where similar types of goods are inventoried in two or more natural business units of the taxpayer, the Commissioner may apportion or allocate such goods among the various natural business units, if he determines that such apportionment or allocation is necessary in order to clearly reflect the income of such taxpayer. Where a manufacturer or processor is also engaged in the wholesaling or retailing of goods purchased from others, any pooling of the LIFO inventory of such purchased goods for the wholesaling or retailing operations shall be determined in accordance with the rules of paragraph (c) of this section. (2) Definition of natural business unit. (i) Whether an enterprise is composed of more than one natural business unit is a matter of fact to be determined from all the circumstances. The natural business divisions adopted by the taxpayer for internal management purposes, the existence of separate and distinct production facilities and processes, and the maintenance of separate profit and loss records with respect to separate operations are important considerations in determining what is a business unit, unless such divisions, facilities, or accounting records are set up merely because of differences in geographical location. In the case of a manufacturer or processor, a natural business unit ordinarily consists of the entire productive activity of the enterprise within one product line or within two or more related product lines including (to the extent engaged in by the enterprise) the obtaining of materials, the processing of materials, and the selling of manufactured or processed goods. Thus, in the case of a manufacturer or processor, the maintenance and operation of a raw material warehouse does not generally constitute, of itself, a natural business unit. If the taxpayer maintains and operates a supplier unit the production of which is both sold to others and transferred to a different unit of the taxpayer to be used as a component part of another product, the supplier unit will ordinarily constitute a separate and distinct natural business unit. Ordinarily, a processing plant would not in itself be considered a natural business unit if the production of the plant, although saleable at this stage, is not sold to others, but is transferred to another plant of the enterprise, not operated as a separate division, for further processing or incorporation into another product. On the other hand, if the production of a manufacturing or processing plant is transferred to a separate and distinct division of the taxpayer, which constitutes a natural business unit, the supplier unit itself will ordinarily be considered a natural business unit. However, the mere fact that a portion of the production of a manufacturing or processing plant may be sold to others at a certain stage of processing with the remainder of the production being further processed or incorporated into another product will not of itself be determinative that the activities devoted to the production of the portion sold constitute a separate business unit. Where a manufacturer or processor is also engaged in the wholesaling or retailing of goods purchased from others, the wholesaling or retailing operations with respect to such purchased goods shall not be considered a part of any manufacturing or processing unit. (ii) The rules of this subparagraph may be illustrated by the following examples: Example (1). A corporation manufactures, in one division, automatic clothes washers and driers of both commercial and domestic grade as well as electric ranges, mangles, and dishwashers. The corporation manufactures, in another division, radios and television sets. The manufacturing facilities and processes used in manufacturing the radios and television sets are distinct from those used in manufacturing the automatic clothes washers, etc. Under these circumstances, the enterprise would consist of two business units and two pools would be appropriate, one consisting of all of the LIFO inventories entering into the manufacture of clothes washers and driers, electric ranges, mangles, and dishwashers and the other consisting of all of the LIFO inventories entering into the production of radio and television sets. Example (2). A taxpayer produces plastics in one of its plants. Substantial amounts of the production are sold as plastics. The remainder of the production is shipped to a [[Page 525]] second plant of the taxpayer for the production of plastic toys which are sold to customers. The taxpayer operates his plastics plant and toy plant as separate divisions. Because of the different product lines and the separate divisions the taxpayer has two natural business units. Example (3). A taxpayer is engaged in the manufacture of paper. At one stage of processing, uncoated paper is produced. Substantial amounts of uncoated paper are sold at this stage of processing. The remainder of the uncoated paper is transferred to the taxpayer's finishing mill where coated paper is produced and sold. This taxpayer has only one natural business unit since coated and uncoated paper are within the same product line. (3) Multiple pools--(i) Principles for establishing multiple pools. (a) A taxpayer may elect to establish multiple pools for inventory items which are not within a natural business unit as to which the taxpayer has adopted the natural business unit method of pooling as provided in subparagraph (1) of this paragraph. Each such pool shall ordinarily consist of a group of inventory items which are substantially similar. In determining whether such similarity exists, consideration shall be given to all the facts and circumstances. The formulation of detailed rules for selection of pools applicable to all taxpayers is not feasible. Important considerations to be taken into account include, for example, whether there is substantial similarity in the types of raw materials used or in the processing operations applied; whether the raw materials used are readily interchangeable; whether there is similarity in the use of the products; whether the groupings are consistently followed for purposes of internal accounting and management; and whether the groupings follow customary business practice in the taxpayer's industry. The selection of pools in each case must also take into consideration such factors as the nature of the inventory items subject to the dollar-value LIFO method and the significance of such items to the taxpayer's business operations. Where similar types of goods are inventoried in natural business units and multiple pools of the taxpayer, the Commissioner may apportion or allocate such goods among the natural business units and the multiple pools, if he determines that such apportionment or allocation is necessary in order to clearly reflect the income of the taxpayer. (b) Raw materials which are substantially similar shall be pooled together in accordance with the principles of this subparagraph. However, inventories of raw or unprocessed materials of an unlike nature may not be placed into one pool, even though such materials become part of otherwise identical finished products. (c) Finished goods and goods-in-process in the inventory shall be placed into pools classified by major classes or types of goods. The same class or type of finished goods and goods-in-process shall ordinarily be included in the same pool. Where the material content of a class of finished goods and goods-in-process included in a pool has been changed, for example, to conform with current trends in an industry, a separate pool of finished goods and goods-in-process will not ordinarily be required unless the change in material content results in a substantial change in the finished goods. (d) The requirement that pools be established by major types of materials or major classes of goods is not to be construed so as to preclude the establishment of a miscellaneous pool. Since a taxpayer may elect the dollar-value LIFO method with respect to all or any designated goods in his inventory, there may be a number of such inventory items covered in the election. A miscellaneous pool shall consist only of items which are relatively insignificant in dollar value by comparison with other inventory items in the particular trade or business and which are not properly includible as part of another pool. (ii) Raw materials content pools. The dollar-value method of pricing LIFO inventories may be used in conjunction with the raw materials content method authorized in Sec. 1.472-1. Raw materials (including the raw material content of finished goods and goods-in-process) which are substantially similar shall be pooled together in accordance with the principles of subdivision (i) of this subparagraph. However, inventories of materials of an unlike nature may not be placed into one pool, even though [[Page 526]] such materials become part of otherwise identical finished products. (4) IPIC method pools. A manufacturer or processor that elects to use the inventory price index computation method described in paragraph (e)(3) of this section (IPIC method) for a trade or business may elect to establish dollar-value pools for those items accounted for using the IPIC method based on the 2-digit commodity codes (i.e., major commodity groups) in Table 6 (Producer price indexes and percent changes for commodity groupings and individual items, not seasonally adjusted) of the ``PPI Detailed Report'' published monthly by the United States Bureau of Labor Statistics (available from New Orders, Superintendent of Documents, PO Box 371954, Pittsburgh, PA 15250-7954). A taxpayer electing to establish dollar-value pools under this paragraph (b)(4) may combine IPIC pools that comprise less than 5 percent of the total current-year cost of all dollar-value pools to form a single miscellaneous IPIC pool. A taxpayer electing to establish dollar-value pools under this paragraph (b)(4) may combine a miscellaneous IPIC pool that comprises less than 5 percent of the total current-year cost of all dollar-value pools with the largest IPIC pool. Each of these 5 percent rules is a method of accounting. A taxpayer may not change to, or cease using, either 5 percent rule without obtaining the Commissioner's prior consent. Whether a specific IPIC pool or the miscellaneous IPIC pool satisfies the applicable 5 percent rule must be determined in the year of adoption or year of change (whichever is applicable) and redetermined every third taxable year. Any change in pooling required or permitted as a result of a 5 percent rule is a change in method of accounting. A taxpayer must secure the consent of the Commissioner pursuant to Sec. 1.446-1(e) before combining or separating pools and must combine or separate its IPIC pools in accordance with paragraph (g)(2) of this section. (c) Principles for establishing pools for wholesalers, retailers, etc. (1) In general. Items of inventory in the hands of wholesalers, retailers, jobbers, and distributors shall be placed into pools by major lines, types, or classes of goods. In determining such groupings, customary business classifications of the particular trade in which the taxpayer is engaged is an important consideration. An example of such customary business classification is the department in the department store. In such case, practices are relatively uniform throughout the trade, and departmental grouping is peculiarly adapted to the customs and needs of the business. However, in appropriate cases, the principles set forth in paragraphs (b) (1) and (2) of this section, relating to pooling by natural business units, may be used, with permission of the Commissioner, by wholesalers, retailers, jobbers, or distributors. Where a wholesaler or retailer is also engaged in the manufacturing or processing of goods, the pooling of the LIFO inventory for the manufacturing or processing operations shall be determined in accordance with the rules of paragraph (b) of this section. (2) IPIC method pools. A retailer that elects to use the inventory price index computation method described in paragraph (e)(3) of this section (IPIC method) for a trade or business may elect to establish dollar-value pools for those items accounted for using the IPIC method based on either the general expenditure categories (i.e., major groups) in Table 3 (Consumer Price Index for all Urban Consumers (CPI-U): U.S. city average, detailed expenditure categories) of the ``CPI Detailed Report'' or the 2-digit commodity codes (i.e., major commodity groups) in Table 6 (Producer price indexes and percent changes for commodity groupings and individual items, not seasonally adjusted) of the ``PPI Detailed Report.'' A wholesaler, jobber, or distributor that elects to use the IPIC method for a trade or business may elect to establish dollar-value pools for any group of goods accounted for using the IPIC method and included within one of the 2-digit commodity codes (i.e., major commodity groups) in Table 6 (Producer price indexes and percent changes for commodity groupings and individual items, not seasonally adjusted) of the ``PPI Detailed Report.'' The ``CPI Detailed Report'' and the ``PPI Detailed Report'' are published monthly by the United [[Page 527]] States Bureau of Labor Statistics (BLS) (available from New Orders, Superintendent of Documents, P.O. Box 371954, Pittsburgh, PA 15250- 7954). A taxpayer electing to establish dollar-value pools under this paragraph (c)(2) may combine IPIC pools that comprise less than 5 percent of the total current-year cost of all dollar-value pools to form a single miscellaneous IPIC pool. A taxpayer electing to establish pools under this paragraph (c)(2) may combine a miscellaneous IPIC pool that comprises less than 5 percent of the total current-year cost of all dollar-value pools with the largest IPIC pool. Each of these 5 percent rules is a method of accounting. Thus, a taxpayer may not change to, or cease using, either 5 percent rule without obtaining the Commissioner's prior consent. Whether a specific IPIC pool or the miscellaneous IPIC pool satisfies the applicable 5 percent rule must be determined in the year of adoption or year of change (whichever is applicable) and redetermined every third taxable year. Any change in pooling required or permitted under a 5 percent rule is a change in method of accounting. A taxpayer must secure the consent of the Commissioner pursuant to section 1.446-1(e) before combining or separating pools and must combine or separate its IPIC pools in accordance with paragraph (g)(2) of this section. (d) Determination of appropriateness of pools. Whether the number and the composition of the pools used by the taxpayer is appropriate, as well as the propriety of all computations incidental to the use of such pools, will be determined in connection with the examination of the taxpayer's income tax returns. Adequate records must be maintained to support the base-year unit cost as well as the current-year unit cost for all items priced on the dollar-value LIFO inventory method, regardless of the method authorized by paragraph (e) of this section which is used in computing the LIFO value of the dollar-value pool. The pool or pools selected must be used for the year of adoption and for all subsequent taxable years unless a change is required by the Commissioner in order to clearly reflect income, or unless permission to change is granted by the Commissioner as provided in paragraph (e) of Sec. 1.446- 1. However, see paragraph (h) of this section for authorization to change the method of pooling in certain specified cases. (e) Methods of computation of the LIFO value of a dollar-value pool--(1) Methods authorized. A taxpayer may ordinarily use only the so- called ``double-extension'' method for computing the base-year and current-year cost of a dollar-value inventory pool. Where the use of the double-extension method is impractical, because of technological changes, the extensive variety of items, or extreme fluctuations in the variety of the items, in a dollar-value pool, the taxpayer may use an index method for computing all or part of the LIFO value of the pool. An index may be computed by double-extending a representative portion of the inventory in a pool or by the use of other sound and consistent statistical methods. The index used must be appropriate to the inventory pool to which it is to be applied. The appropriateness of the method of computing the index and the accuracy, reliability, and suitability of the use of such index must be demonstrated to the satisfaction of the district director in connection with the examination of the taxpayer's income tax returns. The use of any so-called ``link-chain'' method will be approved for taxable years beginning after December 31, 1960, only in those cases where the taxpayer can demonstrate to the satisfaction of the district director that the use of either an index method or the double-extension method would be impractical or unsuitable in view of the nature of the pool. A taxpayer using either an index or link-chain method shall attach to his income tax return for the first taxable year beginning after December 31, 1960, for which the index or link-chain method is used, a statement describing the particular link-chain method or the method used in computing the index. The statement shall be in sufficient detail to facilitate the determination as to whether