Rev. Rul. 88-60

1988-2 C.B. 30, 1988-29 I.R.B. 4.

                       Internal Revenue Service

                                 Revenue Ruling

     FARMERS; SALE OF LIVESTOCK; CASH RECEIPTS AND DISBURSEMENTS METHOD OF

                         ACCOUNTING; USE OF INVENTORIES

                            Published: July 18, 1988

26 CFR 1.61-4: Gross income of farmers

(Also Sections 263A, 471; 1.263A-1T, 1.471-6.)

  Farmers; sale of livestock; cash receipts and disbursements method of accounting; use of inventories. A taxpayer using the cash method of accounting for its purchases and sales of livestock may not determine the cost of livestock sold for purposes of section 1.61-4(a) of the regulations as if it used an inventory method.

  A corporation is engaged in the business of acquiring livestock for resale. The corporation purchases calves and yearlings that it feeds for 9 to 18 months and then sells them for a profit as beef cattle. For Federal income tax purposes, the corporation has consistently computed its farming income in accordance with the cash method of accounting. The uniform capitalization rules of section 263A do not apply to the corporation's raising of livestock. The corporation computes its profit from beef livestock sales by determining the cost of the livestock sold as if the latest cattle acquired were the first sold. Its cost basis of the remaining unsold cattle at year-end reflects the cost of the earliest cattle acquired by the corporation. This system of determining cost is equivalent to the last-in, first-out (LIFO) inventory method.

  ISSUE. At issue is whether, for purposes of regulation section 1.61-4(a), the farming corporation may determine the cost of livestock as if it used an inventory method, while it uses the cash accounting method for its purchases and sales of livestock.

  HOLDING. The Service has held that the farming corporation, if it uses the cash method of accounting for its purchases and sales of livestock, may not, for purposes of regulation section 1.61-4(a), determine the cost of livestock as if it used an inventory method.

  ANALYSIS. A farmer, the Service noted, is permitted under regulation section 1.471-6(a) to elect either an inventory method or the cash method in computing its Federal income tax. Furthermore, the Service said, the section 61 regulations provide that a farmer using the cash method must include in its gross income for the tax year the profits from the sale of any livestock or other items purchased; an accrual method farmer generally must use inventories to determine its gross income.

  Examining rules under both section 61 and section 471, the Service concluded that regardless of a farmer's option under regulation section 1.471-6(a), 'once a farmer adopts the cash method it must utilize such method in the manner prescribed by section 1.61- 4(a).' That rule, the Service said, 'specifically provides that profit from the sale of livestock or other items that were purchased is ascertained by deducting the cost from the sales price in the year in which the sale occurs.' This 'cost,' the Service said, is the actual cost of livestock and not the 'cost' determined by an inventory method taxpayer. Consequently, the Service said, the corporation's purchase price of the livestock must be included in the livestock's basis.

  The Service noted that this ruling does not apply to the costs of raising livestock if, and to the extent that, the uniform capitalization rules of section 263A apply to such activities.

                                     ISSUE

  If a farming corporation uses the cash receipts and disbursements method of accounting (cash method) for its purchases and sales of livestock, then, for purposes of section 1.61-4(a) of the Income Tax Regulations, may it determine the cost of livestock as if it used an inventory method?

                                     FACTS

  The taxpayer is a corporation engaged in the business of acquiring livestock for resale purposes. None of the livestock is held for draft, breeding, or dairy purposes. The taxpayer purchases calves and yearlings that it feeds for 9 to 18 months and then sells for a profit as beef cattle. For federal income tax purposes, it has consistently computed the income from its farming activities in accordance with the cash method, and no provision of the Internal Revenue Code (for example, sections 447 or 448) or the regulations precludes the taxpayer's use of that method. Moreover, the uniform capitalization rules of section 263A do not apply to the taxpayer's raising of livestock.

  The taxpayer computes the profit from the sale of its livestock by determining the cost of the livestock sold as if the latest cattle acquired were the first sold. The cost basis of the remaining unsold cattle at year-end reflects the cost of the earliest cattle acquired by the taxpayer. This system of determining cost is equivalent to the last-in, first-out (LIFO) inventory method.

                                LAW AND ANALYSIS

  Section 1.471-6(a) of the regulations permits a farmer to make its return upon an inventory method instead of the cash method. It is optional with the taxpayer which of these methods of accounting is used but, having elected one method, the option so exercised is binding upon the taxpayer for the year for which the option is exercised and for subsequent years unless another method is authorized by the Commissioner as provided by section 1.446-1(e).

  Section 1.61-4(a) of the regulations provides that a farmer using the cash method shall include in its gross income for the tax year the profits from the sale of any livestock or other items that were purchased. With an exception not here relevant, the profit from the sale of livestock purchased is to be ascertained by deducting the cost from the sales price in the year in which the sale occurs. Section 1.61-4(b) generally provides that a farmer using an accrual method must use inventories to determine its gross income.

  Section 1012 of the Code provides that the basis of property shall be the cost of such property, except as otherwise provided.

  Notwithstanding a farmer's option under section 1.471-6(a) of the regulations to adopt either the cash method or an inventory method, once a farmer adopts the cash method it must utilize such method in the manner prescribed by section 1.61-4(a). Section 1.61- 4(a) specifically provides that profit from the sale of livestock or other items that were purchased is ascertained by deducting the cost from the sales price in the year in which the sale occurs. The term 'cost' as used in section 1.61-4(a) means the actual cost of livestock. It does not include meanings of 'cost' that apply to taxpayers that have adopted an inventory method. Inventories are to be used by farmers using an accrual method. See section 1.61-4(b). Therefore, the taxpayer's purchase price of the livestock must be included in the livestock's basis, as defined in section 1012 of the Code. (However, see Notice 88-24, 1988-14 I.R.B. 6, which allows taxpayers subject to the uniform capitalization rules of section 263A to use certain inventory methods to account for the costs of raising livestock under section 263A, regardless of whether the taxpayer is using the cash or accrual method of accounting.)

  In the present situation, the taxpayer elected the cash method in accordance with the option permitted under section 1.471-6(a) of the regulations. However, the taxpayer's method of determining the cost of its livestock sold is incorrect because the method does not reflect the actual cost of the livestock sold. Instead, it represents the cost of the latest purchases of calves and yearlings. Such a method, while permitted under section 1.61- 4(b), is not permitted by section 1.61-4(a). Accordingly, the taxpayer's use of an inventory method for costing purposes is incorrect.

                                    HOLDING

  If a farming corporation uses the cash method of accounting for its purchases and sales of livestock, then, for purposes of section 1.61-4(a) of the regulations it may not determine the cost of livestock as if it used an inventory method.

  Any change from the taxpayer's present method of accounting for the cost of its livestock to the method described herein is a change in method of accounting to which sections 446 and 481 of the Code and the regulations thereunder apply.

  This revenue ruling does not apply to the costs of raising livestock if, and to the extent that, the uniform capitalization rules of section 263A of the Code apply to such activities. See Notice 88-24.

  This ruling is identified as a designated ruling pursuant to section 5.12 2 of Rev. Proc. 84-74, 1984-2 C.B. 736.

                              DRAFTING INFORMATION

  The principal author of this revenue ruling is Floyd Hase of the Corporation Tax Division. For further information regarding this revenue ruling contact Mr. Hase on (202) 566-4941 (not a toll-free call).

Rev. Rul. 88-60, 1988-2 C.B. 30, 1988-29 I.R.B. 4.