the method used meets the standards set forth in this subparagraph. In addition, a copy of the statement shall be filed with the Commissioner of Internal Revenue, Attention: T:R, Washington, D.C. 20224. The taxpayer shall submit [[Page 528]] such other information as may be requested with respect to such index or link-chain method. Adequate records must be maintained by the taxpayer to support the appropriateness, accuracy, and reliability of an index or link-chain method. A taxpayer may request the Commissioner to approve the appropriateness of an index or link-chain method for the first taxable year beginning after December 31, 1960, for which it is used. Such request must be submitted within 90 days after the beginning of the first taxable year beginning after December 31, 1960, in which the taxpayer desires to use the index or link-chain method, or on or before May 1, 1961, whichever is later. A taxpayer entitled to use the retail method of pricing LIFO inventories authorized by paragraph (k) of Sec. 1.472-1 may use retail price indexes prepared by the United States Bureau of Labor Statistics. Any method of computing the LIFO value of a dollar-value pool must be used for the year of adoption and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner in accordance with paragraph (e) of Sec. 1.446-1 to use a different method. (2) Double-extension method. (i) Under the double-extension method the quantity of each item in the inventory pool at the close of the taxable year is extended at both base-year unit cost and current-year unit cost. The respective extensions at the two costs are then each totaled. The first total gives the amount of the current inventory in terms of base-year cost and the second total gives the amount of such inventory in terms of current-year cost. (ii) The total current-year cost of items making up a pool may be determined-- (a) By reference to the actual cost of the goods most recently purchased or produced; (b) By reference to the actual cost of the goods purchased or produced during the taxable year in the order of acquisition; (c) By application of an average unit cost equal to the aggregate cost of all of the goods purchased or produced throughout the taxable year divided by the total number of units so purchased or produced; or (d) Pursuant to any other proper method which, in the opinion of the Commissioner, clearly reflects income. (iii) Under the double-extension method a base-year unit cost must be ascertained for each item entering a pool for the first time subsequent to the beginning of the base year. In such a case, the base- year unit cost of the entering item shall be the current-year cost of that item unless the taxpayer is able to reconstruct or otherwise establish a different cost. If the entering item is a product or raw material not in existence on the base date, its cost may be reconstructed, that is, the taxpayer using reasonable means may determine what the cost of the item would have been had it been in existence in the base year. If the item was in existence on the base date but not stocked by the taxpayer, he may establish, by using available data or records, what the cost of the item would have been to the taxpayer had he stocked the item. If the base-year unit cost of the entering item is either reconstructed or otherwise established to the satisfaction of the Commissioner, such cost may be used as the base-year unit cost in applying the double-extension method. If the taxpayer does not reconstruct or establish to the satisfaction of the Commissioner a base-year unit cost, but does reconstruct or establish to the satisfaction of the Commissioner the cost of the item at some year subsequent to the base year, he may use the earliest cost which he does reconstruct or establish as the base-year unit cost. (iv) To determine whether there is an increment or liquidation in a pool for a particular taxable year, the end of the year inventory of the pool expressed in terms of base-year cost is compared with the beginning of the year inventory of the pool expressed in terms of base-year cost. When the end of the year inventory of the pool is in excess of the beginning of the year inventory of the pool an increment occurs in the pool for that year. If there is an increment for the taxable year, the ratio of the total current-year cost of the pool to the total base-year cost of the pool must be computed. This ratio when multiplied by the amount of the increment measured in terms of base-year [[Page 529]] cost gives the LIFO value of such increment. The LIFO value of each such increment is hereinafter referred to in this section as the ``layer of increment'' and must be separately accounted for and a record thereof maintained as a separate layer of the pool, and may not be combined with a layer of increment occurring in a different year. On the other hand, when the end of the year inventory of the pool is less than the beginning of the year inventory of the pool, a liquidation occurs in the pool for that year. Such liquidation is to be reflected by reducing the most recent layer of increment by the excess of the beginning of the year inventory over the end of the year inventory of the pool. However, if the amount of the liquidation exceeds the amount of the most recent layer of increment, the preceding layers of increment in reverse chronological order are to be successively reduced by the amount of such excess until all the excess is absorbed. The base-year inventory is to be reduced by liquidation only to the extent that the aggregate of all liquidation exceeds the aggregate of all layers of increment. (v) The following examples illustrate inventories under the double- extension the computation of the LIFO value of method. Example (1). (a) A taxpayer elects, beginning with the calendar year 1961, to compute his inventories by use of the LIFO inventory method under section 472 and further elects to use the dollar-value method in pricing such inventories as provided in paragraph (a) of this section. He creates Pool No. 1 for items A, B, and C. The composition of the inventory for Pool No. 1 at the base date, January 1, 1961, is as follows: ------------------------------------------------------------------------ Unit Total Items Units cost cost ------------------------------------------------------------------------ A.............................................. 1,000 $5 $5,000 B.............................................. 2,000 4 8,000 C.............................................. 500 2 1,000 -------- Total base-year cost at Jan. 1, 1961......... ...... ...... 14,000 ------------------------------------------------------------------------ (b) The closing inventory of Pool No. 1 at December 31, 1961, contains 3,000 units of A, 1,000 units of B, and 500 units of C. The taxpayer computes the current-year cost of the items making up the pool by reference to the actual cost of goods most recently purchased. The most recent purchases of items A, B, and C are as follows: ------------------------------------------------------------------------ Quantity Unit Item Purchase date purchased cost ------------------------------------------------------------------------ A............................... Dec. 15, 1961..... 3,500 $6.00 B............................... Dec. 10, 1961..... 2,000 5.00 C............................... Nov. 1, 1961...... 500 2.50 ------------------------------------------------------------------------ (c) The inventory of Pool No. 1 at December 31, 1961, shown at base- year and current-year cost is as follows: ---------------------------------------------------------------------------------------------------------------- Dec. 31, 1961, Dec. 31, 1961, inventory at inventory at Jan. 1, 1961, current-year Item Quantity base-year cost cost ----------------------------------- Unit Unit cost Amount cost Amount ---------------------------------------------------------------------------------------------------------------- A................................................................. 3,000 $5.00 $15,000 $6.00 $18,000 B................................................................. 1,000 4.00 4,000 5.00 5,000 C................................................................. 500 2.00 1,000 2.50 1,250 ---------- --------- Total........................................................... ........ ...... 20,000 ...... 24,250 ---------------------------------------------------------------------------------------------------------------- (d) If the amount of the December 31, 1961, inventory at base-year cost were equal to, or less than, the base-year cost of $14,000 at January 1, 1961, such amount would be the closing LIFO inventory at December 31, 1961. However, since the base-year cost of the closing LIFO inventory at December 31, 1961, amounts to $20,000, and is in excess of the $14,000 base-year cost of the opening inventory for that year, there is a $6,000 increment in Pool No. 1 during the year. This increment must be valued at current-year cost, i.e., the ratio of 24,250/20,000, or 121.25 percent. The LIFO value of the inventory at December 31, 1961, is $21,275, computed as follows: Pool No. 1 ------------------------------------------------------------------------ Ratio of Dec. 31, total 1961, current- Dec. 31, inventory year cost 1961, at Jan. to total inventory 1, 1961, base-year at LIFO base-year cost value cost (percent) ------------------------------------------------------------------------ Jan. 1, 1961, base cost................ 14,000 100.00 $14,000 Dec. 31, 1961, increment............... 6,000 121.25 7,275 ----------- ---------- Total.............................. 20,000 ......... 21,275 ------------------------------------------------------------------------ Example (2). (a) Assume the taxpayer in example (1) during the year 1962 completely disposes of item C and purchases item D. Assume further that item D is properly includible in Pool No. 1 under the provisions of this section. The closing inventory on December 31, 1962, consists of quantities at current-year unit cost, as follows: [[Page 530]] ------------------------------------------------------------------------ Current- year unit Items Units cost Dec. 31, 1962 ------------------------------------------------------------------------ A.................................................. 2,000 $6.50 B.................................................. 1,500 6.00 D.................................................. 1,000 5.00 ------------------------------------------------------------------------ (b) The taxpayer establishes that the cost of item D, had he acquired it on January 1, 1961, would have been $2.00 per unit. Such cost shall be used as the base-year unit cost for item D, and the LIFO computations at December 31, 1962, are made as follows: ---------------------------------------------------------------------------------------------------------------- Dec. 31, 1962, Dec. 31, 1962, inventory at inventory at Jan. 1, 1961, current-year Item Quantity base-year cost cost ----------------------------------- Unit Unit cost Amount cost Amount ---------------------------------------------------------------------------------------------------------------- A................................................................. 2,000 $5.00 $10,000 $6.50 $13,000 B................................................................. 1,500 4.00 6,000 6.00 9,000 D................................................................. 1,000 2.00 2,000 5.00 5,000 ---------- --------- Total.......................................................... ........ ...... 18,000 ...... 27,000 ---------------------------------------------------------------------------------------------------------------- (c) Since the closing inventory at base-year cost, $18,000, is less than the 1962 opening inventory at base-year cost, $20,000, a liquidation of $2,000 has occurred during 1962. This liquidation is to be reflected by reducing the most recent layer of increment. The LIFO value of the inventory at December 31, 1962, is $18,850, and is summarized as follows: Pool No. 1 ------------------------------------------------------------------------ Ratio of Dec. 31, total 1962, current- Dec. 31, inventory year cost 1962, at Jan. to total inventory 1, 1961, base-year at LIFO base-year cost value cost (percent) ------------------------------------------------------------------------ Jan. 1, 1961, base cost................ 14,000 100.00 $14,000 Dec. 31, 1961, increment............... 4,000 121.25 4,850 ----------- ---------- Total............................... 18,000 ......... 18,850 ------------------------------------------------------------------------ (3) Inventory price index computation (IPIC) method--(i) In general. The inventory price index computation method provided by this paragraph (e)(3) (IPIC method) is an elective method of determining the LIFO value of a dollar-value pool using consumer or producer price indexes published by the United States Bureau of Labor Statistics (BLS). A taxpayer using the IPIC method must compute a separate inventory price index (IPI) for each dollar-value pool. This IPI is used to convert the total current-year cost of the items in a dollar-value pool to base-year cost in order to determine whether there is an increment or liquidation in terms of base-year cost and, if there is an increment, to determine the LIFO inventory value of the current year's layer of increment (layer). Using one IPI to compute the base-year cost of a dollar-value pool for the current taxable year and using a different IPI to compute the LIFO inventory value of the current taxable year's layer is not permitted under the IPIC method. The IPIC method will be accepted by the Commissioner as an appropriate method of computing an index, and the use of that index to compute the LIFO value of a dollar-value pool will be accepted as accurate, reliable, and suitable. The appropriateness of a taxpayer's computation of an IPI, which includes all the steps described in paragraph (e)(3)(iii) of this section, will be determined in connection with an examination of the taxpayer's federal income tax return. A taxpayer using the IPIC method may elect to establish dollar- value pools according to the special rules in paragraphs (b)(4) and (c)(2) of this section or the general rules in paragraphs (b) and (c) of this section. Taxpayers eligible to use the IPIC method are described in paragraph (e)(3)(ii) of this section. The manner in which an IPI is computed is described in paragraph (e)(3)(iii) of this section. Rules relating to the adoption of, or change to, the IPIC method are in paragraph (e)(3)(iv) of this section. (ii) Eligibility. Any taxpayer electing to use the dollar-value LIFO method may elect to use the IPIC method. Except as provided in this paragraph (e)(3)(ii) or in other published guidance, a taxpayer that elects to use the IPIC method for a specific trade or business must use that method to account for all items of dollar-value LIFO inventory. A taxpayer that uses the retail price indexes computed by the BLS and published in ``Department Store Inventory Price Indexes'' (available from the BLS by calling (202) 606-6325 and entering document code 2415) may elect to use the IPIC method for items that do not fall within any of the major groups listed in ``Department Store Inventory Price Indexes.'' (iii) Computation of an inventory price index--(A) In general. The computation [[Page 531]] of an IPI for a dollar-value pool requires the following four steps, which are described in more detail in this paragraph (e)(3)(iii): First, selection of a BLS table and an appropriate month; second, assignment of items in a dollar-value pool to BLS categories (selected BLS categories); third, computation of category inflation indexes for selected BLS categories; and fourth, computation of the IPI. A taxpayer may compute the IPI for each dollar-value pool using either the double- extension method (double-extension IPIC method) or the link-chain method (link-chain IPIC method), without regard to whether the use of a double- extension method is impractical or unsuitable. The use of either the double-extension IPIC method or the link-chain IPIC method is a method of accounting, and the adopted method must be applied consistently to all dollar-value pools within a trade or business accounted for under the IPIC method. A taxpayer that wants to change from the double- extension IPIC method to the link-chain IPIC method, or vice versa, must secure the consent of the Commissioner under Sec. 1.446-1(e). This change must be made with a new base year as described in paragraph (e)(3)(iv)(B)(1). (B) Selection of BLS table and appropriate month--(1) In general. Under the IPIC method, an IPI is computed using the consumer or producer price indexes for certain categories (BLS price indexes and BLS categories, respectively) listed in the selected BLS table of the ``CPI Detailed Report'' or the ``PPI Detailed Report'' for the appropriate month. (2) BLS table selection. Manufacturers, processors, wholesalers, jobbers, and distributors must select BLS price indexes from Table 6 (Producer price indexes and percent changes for commodity groupings and individual items, not seasonally adjusted) of the ``PPI Detailed Report'', unless the taxpayer can demonstrate that selecting BLS price indexes from another table of the ``PPI Detailed Report'' is more appropriate. Retailers may select BLS price indexes from either Table 3 (Consumer Price Index for all Urban Consumers (CPI-U): U.S. city average, detailed expenditure categories) of the ``CPI Detailed Report'' or from Table 6 (or another more appropriate table) of the ``PPI Detailed Report.'' The selection of a BLS table is a method of accounting and must be used for the taxable year of adoption and all subsequent years, unless the taxpayer obtains the Commissioner's consent under Sec. 1.446-1(e) to change its table selection. A taxpayer that changes its BLS table must establish a new base year in the year of change as described in paragraph (e)(3)(iv)(B) of this section. (3) Appropriate month. In the case of a retailer using the retail method, the appropriate month is the last month of the retailer's taxable year. In the case of all other taxpayers, the appropriate month is the month most consistent with the method used to determine the current-year cost of the dollar-value pool under paragraph (e)(2)(ii) of this section and the taxpayer's history of inventory production or purchases during the taxable year. A taxpayer not using the retail method may annually select an appropriate month for each dollar-value pool or make an election on Form 970, ``Application to Use LIFO Inventory Method,'' to use a representative appropriate month (representative month). An election to use a representative month is a method of accounting and the month elected must be used for the taxable year of the election and all subsequent taxable years, unless the taxpayer obtains the Commissioner's consent under Sec. 1.446-1(e) to change or revoke its election. (4) Examples. The following examples illustrate the rules of this paragraph (e)(3)(iii)(B)(3): Example 1. Determining an appropriate month. A wholesaler of seasonal goods timely files a Form 970, ``Application to Use LIFO Inventory Method,'' for the taxable year ending December 31, 2001. The taxpayer indicates elections to use the dollar-value LIFO method, to determine the current-year cost using the earliest acquisitions method in accordance with paragraph (e)(2)(ii)(b) of this section, and to use the IPIC method under paragraph (e)(3) of this section. Although the taxpayer purchases inventory items regularly throughout the year, the items purchased vary according to the seasons. The seasonal items on hand at December 31, 2001, are purchased between October and December. Thus, based on the taxpayer's use of the earliest acquisitions method of determining [[Page 532]] current-year cost and its experience with inventory purchases, the appropriate month for the items represented in the ending inventory at December 31, 2001, is October. Example 2. Electing a representative month. A retailer not using the retail method timely files a Form 970, ``Application to Use LIFO Inventory Method,'' for the taxable year ending December 31, 2001. The taxpayer indicates elections to use the dollar-value LIFO method, the most recent purchases method of determining current-year cost under paragraph (e)(2)(ii)(a) of this section, the IPIC method under paragraph (e)(3) of this section, and December as its representative month under paragraph (e)(3)(iii)(B)(3) of this section. The items in the taxpayer's ending inventory are purchased fairly uniformly throughout the year, with the first purchases normally occurring in January and the last purchases normally occurring in December. The taxpayer's election to use December as its representative month is permissible because the taxpayer elected to use the most recent purchases method and the taxpayer's last purchases of the taxable year normally occur during December, the last month of the taxpayer's taxable year. Example 3. Changing representative month. The facts are the same as in Example 2, except the taxpayer files a Form 3115, ``Application for Change in Accounting Method,'' requesting permission to change to the earliest acquisitions method of determining current-year cost in accordance with paragraph (e)(2)(ii)(b) of this section and to change its representative month from December to January beginning with the taxable year ending December 31, 2003. If the Commissioner consents to the taxpayer's request to change to the earliest acquisitions method, December will no longer be a permissible representative month for this taxpayer because of the absence of a nexus between the earliest acquisitions method, the month of December (the last month of the taxpayer's taxable year), and the taxpayer's experience with inventory purchases during the year. Thus, the Commissioner will permit the taxpayer to change its representative month to January, the first month of the taxpayer's taxable year. Example 4. Changing representative month. The facts are the same as in Example 2. In 2002, the taxpayer changes its annual accounting period to a taxable year ending June 30, which requires the taxpayer to file a return for the short taxable year beginning January 1, 2002, and ending June 30, 2002. As a result, December is no longer a permissible representative month because of the absence of a nexus between the most recent purchases method, the month of December, and the taxpayer's experience with inventory purchases during the year. The taxpayer should file a Form 3115 requesting permission to change its representative month from December to June beginning with the short taxable year ending June 30, 2002. Because the taxpayer's last purchases of the taxable year now will occur in June, the Commissioner will consent to the taxpayer's request to change its representative month to June. Example 5. Changing representative month. The facts are the same as in Example 2, except that the taxpayer elects to use January as its representative month. The taxpayer timely files a Form 3115 requesting permission to change its representative month from January to December beginning with the taxable year ending December 31, 2003. January is not a permissible representative month because of the absence of a nexus between the most recent purchases method, the taxpayer's history of inventory purchases, and the month of January, the first month in the taxpayer's taxable year. Because December is a permissible representative month, the Commissioner will permit the taxpayer to change its representative month to December. (C) Assignment of inventory items to BLS categories--(1) In general. Except as provided in paragraph (e)(3)(iii)(C)(2) of this section, a taxpayer must assign each item in a dollar-value pool to the most- detailed BLS category of the selected BLS table that contains that item. For example, in Table 6 of the ``PPI Detailed Report'' for a given month, the commodity codes for the various BLS categories run from 2 to 8 digits, with the least-detailed BLS categories having a 2-digit code and the most-detailed BLS categories usually (but not always) having an 8-digit code. For purposes of assigning items to the most-detailed BLS category, manufacturers and processors must assign each raw material item to the most-detailed PPI category that includes that raw material and must assign each finished good item to the most-detailed PPI category that includes that finished good. In addition, manufacturers and processors must assign each work-in-process (WIP) item to the most- detailed PPI category that includes the finished good into which the item will be manufactured or processed. For this purpose, finished good means a salable item that the taxpayer regularly sells. For example, a gasoline-engine manufacturer that also manufactures the pistons used in those engines and regularly sells some of the pistons (e.g., to retailers of replacement parts) must assign both finished pistons that have [[Page 533]] not been affixed to an engine block and piston WIP items to the most- detailed PPI category that includes pistons. Finished pistons that have been affixed to an engine block must be assigned to the most-detailed PPI category that includes gasoline engines. In contrast, if sales of these pistons occur infrequently, the taxpayer must assign both finished pistons and piston WIP items to the most-detailed PPI category that includes gasoline engines. (2) 10 percent method. Instead of assigning each item in a dollar- value pool to the most-detailed BLS categories, as described in paragraph (e)(3)(iii)(C)(1) of this section, a taxpayer may elect to use the 10 percent method described in this paragraph (e)(3)(iii)(C)(2). Under the 10 percent method, items are assigned to BLS categories using a three-step procedure. First, when the current-year cost of a specific item is 10 percent or more of the total current-year cost of the dollar- value pool, the taxpayer must assign that item to the most-detailed BLS category that includes that item (10 percent BLS category). Any other item that is includible in that 10 percent BLS category (other than an item that qualifies for its own 10 percent BLS category under the preceding sentence) must be assigned to that 10 percent BLS category. Second, if one or more items have not been assigned to BLS categories in the first step, the taxpayer must investigate successively less-detailed BLS categories and assign the unassigned item(s) to the first BLS category that contains unassigned items whose current-year cost, in the aggregate, is 10 percent or more of the total current-year cost of the dollar-value pool (also, 10 percent BLS categories). This step must be repeated until all the items in the dollar-value pool have been included in an appropriate 10 percent BLS category, the current-year cost of the unassigned items, in the aggregate, is less than 10 percent of the total current-year cost of the dollar-value pool, or the taxpayer determines that a single BLS category is not appropriate for the aggregate of the unassigned items. Third, if items in a dollar-value pool have not been assigned to a 10 percent BLS category because the current-year cost of those items, in the aggregate, is less than 10 percent of the total current-year cost of the dollar-value pool, the taxpayer must assign those items to the most-detailed BLS category that includes all those items (also, a 10 percent category). On the other hand, if items in a dollar-value pool have not been assigned to a 10 percent BLS category because the taxpayer determines that a single BLS category is not appropriate for the aggregate of those items, the taxpayer must assign each of those items to a single miscellaneous BLS category created by the taxpayer (also, a 10 percent category). In no event may a taxpayer assign items in a dollar-value pool to a BLS category that is less detailed than either the major groups of consumer goods described in Table 3 of the monthly ``CPI Detailed Report'' or the major commodity groups of producer goods described in Table 6 of the monthly ``PPI Detailed Report.'' Principles similar to those described in paragraph (e)(3)(iii)(C)(1) apply for purposes of assigning raw material, work-in- process, and finished good items to the most-detailed BLS category under the 10 percent method. (3) Change in method of accounting. The 10 percent method of assigning items in a dollar-value pool to BLS categories is a method of accounting. In addition, a taxpayer's selection of a BLS category for a specific item is a method of accounting. However, the assignment of items to different BLS categories solely as a result of the application of the 10 percent method is a change in underlying facts and not a change in method of accounting. Likewise, the selection of a new BLS category for a specific item as a result of a revision to a BLS table is a change in underlying facts and not a change in method of accounting. A taxpayer that wants to change its method of selecting BLS categories (i.e., to or from the 10-percent method) or of selecting a BLS category for a specific item must secure the Commissioner's consent in accordance with Sec. 1.446-1(e). A taxpayer that voluntarily changes its method of selecting BLS categories or of selecting a BLS category for a specific item must establish a new base year in the [[Page 534]] year of change as described in paragraph (e)(3)(iv)(B) of this section. (D) Computation of a category inflation index--(1) In general. As described in more detail in this paragraph (e)(3)(iii)(D), a category inflation index reflects the inflation that occurs in the BLS price indexes for a selected BLS category (or, if applicable, 10 percent BLS category) during the relevant measurement period. (2) BLS price indexes. The BLS price indexes are the cumulative indexes published in the selected BLS table for the appropriate month. A taxpayer may elect to use either preliminary or final BLS price indexes for the appropriate month, provided that the selected BLS price indexes are used consistently. However, a taxpayer that elects to use final BLS price indexes for the appropriate month must use preliminary BLS price indexes for any taxable year for which the taxpayer files its original federal income tax return before the BLS publishes final BLS price indexes for the appropriate month. If a BLS price index for a most- detailed or 10 percent BLS category is not otherwise available for the appropriate or representative month (but not because the BLS categories in the BLS table have been revised), the taxpayer must use the BLS price index for the next most-detailed BLS category that includes the specific item(s) in the most-detailed or 10 percent BLS category. If a BLS price index is not otherwise available for the appropriate or representative month because the BLS categories in the BLS table have been revised, the rules of paragraph (e)(3)(iii)(D)(4) of this section apply. (3) Category inflation index. (i) In general. Except as provided in paragraph (e)(3)(iii)(D)(4) of this section (concerning compound category inflation indexes) or (e)(3)(iii)(D)(5) of this section (concerning category inflation indexes for certain 10 percent BLS categories), a category inflation index for a selected BLS category (or, if applicable, 10 percent BLS category) is computed under the rules of this paragraph (e)(3)(iii)(D)(3). (ii) Double-extension IPIC method. In the case of a taxpayer using the double-extension IPIC method, the category inflation index for a BLS category is the quotient of the BLS price index for the appropriate or representative month of the current year divided by the BLS price index for the appropriate month of the taxable year preceding the base year (base month). However, if the taxpayer did not have an opening inventory in the year that its election to use the dollar-value LIFO method and double-extension IPIC method became effective, the category inflation index for a BLS category is the quotient of the BLS price index for the appropriate or representative month of the current year divided by the BLS price index for the month immediately preceding the month of the taxpayer's first inventory production or purchase. (iii) Link-chain IPIC method. In the case of a taxpayer using the link-chain IPIC method, the category inflation index for a BLS category is the quotient of the BLS price index for the appropriate or representative month of the current year divided by the BLS price index for the appropriate month used for the immediately preceding taxable year. However, if the taxpayer did not have an opening inventory in the year that its election to use the dollar-value LIFO method and link- chain IPIC method became effective, the category inflation index for a BLS category for the year of election is the quotient of the BLS price index for the appropriate or representative month of the current year divided by the BLS price index for the month immediately preceding the month of the taxpayer's first inventory production or purchase. (iv) Special rules concerning representative months. A taxpayer electing to use a representative month under paragraph (e)(3)(iii)(B)(3) of this section must use an appropriate month, rather than the representative month, to determine category inflation indexes in the circumstances described in this paragraph (e)(3)(iii)(D)(3)(iv) and in other similar circumstances. For example, in the case of a short taxable year, the category inflation index should reflect the inflation that occurs from the base month (in the case of the double-extension IPIC method), or the appropriate or representative month used for the preceding taxable year (in [[Page 535]] the case of the link-chain IPIC method), and the appropriate month for the short taxable year. Similarly, if a taxpayer using the link-chain IPIC method is granted consent to change both its method of determining the current-year cost of a dollar-value pool and its representative month, the category inflation index for the year of change should reflect the inflation that occurs between the old representative month used for the preceding taxable year and the new representative month used for the year of change. (4) Compound category inflation index for revised BLS categories or price indexes--(i) In general. Periodically, the BLS revises a BLS table to add one or more new BLS categories, eliminate one or more previously reported BLS categories, or reset the base-year BLS price index of one or more BLS categories. If the BLS has revised the applicable BLS table for a taxable year, a taxpayer must compute the category inflation index for each BLS category for which the taxpayer cannot compute a category inflation index in accordance with paragraph (e)(3)(iii)(D)(3) of this section (affected BLS category) using a reasonable method, provided the method is used consistently for all affected BLS categories within a particular taxable year. For example, if the BLS revised the CPI by adding new BLS categories as of January 2001 and eliminating some previously reported BLS categories as of December 2000, January 2002 would be the first month for which it would be possible to compute a category inflation index for a 12-month period using the BLS price indexes for any affected category. The compound category inflation index described in paragraph (e)(3)(iii)(D)(4)(ii) of this section is a reasonable method of computing the category inflation index for an affected BLS category. (ii) Computation of compound category inflation index. When the applicable BLS table is revised as described in paragraph (e)(3)(iii)(D)(4)(i) of this section, a taxpayer may use the procedure described in this paragraph (e)(3)(iii)(D)(4)(ii) to compute a compound category inflation index for each affected BLS category represented in the taxpayer's ending inventory. For this purpose, a compound category inflation index is the product of the category inflation index for the ``first portion'' multiplied by the corresponding category inflation index for the ``second portion.'' The category inflation index for the first portion must reflect the inflation that occurs between the end of the base month (in the case of the double-extension IPIC method), or the preceding year's appropriate or representative month (in the case of the link-chain IPIC method), and the end of the last month covered by the unrevised BLS table based on the old BLS category. The corresponding category inflation index for the second portion must reflect the inflation that occurs between the beginning of the first month covered by the revised BLS table based on the new BLS category and the end of the current year's appropriate or representative month. First, using the revised BLS table for the current-year's appropriate or representative month, the taxpayer assigns items in the dollar-value pool using its method of assigning items to BLS categories as described in paragraph (e)(3)(iii)(C) of this section. Second, for each affected BLS category represented in the ending inventory, the taxpayer computes the category inflation index for the second portion using this formula: [A/B], where A equals the BLS price index for the current year's appropriate or representative month and B equals the BLS price index for the last month covered by the unrevised BLS table (as published for the first month of the revised BLS table). Third, using the unrevised BLS table for the base month (in the case of the double extension IPIC method) or the preceding year's appropriate or representative month (in the case of the link-chain IPIC method), the taxpayer assigns each of the items in the dollar-value pool using its method of assigning items to BLS categories. Fourth, for each affected BLS category represented in the ending inventory, the taxpayer computes the category inflation index for the first portion using this formula: [C/D], where C equals the BLS price index for the last month covered by the unrevised BLS table (as published for the last month of the unrevised BLS table) and D equals the BLS price index for the base month (in [[Page 536]] the case of the double-extension IPIC method) or the preceding year's appropriate or representative month (in the case of the link-chain IPIC method). Fifth, for each affected BLS category represented in the ending inventory, the taxpayer computes the compound category inflation index using this formula: [X*Y], where X equals the category inflation index for the second portion, and Y equals the corresponding category inflation index for the first portion. For the purpose of computing the compound category inflation index for each affected BLS category, the corresponding category inflation index for the first portion is the category inflation index for the unrevised BLS category that includes the specific inventory item(s) included in the revised BLS category. If items included in a single revised BLS category had been included in separate BLS categories before the revision of the BLS table, the corresponding category inflation index for the first portion is the weighted harmonic mean of the category inflation indexes for these unrevised BLS categories. See paragraph (e)(3)(iii)(E)(1) of this section for a formula of the weighted harmonic mean. When computing this weighted-average category inflation index, a taxpayer must use the current-year costs (or in the case of a retailer using the retail method, the retail selling prices) in ending inventory as the weights. (iii) New base year. A taxpayer may establish a new base year in the year following the taxable year for which the taxpayer computed a compound category inflation index under this paragraph (e)(3)(iii)(D)(4) for one or more affected BLS categories in a dollar-value pool. See paragraph (e)(3)(iv)(B) of this section for the procedures and computations incident to establishing a new base year. (iv) Examples. The following examples illustrate the rules of this paragraph (e)(3)(iii)(D)(4): Example 1. BLS categories eliminated. (i) A retailer, whose taxable year ends January 31, elected to account for its inventories using the dollar-value LIFO method and double-extension IPIC method (based on the CPI), beginning with the taxable year ending January 31, 1997. The taxpayer does not use the retail method, but elected to use January as its representative month. On January 31, 1999, the taxpayer's only dollar-value pool contains only two items--lemons and peaches. The total current-year cost of these items is as follows: lemons, $40, and peaches, $30. (ii) The CPI was revised in October of 1998 to eliminate the ``Citrus fruits'' subcategory of ``Other fresh fruits.'' In addition, the base-year BLS price index for ``Other fresh fruits'' was reset to 100.00 as of October 1, 1998. In relevant part, the January 1999 CPI permits the assignment of both lemons and peaches to ``Other fresh fruits.'' The January 1999 BLS price indexes for ``Citrus fruits'' and ``Other fresh fruits'' are 96.6 and 105.6, respectively. In relevant part, the September 1998 CPI permits the assignment of lemons to ``Citrus fruits'' and peaches to ``Other fresh fruits.'' The September 1998 BLS price indexes for ``Citrus fruits'' and ``Other fresh fruits'' are 194.9 and 294.9, respectively, and the January 1997 BLS price indexes for ``Citrus fruits'' and ``Other fresh fruits'' are 190.2 and 290.2, respectively. (iii) Because the BLS eliminated the category, ``Citrus fruits,'' as of October 1998, it did not publish a BLS price index for that category in the January 1999 CPI. Thus, the taxpayer cannot compute a category inflation index for ``Citrus fruits'' under the normal procedures, but may compute a compound category inflation index for that affected BLS category using the procedures described in paragraph (e)(3)(iii)(D)(4)(ii) of this section. (iv) The taxpayer computes a compound category inflation index for the two BLS categories that formerly included lemons and peaches. The taxpayer first assigns lemons and peaches to ``Other fresh fruits,'' the most-detailed index in the January 1999 CPI, and then computes the category inflation index for the second portion as follows: ---------------------------------------------------------------------------------------------------------------- Jan. 1999 index/Sept. Item 1999 category 1998 index (as Category published in Oct. 1998) inflation index ---------------------------------------------------------------------------------------------------------------- Lemons and Peaches............. Other fresh fruits................. 105.6/100.0 1.0560 ---------------------------------------------------------------------------------------------------------------- (v) The taxpayer assigns the lemons and peaches to the most-detailed BLS categories in the January 1998 CPI as follows: lemons to ``Citrus fruits'' and peaches to ``Other fresh fruits.'' Then, the taxpayer computes the category inflation index for the first portion as follows: [[Page 537]] ---------------------------------------------------------------------------------------------------------------- Sept. 1998 index (as Item 1998 category published in Sept. Category inflation 1998)/Jan. 1997 index ---------------------------------------------------------------------------------------------------------------- Lemons........................ Citrus fruits...................... 194.9/190.2 1.0247 Peaches....................... Other fresh Fruits................. 294.9/290.2 1.0162 ---------------------------------------------------------------------------------------------------------------- (vi) Because lemons and peaches, which are included together in the revised ``Other fresh fruits'' category, had been included in separate BLS categories before the BLS table was revised, the taxpayer must compute a single corresponding category inflation index for the affected BLS categories for the first portion. This corresponding category inflation index is the weighted harmonic mean of the separate corresponding category inflation indexes for the first portion using the cost of the items in ending inventory as the weights. The taxpayer computes the corresponding category inflation index for ``Other fresh fruits'' for the first portion as follows: ---------------------------------------------------------------------------------------------------------------- (I) Weight (II) Category (III) Quotient: Item (cost of item) inflation index (I)/(II) ---------------------------------------------------------------------------------------------------------------- Lemons.................................................... $40.00 1.0247 $39.04 Peaches................................................... 30.00 1.0162 29.52 ------------------- Total................................................. 70.00 ................ 68.56 ---------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------------- (V) Sum of (weight/ (VI) Weighted harmonic (IV) Sum of weights category inflation mean of other fresh index) fruits: (IV)/(V) ---------------------------------------------------------------------------------------------------------------- $70.00...................................................... $68.56 1.0210 ---------------------------------------------------------------------------------------------------------------- (vii) Finally, the taxpayer computes the compound category inflation index for Other fresh fruits as follows: ---------------------------------------------------------------------------------------------------------------- (III) Compound (I) Category (II) Category category Item inflation index inflation index inflation index: (second portion) (first portion) (I)*(II) ---------------------------------------------------------------------------------------------------------------- Other fresh fruits..................................... 1.0560 1.0210 1.0782 ---------------------------------------------------------------------------------------------------------------- (viii) The taxpayer may establish a new base year for the taxable year ending January 31, 2000. Example 2. BLS categories separated. (i) The facts are the same as in Example 1, except prior to October 1998, both lemons and peaches were assigned to ``Other fresh fruits'' and in the October 1998 CPI, the BLS created a new category, ``Citrus fruits,'' for citrus fruits, such as lemons. Moreover, the BLS reset the base-year BLS price index for ``Other fresh fruits'' to 100.0 as of October 1, 1998. As a result of these changes, the taxpayer may no longer assign lemons to ``Other fresh fruits.'' (ii) Because ``Citrus fruits'' is new as of October 1998, the BLS did not publish a BLS price index for this BLS category in the January 1999 CPI. Thus, because the taxpayer cannot compute a category inflation index for ``Citrus fruits'' under the normal procedures, the taxpayer may compute a compound category inflation index for the affected BLS category using the procedures described in paragraph (e)(3)(iii)(D)(4)(ii) of this section. (iii) Based on the January 1999 CPI, the taxpayer assigns lemons to ``Citrus fruits'' and peaches to ``Other fresh fruits.'' Then, the taxpayer computes a compound category inflation index for each of the two BLS categories. The computation of the category inflation index for the second portion is as follows: ---------------------------------------------------------------------------------------------------------------- Jan. 1999 index/Sept. Item 1999 category 1998 index (as Category published in Oct. 1998) inflation index ---------------------------------------------------------------------------------------------------------------- Lemons......................... Citrus fruits...................... 96.6/100 0.9660 Peaches........................ Other fresh fruits................. 105.6/100 1.0560 ---------------------------------------------------------------------------------------------------------------- [[Page 538]] (iv) Then, the taxpayer computes the category inflation index for the first portion as follows: ---------------------------------------------------------------------------------------------------------------- Sept. 1998 index (as Item 1998 category published in Sept. 1998)/ Category inflation Jan. 1997 index ---------------------------------------------------------------------------------------------------------------- Lemons & Peaches.............. Other fresh fruits................ 294.9/290.2 1.0162 ---------------------------------------------------------------------------------------------------------------- (v) Finally, the taxpayer computes the compound category inflation index for ``Citrus fruits'' and ``Other fresh fruits'': ---------------------------------------------------------------------------------------------------------------- (III) Compound (I) Category (II) Category category Item inflation index inflation index inflation index: (second portion) (first portion) (I)*(II) ---------------------------------------------------------------------------------------------------------------- Citrus fruits............................................. 0.9660 1.0162 0.9816 Other fresh fruits........................................ 1.0560 1.0162 1.0731 ---------------------------------------------------------------------------------------------------------------- (vi) The taxpayer may establish a new base year for the taxable year ending January 31, 2000. (5) 10 percent method. (i) Applicability. A taxpayer that elects to use the 10 percent method described in paragraph (e)(3)(iii)(C)(2) of this section must compute a category inflation index for a less-detailed 10 percent BLS category as provided in this paragraph (e)(3)(iii)(D)(5). A less-detailed 10 percent category is a BLS category that-- (A) subsumes two or more BLS categories; (B) Does not have a single assigned item whose current-year cost is 10 percent or more of the current-year cost of all the items in the dollar-value pool; (C) Has at least one item in at least one of the subsumed BLS categories; and (D) Has at least one subsumed BLS category that either does not have any assigned items or is a separate 10 percent BLS category. (ii) Determination of category inflation index. If the rules of this paragraph (e)(3)(iii)(D)(5) apply, the category inflation index for the less-detailed 10 percent BLS category is equal to the weighted arithmetic mean of the category inflation index (or, compound category inflation index, if applicable) for each of the subsumed BLS categories that have been assigned at least one item from the taxpayer's dollar- value pool (excluding any item that is properly assigned to a separate 10 percent BLS category). [Weighted Arithmetic Mean = Sum of (Weight x Category Inflation Index)]/Sum of Weights]. The appropriate weight for each of the most-detailed BLS categories referenced in the preceding sentence is the corresponding BLS weight. Currently, in January of each year, the BLS publishes the BLS weights determined for December of the preceding year. In the case of a taxpayer using the double-extension IPIC method, the BLS weights for December of the taxable year preceding the base year are to be used for all taxable years. In the case of a taxpayer using the link-chain IPIC method, the BLS weights for December of a given calendar year are to be used for taxable years that end during the 12-month period that begins on July 1 of the following calendar year. However, if the BLS weights are not published for all of the most-detailed BLS categories referenced above, the taxpayer may use the current-year cost (or in the case of a retailer using the retail method, the retail selling prices) of all items assigned to a specific most-detailed BLS category as the appropriate weight for that category, but must compute a weighted harmonic mean. See paragraph (e)(3)(iii)(E)(1) of this section for a formula of the weighted harmonic mean. (E) Computation of Inventory Price Index (IPI)--(1) Double-extension IPIC method. Under the double-extension IPIC method, the IPI for a dollar-value pool is the weighted harmonic mean of [[Page 539]] the category inflation indexes (or, if applicable, compound category inflation indexes) determined under paragraph (e)(3)(iii)(D) of this section for each selected BLS category (or, if applicable 10 percent BLS category) represented in the taxpayer's dollar-value pool at the end of the taxable year. The formula for computing the weighted harmonic mean of the category inflation indexes is: [Sum of Weights/Sum of (Weight/ Category Inflation Index)]. The weights to be used when computing this weighted harmonic mean are the current-year costs (or, in the case of a retailer using the retail method, the retail selling prices) in each selected BLS category represented in the dollar-value pool at the end of the taxable year. (2) Link-chain IPIC method. Under the link-chain IPIC method, the IPI for a dollar-value pool is the product of the weighted harmonic mean of the category inflation indexes (or, if applicable, the compound category inflation indexes) determined under paragraph (e)(3)(iii)(D) of this section for each selected BLS category (or, if applicable, 10 percent BLS category) represented in the taxpayer's dollar-value pool at the end of the taxable year multiplied by the IPI for the immediately preceding taxable year. The formula for computing the weighted harmonic mean of the category inflation indexes is: [Sum of Weights/Sum of (Weight/Category Inflation Index)]. The weights to be used when computing this weighted harmonic mean are the current-year costs (or, in the case of a retailer using the retail method, the retail selling prices) in each selected BLS category represented in the dollar-value pool at the end of the taxable year. (3) Examples. The following examples illustrate the rules of this paragraph (e)(3)(iii)(E): Example 1. Double-extension method. (i) Introduction. R is a retail furniture merchant that does not use the retail method. For the taxable year ending December 31, 2000, R used the first-in, first-out method of identifying inventory and valued its inventory at cost. The total cost of R's inventory on December 31, 2000, was $850,000. R elected to use the dollar-value LIFO and double-extension IPIC methods for its taxable year ending December 31, 2001. R does not elect to use the 10 percent method described in paragraph (e)(3)(iii)(C)(2) of this section. R determines the current-year cost of the items using the actual cost of the most recently purchased goods. R elected to pool its inventory based on the major groups in Table 6 of the monthly ``PPI Detailed Report'' in accordance with the special IPIC pooling rules of paragraph (b)(4) of this section. All items in R's inventory fall within the 2-digit commodity code in Table 6 of the monthly ``PPI Detailed Report'' for ``furniture and household durables.'' Therefore, R will maintain a single dollar-value pool. (ii) Select a BLS table and appropriate month for 2001. R determines that the appropriate month for 2001 is October. R also determines that the appropriate month for 2000 would have been December if R had used the IPIC method for that year. (iii) Assign inventory items to BLS categories for 2001. For 2001, R assigns all items in the dollar-value pool to the most-detailed BLS categories listed in Table 6 of the October 2001 ``PPI Detailed Report'' that contain those items. The BLS categories and the current-year cost of the items assigned to them are summarized as follows: ---------------------------------------------------------------------------------------------------------------- Current-year Commodity code Category cost ---------------------------------------------------------------------------------------------------------------- 12120101........................................ Living Room Table........................... $111,924.00 12120211........................................ Dining Room Table........................... 159,578.00 12120216........................................ Dining Room Chairs.......................... 98,639.00 12130101........................................ Upholstered Sofas........................... 332,488.00 12130111........................................ Upholstered Chairs.......................... 218,751.00 ----------------- Total....................................... ............................................ 921,380.00 ---------------------------------------------------------------------------------------------------------------- (iv) Compute category inflation indexes for 2001. Because R elected to use the double-extension IPIC method and did not elect the 10 percent method, the category inflation indexes are computed in accordance with paragraph (e)(3)(iii)(D)(3)(ii) of this section (BLS price indexes for October 2001 divided by BLS price indexes for December 2000). R computes the category inflation indexes for 2001 as follows: [[Page 540]] ---------------------------------------------------------------------------------------------------------------- (III) Category Category (I) Oct. 2001 (II) Dec. 2000 inflation index: index index (I)/(II) ---------------------------------------------------------------------------------------------------------------- Living Room Table......................................... 172.4 169.2 1.018913 Dining Room Table......................................... 171.9 168.1 1.022606 Dining Room Chairs........................................ 172.8 169.7 1.018268 Upholstered Sofas......................................... 142.2 140.9 1.009226 Upholstered Chairs........................................ 134.1 132.5 1.012075 ---------------------------------------------------------------------------------------------------------------- (v) Compute IPI for 2001. R must compute the IPI for 2001, which is the weighted harmonic mean of the category inflation indexes for 2001. The formula for the weighted harmonic mean provided in paragraph (e)(3)(iii)(E)(1) of this section is [Sum of Weights/Sum of (Weight/ Category Inflation Index)]. The IPI for 2001 is computed as follows: ---------------------------------------------------------------------------------------------------------------- (II) Category (III) Quotient: Category (I) Weight inflation index (I)/(II) ---------------------------------------------------------------------------------------------------------------- Living Room Table......................................... $111,924.00 1.018913 $109,846.47 Dining Room Table......................................... 159,578.00 1.022606 156,050.33 Dining Room Chairs........................................ 98,639.00 1.018268 96,869.39 Upholstered Sofas......................................... 332,488.00 1.009226 329,448.51 Upholstered Chairs........................................ 218,751.00 1.012075 216,141.10 ------------------- Total................................................. $921,380.00 ................ $908,355.80 ---------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------------- (V) Sum of (weight/ (IV) Sum of weights category inflation (VI) Inventory price index) index: (IV)/(V) ---------------------------------------------------------------------------------------------------------------- $921,380.00....................................................... $908,355.80 1.01433821 ---------------------------------------------------------------------------------------------------------------- (vi) Determine the LIFO value of the dollar-value pool for 2001. For 2001, R determines the total base-year cost of its ending inventory by dividing the total current-year cost of the items in the dollar-value pool by the IPI for 2001. The total base-year cost of R's ending inventory is $908,355.80 ($921,380/1.01433821). Comparing the base-year cost of the ending inventory to the base-year cost of the beginning inventory, R determines that the base-year cost of the 2001 increment is $58,355.80 ($908,355.80 - $850,000.00). R multiplies the base-year cost of the 2001 increment by the IPI for 2001 and determines that the LIFO value of the 2001 layer is $59,192.52 ($58,355.80 * 1.01433821). Thus, the LIFO value of R's total inventory at the end of 2001 is $909,192.52 ($850,000.00 (opening inventory) + $59,192.52 (2001 layer)). (vii) Select a BLS table and appropriate month for 2002. For 2002, R must compute a new IPI under the double-extension IPIC method to determine the LIFO value of its dollar-value pool. R determines that the appropriate month for 2002 is November. (viii) Assign inventory items to BLS categories for 2002. For 2002, R assigns all items in the dollar-value pool to the most-detailed BLS categories listed in Table 6 of the November 2002 ``PPI Detailed Report'' that contain those items. The BLS categories and the current- year cost of the items assigned to them are summarized as follows: ---------------------------------------------------------------------------------------------------------------- Current-year Commodity code Category cost ---------------------------------------------------------------------------------------------------------------- 12120103........................................ Living Room Desks........................... $125,008.00 12120211........................................ Dining Room Table........................... 136,216.00 12120216........................................ Dining Room Chairs.......................... 113,569.00 12130101........................................ Upholstered Sofas........................... 343,900.00 12130111........................................ Upholstered Chairs.......................... 233,050.00 ----------------- Total....................................... ............................................ $951,743.00 ---------------------------------------------------------------------------------------------------------------- (ix) Compute category inflation indexes for 2002. Because R uses the double-extension IPIC method and did not elect the 10 percent method, the category inflation indexes are computed in accordance with paragraph (e)(3)(iii)(D)(3)(ii) of this section (BLS price indexes for November 2002 divided by BLS price indexes for December 2000). R computes [[Page 541]] the category inflation indexes for 2002 as follows: ---------------------------------------------------------------------------------------------------------------- (III) Category Category (I) Nov. 2002 (II) Dec. 2000 inflation index index index (I)/(II) ---------------------------------------------------------------------------------------------------------------- Living Room Desks......................................... 172.6 160.3 1.076731 Dining Room Table......................................... 174.8 168.1 1.039857 Dining Room Chairs........................................ 177.0 169.7 1.043017 Upholstered Sofas......................................... 144.9 140.9 1.028389 Upholstered Chairs........................................ 136.6 132.5 1.030943 ---------------------------------------------------------------------------------------------------------------- (x) Compute IPI for 2002. R must compute the IPI for 2002, which is the weighted harmonic mean [Sum of Weights/Sum of (Weight/Category Inflation Index)] of the category inflation indexes for 2002. The IPI for 2002 is computed as follows: ---------------------------------------------------------------------------------------------------------------- (II) Category (III) Quotient: Category (I) Weight inflation index (I)/(II) ---------------------------------------------------------------------------------------------------------------- Living Room Desks......................................... $125,008.00 1.076731 $116,099.56 Dining Room Table......................................... 136,216.00 1.039857 130,994.93 Dining Room Chairs........................................ 113,569.00 1.043017 108,885.09 Upholstered Sofas......................................... 343,900.00 1.028389 334,406.53 Upholstered Chairs........................................ 233,050.00 1.030943 226,055.17 ------------------- Total................................................. 951,743.00 ................ 916,441.28 ---------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------------- (V) Category (VI) Inventory price (IV) Sum of weights inflation index index: (IV)/(V) ---------------------------------------------------------------------------------------------------------------- $951,743.00....................................................... $916,441.28 1.03852044 ---------------------------------------------------------------------------------------------------------------- (xi) Determine the LIFO value of the pool for 2002. For 2002, R determines the total base-year cost of its ending inventory by dividing the total current-year cost of the items in the dollar-value pool by the IPI for 2002. The total base-year cost of the ending inventory is $916,441.28 ($951,743.00/1.03852044). Comparing the base-year cost of the ending inventory to the base-year cost of the beginning inventory, R determines that the base-year cost of the 2002 increment is $8,085.48 ($916,441.28-$908,355.80). R multiplies the base-year cost of the 2002 increment by the IPI for 2002 and determines that the LIFO value of the 2002 layer is $8,396.94 ($8,085.48 * 1.03852044). Thus, the LIFO value of R's total inventory at the end of 2002 is $917,589.46 ($850,000.00 (opening inventory) + $59,192.52 (2001 layer) + $8,396.94 (2002 layer)). Example 2. Link-chain method. (i) Introduction. The facts are the same as Example 1, except that R uses the link-chain IPIC method. The double-extension IPIC method and the link-chain IPIC method yield the same results for the first taxable year in which the dollar-value LIFO and IPIC methods are used. Therefore, this example illustrates only how R will compute the IPI for, and determine the LIFO value of, its dollar- value pool for 2002. (ii) Select a BLS table and appropriate month for 2002. R determines that the appropriate month for 2002 is November. (iii) Assign inventory items to BLS categories for 2002. For 2002, R assigns all items in the dollar-value pool to the most-detailed BLS categories listed in Table 6 of the November 2002 ``PPI Detailed Report'' that contain those items. The BLS categories and the current- year cost of the items assigned to them are summarized as follows: ---------------------------------------------------------------------------------------------------------------- Current-year Commodity code Category cost ---------------------------------------------------------------------------------------------------------------- 12120103........................................ Living Room Desks........................... $125,008.00 12120211........................................ Dining Room Table........................... 136,216.00 12120216........................................ Dining Room Chairs.......................... 113,569.00 12130101........................................ Upholstered Sofas........................... 343,900.00 12130111........................................ Upholstered Chairs.......................... 233,050.00 ----------------- Total....................................... ............................................ 951,743.00 ---------------------------------------------------------------------------------------------------------------- [[Page 542]] (iv) Compute category inflation indexes for 2002. Because R uses the link-chain IPIC method and did not elect the 10 percent method, the category inflation indexes are computed in accordance with paragraph (e)(3)(iii)(D)(3)(iii) of this section (BLS price indexes for November 2002 divided by BLS price indexes for October 2001). R computes the category inflation indexes for 2002 as follows: ---------------------------------------------------------------------------------------------------------------- (III) Category Category (I) Nov. 2002 (II) Oct. 2001 inflation index: index index (I)/(II) ---------------------------------------------------------------------------------------------------------------- Living Room Desks......................................... 172.6 162.0 1.065432 Dining Room Table......................................... 174.8 171.9 1.016870 Dining Room Chairs........................................ 177.0 172.8 1.024306 Upholstered Sofas......................................... 144.9 142.2 1.018987 Upholstered Chairs........................................ 136.6 134.1 1.018643 ---------------------------------------------------------------------------------------------------------------- (v) Compute IPI for 2002. As provided in paragraph (e)(3)(iii)(E)(2) of this section, R must compute the IPI for 2002 by multiplying the weighted harmonic mean of the category inflation indexes for 2002 by the IPI for 2001. The IPI for 2002 is computed as follows: ---------------------------------------------------------------------------------------------------------------- (II) Category (III) Quotient: Category (I) Weight inflation index (I)/(II) ---------------------------------------------------------------------------------------------------------------- Living Room Desks......................................... $125,008.00 1.065432 $117,330.81 Dining Room Table......................................... 136,216.00 1.016870 133,956.16 Dining Room Chairs........................................ 113,569.00 1.024306 110,874.09 Upholstered Sofas......................................... 343,900.00 1.018987 337,492.04 ------------------ ----------------- Upholstered Chairs........................................ 233,050.00 1.018643 228,784.77 Total................................................. 951,743.00 ................ 928,437.87 ---------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------------- (VI) Weighted (V) Sum of (weight/ harmonic mean of (VII) Inventory (VIII) Inventory (IV) Sum of weights category inflation category inflation price index for price index for index) indexes for 2002: 2001 2002: (VI)*(VII) (IV)/(V) ---------------------------------------------------------------------------------------------------------------- $951,743.00................. $928,437.87 1.02510144 1.01433821 1.03979956 ---------------------------------------------------------------------------------------------------------------- (vi) Determine the LIFO value of the pool for 2002. R determines the total base-year cost of its ending inventory by dividing the total current-year cost of the items in the dollar-value pool by the IPI for 2002. The total base-year cost of the ending inventory is $915,313.91 ($951,743.00 / 1.03979956). Comparing the base-year cost of the ending inventory to the base-year cost of the beginning inventory, R determines that the base-year cost of the 2002 layer is $6,958.11 ($915,313.91- $908,355.80). R multiplies the base-year cost of the 2002 layer by the IPI for 2002 and determines that the LIFO value of the 2002 layer is $7,235.04 ($6,958.11 * 1.03979956). Thus, the LIFO value of R's total inventory at the end of 2002 is $916,427.56 ($850,000.00 (opening inventory) + $59,192.52 (2001 layer) + $7,235.04 (2002 layer)). (iv) Adoption or change of method--(A) Adoption or change to IPIC method. The use of an inventory price index computed under the IPIC method is a method of accounting. A taxpayer permitted to adopt the dollar-value LIFO method without first securing the Commissioner's consent also may adopt the IPIC method without first securing the Commissioner's consent. The IPIC method may be adopted and used, however, only if the taxpayer provides the following information on a Form 970, ``Application to Use LIFO Inventory Method,'' or in another manner as may be acceptable to the Commissioner: A complete list of dollar-value pools (including a description of the items in each dollar- value pool); the BLS table (i.e., CPI or PPI) selected for each dollar- value pool; the representative month, if applicable, elected for each dollar-value pool; the BLS categories to which the items in each dollar- value pool will be assigned; the method of assigning items to BLS categories (e.g., the 10 percent method) for each dollar-value pool; and the method [[Page 543]] of computing the IPI (i.e., double-extension IPIC method or link-chain IPIC method) for each dollar-value pool. In the case of a taxpayer permitted to adopt the IPIC method without requesting the Commissioner's consent, the Form 970 must be attached to the taxpayer's income tax return for the taxable year of adoption. In all other cases, a taxpayer may change to the IPIC method only after securing the Commissioner's consent as provided in Sec. 1.446-1(e). In these latter cases, the Form 970 containing the information described in this paragraph (e)(3)(iv)(A) must be attached to a Form 3115, ``Application for Change in Accounting Method,'' filed as required by Sec. 1.446-1(e). A taxpayer that simultaneously changes to the dollar-value LIFO and IPIC methods from another LIFO method must apply the rules of paragraph (f)(2) of this section before applying the rules of paragraph (e)(3)(iv)(B)(1) of this section. To satisfy the requirements of Sec. 1.472-2(h), taxpayers must maintain adequate books and records, including those concerning the use of the IPIC method and necessary computations. Notwithstanding the rules in paragraph (e)(1) of this section, a taxpayer that adopts, or changes to, the link-chain IPIC method is not required to demonstrate that the use of any other method of determining the LIFO value of a dollar-value pool is impractical. (B) New base year--(1) Voluntary change--(i) In general. In the case of a taxpayer using a non-IPIC method to determine the LIFO value of inventory, the layers previously determined under that method, if any, and the LIFO values of those layers are retained if the taxpayer voluntarily changes to the IPIC method. Instead of using the earliest taxable year for which the taxpayer adopted the LIFO method for any items in the dollar-value pool, the year of change is used as the new base year for the purpose of determining the amount of increments and liquidations, if any, for the year of change and subsequent taxable years. The base-year cost of the layers in a dollar-value pool at the beginning of the year of change must be restated in terms of new base- year cost using the year of change as the new base year and, if applicable, the indexes for the previously determined layers must be recomputed accordingly. The recomputed indexes will be used to determine the LIFO value of subsequent liquidations. For purposes of computing an IPI under paragraph (e)(3)(iii)(E) of this section, the IPI for the immediately preceding year is 1.00. The new total base-year cost of the items in a dollar-value pool for the purpose of determining future increments and liquidations is equal to the total current-year cost of the items in the dollar-value pool (determined using the taxpayer's method of determining the total current-year cost of the items in the dollar-value pool under paragraph (e)(2)(ii) of this section). A taxpayer must allocate this new total base-year cost to each layer based on the ratio of the old base-year cost of the layer to the old total base-year cost of the dollar-value pool. (ii) Example. The following example illustrates the rules of this paragraph (e)(3)(iv)(B)(1): Example. (i) In 1990, X elected to use a dollar-value LIFO method (other than the IPIC method) for its single dollar-value pool. X is granted permission to change to the link-chain IPIC method, beginning with the taxable year ending December 31, 2001. X will continue using a single dollar-value pool. X's beginning inventory as of January 1, 2001, computed using its former inventory method, is as follows: ---------------------------------------------------------------------------------------------------------------- (III) LIFO Layer (I) Base-year (II) Inflation value: (I) * cost index (II) ---------------------------------------------------------------------------------------------------------------- Base layer................................................ $135,000 1.00 $135,000 1991 layer................................................ 20,000 1.43 28,600 1994 layer................................................ 60,000 1.55 93,000 1995 layer................................................ 13,000 1.59 20,670 1997 layer................................................ 2,000 1.61 3,220 ------------------ ----------------- Total................................................. 230,000 ................ 280,490 ---------------------------------------------------------------------------------------------------------------- [[Page 544]] (ii) Under X's method of determining the current-year cost of items in a dollar-value pool, the current-year cost of the beginning inventory is $391,000. Thus, X's new base-year cost as of January 1, 2001, is $391,000. X allocates this new base-year cost to each layer based on the ratio of old base-year cost of the layer to the total old base-year cost of the dollar-value pool. To recompute the inflation indexes for each of its layers, X divides the LIFO value of each layer by the new base-year cost attributable to the layer. The new base-year cost, recomputed inflation indexes, and LIFO value of X's layers as of January 1, 2001, are as follows: ---------------------------------------------------------------------------------------------------------------- (III) LIFO Layer (I) Base-year (II) Inflation value: (I) * cost index (II) ---------------------------------------------------------------------------------------------------------------- Base layer................................................ $229,500 0.588235 $135,000 1991 layer................................................ 34,000 0.841176 28,600 1994 layer................................................ 102,000 0.911765 93,000 1995 layer................................................ 22,100 0.935294 20,670 1997 layer................................................ 3,400 0.947059 3,220 ------------------ ----------------- Total................................................. 391,000 ................ 280,490 ---------------------------------------------------------------------------------------------------------------- (iii) In 2001, the current-year cost of X's ending inventory is $430,139. The weighted harmonic mean of the category inflation indexes applicable to X's ending inventory is 1.075347, and in accordance with paragraph (e)(3)(iv)(B)(1)(i) of this section, the inflation index for the immediately preceding taxable year is 1.00. Thus, X's IPI for 2001 is 1.075347 (1.00 * 1.075347). The total base-year cost of X's ending inventory is $400,000 ($430,139/1.075347). The base-year cost, IPI, and LIFO value of X's layers as of December 31, 2001, are as follows: ---------------------------------------------------------------------------------------------------------------- (III) LIFO Layer (I) Base-year (II) Inventory value: (I) * cost price index (II) ---------------------------------------------------------------------------------------------------------------- Base layer................................................ $229,500 0.588235 $135,000 1991 layer................................................ 34,000 0.841176 28,600 1994 layer................................................ 102,000 0.911765 93,000 1995 layer................................................ 22,100 0.935294 20,670 1997 layer................................................ 3,400 0.947059 3,220 2001 layer................................................ 9,000 1.075347 9,678 ------------------ ----------------- Total................................................. 400,000 ................ 290,168 ---------------------------------------------------------------------------------------------------------------- (iv) In 2002, the current-year cost of X's ending inventory is $418,000. The weighted harmonic mean of the category inflation indexes applicable to X's ending inventory is 1.02292562, and the IPI for the immediately preceding year is 1.075347. Thus, X's IPI for 2001 is 1.10 (1.075347 * 1.02292562). The total base-year cost of X's ending inventory is $380,000 ($418,000/1.10), which results in a liquidation of $20,000 ($400,000-$380,000) in terms of base-year cost. This liquidation eliminates the 2001 layer ($9,000 base-year cost), the 1997 layer ($3,400 base-year cost), and part of the 1995 layer ($7,600 base-year cost). The base-year cost, indexes, and LIFO value of X's layers as of December 31, 2002, are as follows: ---------------------------------------------------------------------------------------------------------------- (III) LIFO Layer (I) Base-year (II) Inventory value: (I) * cost price index (II) ---------------------------------------------------------------------------------------------------------------- Base layer................................................ $229,500 0.588235 $135,000 1991 layer................................................ 34,000 0.841176 28,600 1994 layer................................................ 102,000 0.911765 93,000 1995 layer................................................ 14,500 0.935294 13,562 ------------------ ----------------- Total................................................. 380,000 ................ 270,162 ---------------------------------------------------------------------------------------------------------------- (2) Involuntary change--(i) In general. If a taxpayer uses a non- IPIC method to compute the LIFO value of a dollar-value pool, and if the Commissioner determines that the taxpayer's method does not clearly reflect income, the [[Page 545]] Commissioner may require the taxpayer to change to the IPIC method. If the Commissioner requires a taxpayer to change to the IPIC method, and the taxpayer does not provide sufficient information from its books and records to compute an adjustment under section 481, the Commissioner may implement the change using the simplified transition method described in paragraph (e)(3)(iv)(B)(2)(ii) of this section. (ii) Simplified Transition Method. Under the simplified transition method, the Commissioner will recompute the LIFO value of each dollar- value pool as of the beginning of the year of change using the double- extension IPIC method or the link-chain IPIC method. The adjustment under section 481 is equal to the difference between the recomputed LIFO value and the LIFO value of the pool determined under the taxpayer's former method. The Commissioner will compute an IPI using the double- extension IPIC method or link-chain IPIC method for each taxable year in which the LIFO method was used by the taxpayer based on the assumptions that the ending inventory of the pool in each taxable year was comprised of items that fall into the same BLS categories as the items in the ending inventory of the year of change and that the relative weights of those BLS categories in all prior years were the same as the relative weights of those BLS categories in the ending inventory of the year of change. The base-year cost of the items in a dollar-value pool at the end of a taxable year will be determined by dividing the IPI computed for the taxable year into the current-year cost of the items in that pool determined in accordance with paragraph (e)(2)(ii) of this section. If the comparison of the base-year cost of the beginning and ending inventory produces a current-year increment, the base-year cost of that increment will be multiplied by the IPI computed for that taxable year to determine the LIFO value of that layer. (iii) Example. The following example illustrates the rules of this paragraph (e)(3)(iv)(B)(2)(ii). Example. (i) Z began using a dollar-value LIFO method other than the IPIC method in the taxable year ending December 31, 1998, and maintains a single dollar-value pool. Z's beginning inventory as of January 1, 2000, computed using its method of accounting, was as follows: ---------------------------------------------------------------------------------------------------------------- (I) Base-year (II) Inflation (III) LIFO Layer cost index value: (I)*(II) ---------------------------------------------------------------------------------------------------------------- Base layer................................................ $105,000 1.00 $105,000 1998 layer................................................ 3,000 1.40 4,200 ------------------ ----------------- Total................................................. 108,000 ................ 109,200 ---------------------------------------------------------------------------------------------------------------- (ii) Upon examining Z's federal income tax return for the taxable year ending December 31, 2000, the examining agent determines that Z's dollar-value LIFO method does not clearly reflect income. The examining agent chooses to change Z to the double-extension IPIC method for 2000 and implements the change using the simplified transition method as follows. First, the inventory in Z's dollar-value pool at the end of 2000 is assigned to the most-detailed categories in the CPI or PPI, whichever is appropriate. Assume that 80 percent of the current-year cost of Z's inventory as of December 31, 2000, is assigned to Category 1, 10 percent is assigned to Category 2, and 10 percent is assigned to Category 3. Assume further that the current-year cost of the inventory in Z's dollar-value pool at the end of 1998 and 1999 was $133,000 and $145,000, respectively. (iii) The category inflation indexes for 1998 computed under the double-extension IPIC method are 1.17 for Category 1, 1.26 for Category 2, and 1.19 for Category 3. The weights to be used in computing the IPI for 1998 are $106,400 ($133,000 * 80 percent) for Category 1, $13,300 ($133,000 * 10 percent) for Category 2, and $13,300 ($133,000 * 10 percent) for Category 3. The IPI for 1998 is computed as follows: ---------------------------------------------------------------------------------------------------------------- (II) Category (III) Quotient: Category (I) Weight inflation index (I)/(II) ---------------------------------------------------------------------------------------------------------------- 1......................................................... $106,400 1.17 90,940 2......................................................... 13,300 1.26 10,556 [[Page 546]] 3......................................................... 13,300 1.19 11,176 ------------------ ----------------- Total................................................. 133,000 ................ 112,672 ---------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------------- (V) Sum of (weight/ (IV) Sum of weights category inflation (VI) Inventory price index) index: (IV)/(V) ---------------------------------------------------------------------------------------------------------------- $133,000......................................................... $112,672 1.180417 ---------------------------------------------------------------------------------------------------------------- (iv) The base-year cost of the inventory in Z's pool at the end of 1998 is $112,672 ($133,000/1.180417), and the base-year cost of the 1998 increment is $7,672 ($112,672-$105,000). The LIFO value of the 1998 layer is $9,056 ($7,672x1.180417). (v) The category inflation indexes for 1999 computed under the double-extension IPIC method were 1.21 for Category 1, 1.29 for Category 2 and 1.23 for Category 3. The weights to be used in computing the IPI for 1999 are $116,000 ($145,000x80 percent) for Category 1, $14,500 ($145,000x10 percent) for Category 2, and $14,500 ($145,000x10 percent) for Category 3. The IPI for 1999 is computed as follows: ---------------------------------------------------------------------------------------------------------------- (II) Category (III) Quotient: Category (I) Weight inflation index (I)/(II) ---------------------------------------------------------------------------------------------------------------- 1......................................................... $116,000 1.21 $95,868 2......................................................... 14,500 1.29 11,240 3......................................................... 14,500 1.23 11,789 ------------------ ----------------- Total................................................. 145,000 ................ 118,897 ---------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------------------------------- (V) Sum of (weight/ (IV) Sum of weights category inflation (VI) Inventory price index) index: (IV)/(V) ---------------------------------------------------------------------------------------------------------------- $145,000.......................................................... $118,897 1.219543 ---------------------------------------------------------------------------------------------------------------- (vi) The base-year cost of the inventory in Z's pool at the end of 1999 is $118,897 ($145,000/1.219543), and the base-year cost of the 1999 layer is $6,225 ($118,897-$112,672). The LIFO value of the 1999 layer is $7,592 ($6,225x1.219543). (vii) The LIFO value of Z's dollar-value pool at the end of 1999 computed under the double-extension IPIC method is as follows: ---------------------------------------------------------------------------------------------------------------- (I) Base-year (II) Inventory (III) LIFO Layer cost price index value: (I)*(II) ---------------------------------------------------------------------------------------------------------------- Base layer................................................ $105,000 1.000000 $105,000 1998 layer................................................ 7,672 1.180417 9,056 1999 layer................................................ 6,225 1.219542 7,592 ššššššššššššššššššššššššššššššššššššššššššššššššššššššššššš ---------------------------------------------------------------------------------------------------------------- (viii) The section 481(a) adjustment is equal to the difference between the LIFO value of the inventory at the beginning of 2000 computed under Z's former method of accounting and recomputed by the examining agent under the double-extension IPIC method, or $12,448 ($121,648--$109,200). (ix) Finally, the examining agent will recompute Z's taxable income for 2000 and succeeding taxable years using the double-extension IPIC method. (v) Effective date--(A) In general. The rules of this paragraph (e)(3) and paragraphs (b)(4) and (c)(2) of this section are applicable for taxable years ending on or after December 31, 2001. (B) Change in method of accounting. Any change in a taxpayer's method of accounting necessary to comply with this paragraph (e)(3) or with paragraphs (b)(4) or (c)(2) of this section is [[Page 547]] a change in method of accounting to which the provisions of section 446 and the regulations thereunder apply. For the first or second taxable year ending on or after December 31, 2001, a taxpayer is granted the consent of the Commissioner to change its method of accounting to a method required or permitted by this paragraph (e)(3) and paragraphs (b)(4) and (c)(2) of this section. A taxpayer that wants to change its method of accounting under this paragraph (e)(3)(v) must follow the automatic consent procedures in Rev. Proc. 2002-9 (2002-3 I.R.B. xxx) (see Sec. 601.601(d)(2) of this chapter). However, the scope limitations in section 4.02 of Rev. Proc. 2002-9 do not apply, and the five-year limitation on the readoption of the LIFO method under section 10.01(2) of the Appendix is waived. In addition, if the taxpayer's method of accounting for its LIFO inventories is an issue under consideration at the time the application is filed with the national office, the audit protection of section 7 of Rev. Proc. 2002-9 does not apply. If a taxpayer changing its method of accounting under this paragraph (e)(3)(v)(B) is under examination, before an appeals office, or before a federal court with respect to any income tax issue, the taxpayer must provide a copy of the application to the examining agent(s), appeals officer or counsel for the government, as appropriate, at the same time it files the application with the national office. Any change under this paragraph (e)(3)(v)(B) must be made using a cut-off method and new base year. See paragraph (e)(3)(iv)(B)(1) of this section for an example of this computation. Because a change under this paragraph (e)(3)(v)(B) is made using a cut-off method, a section 481(a) adjustment is not permitted. However, a taxpayer changing its method of accounting under this paragraph (e)(3)(v)(B) must comply with the requirements of section 10.06(3) of the APPENDIX of Rev. Proc. 2002-9 (concerning bargain purchases). (f) Change to dollar-value method from another method of pricing LIFO inventories--(1) Consent required. Except as provided in Sec. 1.472-3 in the case of a taxpayer electing to use a LIFO inventory method for the first time, or in the case of a taxpayer changing to the dollar-value method and continuing to use the same pools as were used under another LIFO method, a taxpayer using another LIFO method of pricing inventories may not change to the dollar-value method of pricing such inventories unless he first secures the consent of the Commissioner in accordance with paragraph (e) of Sec. 1.446-1. (2) Method of converting inventory. Where the taxpayer changes from one method of pricing LIFO inventories to the dollar-value method, the ending LIFO inventory for the taxable year immediately preceding the year of change shall be converted to the dollar-value LIFO method. This is done to establish the base-year cost for subsequent calculations. Thus, if the taxpayer was previously valuing LIFO inventories on the specific goods method, these separate values shall be combined into appropriate pools. For this purpose, the base year for the pool shall be the earliest taxable year for which the LIFO inventory method had been adopted for any item in that pool. No change will be made in the overall LIFO value of the opening inventory for the year of change as a result of the conversion, and that inventory will merely be restated in the manner used under the dollar-value method. All layers of increment for such inventory must be retained, except that all layers of increment which occurred in the same taxable year must be combined. The following examples illustrate the provisions of this subparagraph: Example (1). (i) Assume that the taxpayer has used another LIFO method for finished goods since 1954 and has complied with all the requirements prerequisite for a change to the dollar-value method. Items A, B, and C, which have previously been inventoried under the specific goods LIFO method, may properly be included in a single dollar-value LIFO pool. The LIFO inventory value of items A, B, and C at December 31, 1960, is $12,200, computed as follows: ------------------------------------------------------------------------ Dec. 31, Base 1960, Year quantity Unit inventory and yearly cost at LIFO increments value ------------------------------------------------------------------------ Item A 1954 (base year)........................ 100 $1 $100 1955.................................... 200 2 400 1956.................................... 100 4 400 [[Page 548]] 1960.................................... 100 6 600 ------------ ---------- Total................................ 500 ....... 1,500 Item B 1954 (base year)........................ 300 6 1,800 1955.................................... 100 8 800 1960.................................... 50 10 500 ------------ ---------- Total................................ 450 ....... 3,100 Item C 1954 (base year)........................ 1,000 4 4,000 1955.................................... 200 6 1,200 1956.................................... 300 8 2,400 ------------ ---------- Total................................. 1,500 ....... 7,600 ============ LIFO value of items A, B, and C at .......... ....... 12,200 Dec. 31, 1960........................ ------------------------------------------------------------------------ There were no increments in the years 1957, 1958, or 1959. (ii) The computation of the ratio of the total current-year cost to the total base-year cost for the base year and each layer of increment in Pool No. 1 is shown as follows: ---------------------------------------------------------------------------------------------------------------- 1954 Increments base- -------------------------------------- Item year Year 1954 unit 1955 1956 1960 cost ---------------------------------------------------------------------------------------------------------------- A Base-year cost..................................... $1.00 $100 $200 $100 $100 LIFO value......................................... ....... 100 400 400 600 B Base-year cost..................................... 6.00 1,800 600 ........... 300 LIFO value......................................... ....... 1,800 800 ........... 500 C Base-year cost..................................... 4.00 4,000 800 1,200 ........... LIFO value......................................... ....... 4,000 1,200 2,400 ........... -------------- Total--Base-year cost.............................. 5,900 1,600 1,300 400 Total--LIFO value.................................. 5,900 2,400 2,800 1,100 ============== Ratio of total current-year cost to total base-year ....... 100.00 150.00 215.38 275.00 cost (percent).................................... ---------------------------------------------------------------------------------------------------------------- (iii) On the basis of the foregoing computations, the LIFO inventory of Pool No. 1, at December 31, 1960, is restated as follows: ------------------------------------------------------------------------ Ratio of total Dec. 31, current- Dec. 31, 1960, year cost 1960, inventory to total inventory at base- base-year at LIFO year cost cost value (percent) ------------------------------------------------------------------------ 1954 base cost....................... $5,900 100.00 $5,900 1955 increment....................... 1,600 150.00 2,400 1956 increment....................... 1,300 215.38 2,800 1960 increment....................... 400 275.00 1,100 ------------ ---------- Total............................ 9,200 .......... 12,200 ------------------------------------------------------------------------ Example (2). Assume the same facts as in example (1) and assume further that the base-year cost of Pool No. 1 at December 31, 1961, is $8,350. Since the closing inventory for the taxable year 1961 at base- year cost is less than the opening inventory for that year at base-year cost, a liquidation has occurred during 1961. This liquidation absorbs all of the 1960 layer of increment and part of the 1956 layer of increment. The December 31, 1961, inventory is $10,131, computed as follows: ------------------------------------------------------------------------ Ratio of total Dec. 31, current- Dec. 31, 1961, year cost 1961, inventory to total inventory at base- base-year at LIFO year cost cost value (percent) ------------------------------------------------------------------------ 1954 base cost....................... $5,900 100.00 $5,900 1955 increment....................... 1,600 150.00 2,400 1956 increment....................... 850 215.38 1,831 ------------ ---------- Total............................ 8,350 .......... 10,131 ------------------------------------------------------------------------ (g) Transitional rules--(1) Change in method of pooling. Any method of pooling authorized by this section and used by the taxpayer in computing his LIFO inventories under the dollar-value method shall be treated as a method of accounting. Any method of pooling which is authorized by this section [[Page 549]] shall be used for the year of adoption and for all subsequent taxable years unless a change is required by the Commissioner in order to clearly reflect income, or unless permission to change is granted by the Commissioner as provided in paragraph (e) of Sec. 1.446-1. Where the taxpayer changes from one method of pooling to another method of pooling permitted by this section, the ending LIFO inventory for the taxable year preceding the year of change shall be restated under the new method of pooling. (2) Manner of combining or separating dollar-value pools. (i) A taxpayer who has been using the dollar-value LIFO method and who is permitted or required to change his method of pooling, shall combine or separate the LIFO value of his inventory for the base year and each yearly layer of increment in order to conform to the new pool or pools. Each yearly layer of increment in the new pool or pools must be separately accounted for and a record thereof maintained, and any liquidation occurring in the new pool or pools subsequent to the formation thereof shall be treated in the same manner as if the new pool or pools had existed from the date the taxpayer first adopted the LIFO inventory method. The combination or separation of the LIFO value of his inventory for the base year and each yearly layer of increment shall be made in accordance with the appropriate method set forth in this subparagraph, unless the use of a different method is approved by the Commissioner. (ii) Where the taxpayer is permitted or required to separate a pool into more than one pool, the separation shall be made in the following manner: First, each item in the former pool shall be placed in an appropriate new pool. Every item in each new pool is then extended at its base-year unit cost and the extensions are totaled. Each total is the amount of inventory for each new pool expressed in terms of base- year cost. Then a ratio of the total base-year cost of each new pool to the base-year cost of the former pool is computed. The resulting ratio is applied to the amount of inventory for the base year and each yearly layer of increment of the former pool to obtain an allocation to each new pool of the base-year inventory of the former pool and subsequent layers of increment thereof. The foregoing may be illustrated by the following example of a change for the taxable year 1961: Example. (a) Assume that items A, B, C, and D are all grouped together in one pool prior to December 31, 1960. The LIFO inventory value at December 31, 1960, is computed as follows: ------------------------------------------------------------------------ Pool ABCD ---------------------------------- Ratio of Dec. 31, total 1960, current- Dec. 31, inventory year cost 1960, at Jan. 1, to total inventory 1956, base- base-year at LIFO year cost cost value (percent) ------------------------------------------------------------------------ Jan. 1, 1956, base cost.............. $10,000 100 $10,000 Dec. 31, 1956, increment............. 1,000 110 1,100 Dec. 31, 1958, increment............. 5,000 120 6,000 Dec. 31, 1960, increment............. 4,000 125 5,000 ------------ ---------- Total.............................. 20,000 .......... 22,100 ------------------------------------------------------------------------ (b) The extension of the quantity of items A, B, C, and D at respective base-year unit costs is as follows: ------------------------------------------------------------------------ Base- year Item Quantity unit Amount cost ------------------------------------------------------------------------ A.......................................... 2,000 $2 $4,000 B.......................................... 1,000 3 3,000 C.......................................... 1,000 5 5,000 D.......................................... 4,000 2 8,000 -------- Total.................................. ........ ........ 20,000 ------------------------------------------------------------------------ (c) Under the provisions of this section the taxpayer separates former Pool ABCD into two pools, Pool AB and Pool CD. The computation of the ratio of total base-year cost for each of the new pools to the base- year cost of the former pool is as follows: ------------------------------------------------------------------------ Total Item base-year Ratio cost ------------------------------------------------------------------------ Pool AB: A.......................................... $4,000 .............. B.......................................... 3,000 .............. ----------- 7,000 7,000/20,000 =========== Pool CD: C.......................................... 5,000 .............. D.......................................... 8,000 .............. 13,000 13,000/20,000 ----------- Total for pool ABCD........................ 20,000 .............. ------------------------------------------------------------------------ [[Page 550]] (d) The ratio of the base-year cost of new Pools AB and CD to the base-year cost of former Pool ABCD is 7,000/20,000 and 13,000/20,000, respectively. The allocation of the January 1, 1956 base cost and subsequent yearly layers of increment of former Pool ABCD to new Pools AB and CD is as follows: ------------------------------------------------------------------------ Base-year Pool cost to ----------------- be allocated AB CD ------------------------------------------------------------------------ Jan. 1, 1956, base cost.................... $10,000 $3,500 $6,500 Dec. 31, 1956, increment................... 1,000 350 650 Dec. 31, 1958, increment................... 5,000 1,750 3,250 Dec. 31, 1960, increment................. 4,000 1,400 2,600 ------------ Total................................ 20,000 7,000 13,000 ------------------------------------------------------------------------ (e) The LIFO value of new Pools AB and CD at December 31, 1960, as allocated, is as follows: ------------------------------------------------------------------------ Ratio of Dec. 31, total 1960, current- Dec. 31, inventory year cost 1960, at Jan. 1, to total inventory 1956, base- base-year at LIFO year cost cost value (percent) ------------------------------------------------------------------------ Pool AB Jan. 1, 1956, base cost.............. $3,500 100 $3,500 Dec. 31, 1956, increment............. 350 110 385 Dec. 31, 1958, increment............. 1,750 20 2,100 Dec. 31, 1960, increment............. 1,400 125 1,750 ------------ ---------- Total.......................... 7,000 .......... 7,735 ============= Pool CD Jan. 1, 1956, base cost.............. 6,500 100 6,500 Dec. 31, 1956, increment............. 650 110 715 Dec. 31, 1958, increment............. 3,250 120 3,900 Dec. 31, 1960, increment............. 2,600 125 3,250 ------------ ---------- Total.......................... 13,000 .......... 14,365 ------------------------------------------------------------------------ (iii) Where the taxpayer is permitted or required to combine two or more pools having the same base year, they shall be combined into one pool in the following manner: The LIFO value of the base-year inventory of each of the former pools is combined to obtain a LIFO value of the base-year inventory for the new pool. Then, any layers of increment in the various pools which occurred in the same taxable year are combined into one total layer of increment for that taxable year. However, layers of increment which occurred in different taxable years may not be combined. In combining the layers of increment a new ratio of current- year cost to base-year cost is computed for each of the combined layers of increment. The foregoing may be illustrated by the following example: Example. (a) Assume the taxpayer has two pools at December 31, 1960. Under the provisions of this section the taxpayer combines these pools into a single pool as of January 1, 1961. The LIFO inventory value of each pool at December 31, 1960, is shown as follows: ------------------------------------------------------------------------ Ratio of Dec. 31, total 1960, current- Dec. 31, inventory year cost 1960, at Jan. 1, to total inventory 1957, base- base-year at LIFO year cost cost value (percent) ------------------------------------------------------------------------ Pool No. 1 Jan. 1, 1956, base cost.............. $10,000 100 $10,000 Dec. 31, 1957, increment............. 2,000 110 2,200 Dec. 31, 1960, increment............. 1,000 120 1,200 ------------ ---------- Total.......................... 13,000 .......... 13,400 ============= Pool No. 2 Jan. 1, 1957, base cost.............. 5,000 100 5,000 Dec. 31, 1960, increment............. 3,000 140 4,200 ------------ ---------- Total.......................... 8,000 .......... 9,200 ------------------------------------------------------------------------ (b) The computation of the ratio of the total current-year cost to the total base-year cost for the base year and each yearly layer of increment in the new pool is as follows: ------------------------------------------------------------------------ Increments Base ------------------- Pool year Dec. 31, Dec. 31, 1957 1957 1960 ------------------------------------------------------------------------ No. 1: Base-year cost.......................... $10,000 $2,000 $1,000 LIFO value.............................. 10,000 2,200 1,200 No. 2: Base-year cost.......................... 5,000 ........ 3,000 LIFO value.............................. 5,000 ........ 4,200 ----------- Total, base-year cost................... 15,000 2,000 4,000 Total, LIFO value....................... 15,000 2,200 5,400 =========== Ratio of total current-year cost to total 100 110 135 base-year cost (percent)................. ------------------------------------------------------------------------ (c) On the basis of the foregoing computations, the LIFO inventory of the new pool at December 31, 1960, is restated as follows: [[Page 551]] ------------------------------------------------------------------------ Ratio of Dec. 31, total 1960, current- Dec. 31, inventory year cost 1960, at Jan. 1, to total inventory 1957, base- base-year at LIFO year cost cost value (percent) ------------------------------------------------------------------------ Jan. 1, 1957, base cost.............. $15,000 100 $15,000 Dec. 31, 1957, increment............. 2,000 110 2,200 Dec. 31, 1960, increment............. 4,000 135 5,400 ------------ ---------- Total.......................... 21,000 .......... 22,600 ------------------------------------------------------------------------ (iv) In combining pools having different base years, the principles set forth in subdivision (iii) of this subparagraph are to be applied, except that all base years subsequent to the earliest base year shall be treated as increments, and the base-year costs for all pools having a base year subsequent to the earliest base year of any pool shall be redetermined in terms of the base cost for the earliest base year. The foregoing may be illustrated by the following example: Example. (a) Assume that the taxpayer has two pools at December 31, 1960. Under the provisions of this section the taxpayer combines these pools into a single pool as of January 1, 1961. The LIFO inventory value of each pool at December 31, 1960, is shown as follows: ------------------------------------------------------------------------ Ratio of Dec. 31, total 1960, current Dec. 31, inventory rent-year 1960, at Jan. 1, cost to inventory 1956, base- total base- at LIFO year cost year cost value (percent) ------------------------------------------------------------------------ Pool No. 1 Jan. 1, 1956, base cost.............. $7,000 100 $7,000 Dec. 31, 1956, increment............. 1,000 105 1,050 Dec. 31, 1957, increment............. 500 110 550 Dec. 31, 1958, increment............. 500 110 550 Dec. 31, 1960, increment............. 1,000 120 1,200 ------------ ---------- Total.......................... 10,000 .......... 10,350 ============= Pool No. 2 Jan. 1, 1958, base cost.............. 3,500 100 3,500 Dec. 31, 1958, increment............. 1,000 110 1,100 Dec. 31, 1959, increment............. 500 115 575 Total.......................... 5,000 .......... 5,175 ------------------------------------------------------------------------ (b) The next step is to redetermine the 1958 base-year cost for Pool No. 2 in terms of 1956 base-year cost. January 1, 1956 base-year unit cost must be reconstructed or established in accordance with paragraph (e)(2) of this section for each item in Pool No. 2. Such costs are assumed to be $9.00 for item A, $20.00 for item B, and $1.80 for item C. A ratio of the 1958 total base-year cost to the 1956 total base-year cost for Pool No. 2 is computed as follows: ------------------------------------------------------------------------ Jan. 1, 1956, Jan. 1, base- 1956, Item Quantity year base- unit year cost cost ------------------------------------------------------------------------ A......................................... 250 $9.00 $2,250 B......................................... 75 20.00 1,500 C......................................... 500 1.80 900 --------- Total............................... ........ ........ 4,650 ----------- A......................................... 250 10.00 2,500 B......................................... 75 20.00 1,500 C......................................... 500 2.00 1,000 --------- Total............................... ........ ........ 5,000 ------------------------------------------------------------------------ (c) The ratio of the 1956 total base-year cost to the 1958 total base-year cost for Pool No. 2 is 4,650/5,000 or 93 percent. The January 1, 1958 base cost and each yearly layer of increment at 1958 base-year cost is multiplied by this ratio. Such computation is as follows: ------------------------------------------------------------------------ Dec. 31, Dec. 31, 1960, 1960, inventory inventory Ratio restated at Jan. 1, (percent) at Jan. 1, 1958, base- 1956, base- year cost year cost ------------------------------------------------------------------------ Jan. 1, 1958, base cost.............. $3,500 93 $3,255 Dec. 31, 1958, increment............. 1,000 93 930 Dec. 31, 1959, increment............. 500 93 465 ----------- Total.......................... .......... ......... 4,650 ------------------------------------------------------------------------ (d) The computation of the ratio of the total current-year cost to the total base-year cost for the base year (1956) and each yearly layer of increment in the new pool is as follows: [[Page 552]] ---------------------------------------------------------------------------------------------------------------- Increments Base year ------------------------------------------------------ Pool 1956 Dec. 31, Dec. 31, Dec. 31, Dec. 31, Dec. 31, 1956 1957 1958 1959 1960 ---------------------------------------------------------------------------------------------------------------- No. 1: Base-year cost............................. $7,000 $1,000 $500 $500 ......... $1,000 LIFO value................................. 7,000 1,050 550 550 ......... 1,200 No. 2: Base-year cost as restated................. .......... ......... 3,255 930 $465 ......... LIFO value................................. .......... ......... 3,500 1,100 575 ......... ------------- Total, base-year cost.................. 7,000 1,000 3,755 1,430 465 1,000 Total, LIFO value...................... 7,000 1,050 4,050 1,650 575 1,200 ============= Ratio of total current-year cost to total 100.00 105.00 107.86 115.38 133.66 120.00 base-year cost (percent).................. ---------------------------------------------------------------------------------------------------------------- (e) On the basis of the foregoing computation, the LIFO inventory of the new pool at December 31, 1960, is restated as follows: ------------------------------------------------------------------------ Ratio of Dec. 31, total 1960, current- Dec. 31, inventory year cost 1960, at Jan. 1, to total inventory 1956, base- base-year at LIFO year cost cost value (percent) ------------------------------------------------------------------------ Jan. 1, 1956, base cost.............. $7,000 100.00 $7,000 Dec. 31, 1956, increment............. 1,000 105.00 1,050 Dec. 31, 1957, increment............. 3,755 107.86 4,050 Dec. 31, 1958, increment............. 1,430 115.38 1,650 Dec. 31, 1959, increment............. 465 123.66 575 Dec. 31, 1960, increment............. 1,000 120.00 1,200 ------------ ---------- Total.......................... 14,650 .......... 15,525 ------------------------------------------------------------------------ (3) Change in methods of computation at the LIFO value of a dollar- value pool. For the first taxable year beginning after December 31, 1960, the taxpayer must use a method authorized by paragraph (e)(1) of this section in computing the base-year cost and current-year cost of a dollar-value inventory pool for the end of such year. If the taxpayer had previously used any methods other than one authorized by paragraph (e)(1) of this section, he shall not be required to recompute his LIFO inventories for taxable years beginning on or before December 31, 1960, under a method authorized by such paragraph. The base cost and layers of increment previously computed by such other method shall be retained and treated as if such base cost and layers of increment had been computed under a method authorized by paragraph (e)(1) of this section. The taxpayer shall use the year of change as the base year in applying the double-extension method or other method approved by the Commissioner, instead of the earliest year for which he adopted the LIFO method for any items in the pool. (h) LIFO inventories received in certain nonrecognition transactions--(1) In general. Except as provided in paragraph (h)(3) of this section, if inventory items accounted for under the LIFO method are received in a transaction described in paragraph (h)(2) of this section, then, for the purpose of determining future increments and liquidations, the transferee must use the year of transfer as the base year and must use its current-year cost (computed under the transferee's method of accounting) of those items as their new base-year cost. If the transferee had opening inventories in the year of transfer, then, for the purpose of determining future increments and liquidations, the transferee must use its current-year cost (computed under the transferee's method of accounting) of those inventories as their new base-year cost. For this purpose, ``opening inventory'' refers to all items owned by the transferee before the transfer for which the transferee uses, or elects to use, the LIFO method. The total new base- year cost of the transferee's inventory as of the beginning of the year of transfer is equal to the new base-year cost of the inventory received from the transferor and the new base-year cost of the transferee's opening inventory. The index (or, the cumulative index in the case of the link-chain method) for the year immediately preceding the year of transfer is 1.00. The base-year cost of any layers in the dollar-value pool, as [[Page 553]] determined after the transfer, must be recomputed accordingly. See paragraph (e)(3)(iv)(B)(1) of this section for an example of this computation. (2) Transactions to which this paragraph (h) applies. The rules in this paragraph (h) apply to a transaction in which-- (i) The transferee determines its basis in the inventories, in whole or in part, by reference to the basis of the inventories in the hands of the transferor; (ii) The transferor used the dollar-value LIFO method to account for the transferred inventories; (iii) The transferee uses the dollar-value LIFO method to account for the inventories in the year of the transfer; and (iv) The transaction is not described in section 381(a). (3) Anti-avoidance rule. The rules in this paragraph (h) do not apply to a transaction entered into with the principal purpose to avail the transferee of a method of accounting that would be unavailable to the transferor (or would be unavailable to the transferor without securing consent from the Commissioner). In determining the principal purpose of a transfer, consideration will be given to all of the facts and circumstances. However, a transfer is deemed made with the principal purpose to avail the transferee of a method of accounting that would be unavailable to the transferor without securing consent from the Commissioner if the transferor acquired inventory in a bargain purchase within the five taxable years preceding the year of the transfer and used a dollar-value LIFO method to account for that inventory that did not treat the bargain purchase inventory and physically identical inventory acquired at market prices as separate items. Inventory is deemed acquired in a bargain purchase if the actual cost of the inventory (or, if appropriate, the allocated cost of the inventory) was less than or equal to 50 percent of the replacement cost of physically identical inventory. Inventory is not considered acquired in a bargain purchase if the actual cost of the inventory (or, if appropriate, the allocated cost of the inventory) was greater than or equal to 75 percent of the replacement cost of physically identical inventory. (4) Effective date. The rules of this paragraph (h) are applicable for transfers that occur during a taxable year ending on or after December 31, 2001. [T.D. 6539, 26 FR 518, Jan. 20, 1961, as amended by T.D. 7814, 47 FR 11272, Mar. 16, 1982; T.D. 8976, 67 FR 1082, Jan. 9, 2002; 67 FR 5062, 5148, Feb. 4, 2002]