rp-06-14.pdf

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Part III

Administrative, Procedural, and Miscellaneous

26 CFR 601.204: Changes in accounting periods and in methods of accounting.
(Also Part I, §§ 446, 471, 472, 481; 1.446-1, 1.471-3(d), 1.472-8, 1.481-1)

Rev. Proc. 2006-14

SECTION 1. PURPOSE

This revenue procedure provides heavy equipment dealers (as defined in
section 4.05 of this revenue procedure) with a safe harbor method of accounting
for their heavy equipment parts inventory (as defined in section 4.06 of this
revenue procedure). This safe harbor method permits heavy equipment dealers
to approximate the cost of their heavy equipment parts inventory using the
replacement cost of the heavy equipment parts pursuant to the replacement cost
method described in section 4 of this revenue procedure. This revenue
procedure also provides procedures for heavy equipment dealers to obtain the
automatic consent of the Commissioner to change to the replacement cost
method.
SECTION 2. BACKGROUND

.01 Section 471 of the Internal Revenue Code provides that inventories
must be taken on such basis as the Secretary may prescribe as conforming as
nearly as may be to the best accounting practice in the trade or business and as
most clearly reflecting income.

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.02 Section 1.471-3(d) of the Income Tax Regulations provides that in any
industry in which the usual rules for computation of cost are inapplicable, cost
may be approximated upon such basis as may be reasonable and in conformity
with established trade practice in the particular industry.
.03 Section 472(a) provides that a taxpayer may use the last-in, first-out
(LIFO) inventory method. Under the LIFO inventory method, a taxpayer treats
those goods remaining on hand at the close of the taxable year as being: First,
those included in the opening inventory of the taxable year (in the order of
acquisition) to the extent thereof, and second, those acquired in the taxable year.
The change to, and use of, the LIFO inventory method must be in accordance
with such regulations as the Secretary may prescribe as necessary in order that
the use of such method may clearly reflect income.
.04 Section 472(b)(2) provides that a taxpayer using the LIFO inventory
method must inventory its goods at cost.
.05 Section 1.472-8(a) provides that a taxpayer may elect to determine
the cost of its LIFO inventories under the dollar-value LIFO method, provided
such method is used consistently and clearly reflects the income of the taxpayer
in accordance with the rules of that section.
.06 Section 1.472-8(e)(2)(ii) provides that the total current-year cost of
items making up a dollar-value LIFO 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

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equal to the aggregate cost of all 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.
.07 Section 263A generally requires direct costs and an allocable portion
of indirect costs of certain property produced or acquired for resale by a taxpayer
to be included in inventory costs, in the case of property that is inventory, or to be
capitalized, in the case of other property. Section 1.263A-1(e)(2)(ii) provides that
resellers must capitalize the acquisition costs of property acquired for resale. In
addition, resellers must capitalize the indirect costs described in § 1.263A-
1(e)(3), which are properly allocable to property acquired for resale. These
indirect costs often include purchasing, handling, and storage costs. See
§ 1.263A-3(c)(1).
.08 In Mountain State Ford v. Commissioner, 112 T.C. 58 (1999), the Tax
Court held that a taxpayer that sold heavy truck parts and used the dollar-value
LIFO method to account for its parts inventory was not entitled to determine the
current-year cost of the parts in its ending inventory by reference to their
replacement cost. In so doing, the court found that the taxpayer's replacement
cost method was not in accordance with the method elected on its Form 970,
Application to Use LIFO Inventory Method. The taxpayer's Form 970 indicated
that it would determine the current-year cost of the items in its ending inventory
by reference to the actual cost of the goods most recently purchased or produced
in accordance with § 1.472-8(e)(2)(ii)(a). The court further concluded that even if

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the taxpayer had elected to use another proper method under § 1.472-
8(e)(2)(ii)(d), it could not use the replacement cost of the parts to determine
current-year cost because replacement cost does not determine current-year
cost on the basis of, or by reference to, actual cost (or in some instances a
reasonable approximation of actual cost) in accordance with § 472(b).
.09 Subsequent to the Mountain State Ford decision, the Internal
Revenue Service gave careful consideration to the following unique
circumstances surrounding the use of replacement cost by automobile dealers:
(1) Industry practice. It has been the long-standing and widespread
practice of automobile dealers to use replacement cost to determine the cost of
their vehicle parts inventory both for financial accounting and federal income tax
purposes.
(2) Use of replacement cost required by third party. Automobile dealers
are commonly required by their franchisors (i.e., the vehicle's manufacturer) to
value their vehicle parts inventory using replacement cost, rather than actual
cost.
(3) Substantial burden associated with switching to actual cost. The
automobile dealer industry has represented that automobile dealers that are
presently using replacement cost to value their vehicle parts inventory likely
would incur substantial expense if they were required to modify their existing
record keeping systems to determine the cost of such inventory using actual
cost.

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(4) Replacement cost approximates actual cost in this industry. The
automobile dealer industry has provided data to demonstrate that, on average, in
their industry, due to relatively low inflation and high inventory turnover, the
replacement cost of vehicle parts approximates the actual cost of such parts.
.10 Consideration of these factors led the Service to conclude that, for
reasons of administrative convenience, burden reduction, and avoidance of
further controversy in this area, a safe harbor method of accounting to determine
the cost of vehicle parts inventory using replacement cost to approximate actual
cost should be provided to automobile dealers. Accordingly, automobile dealers
were provided a safe harbor method of accounting in Rev. Proc. 2002-17, 2002-1
C.B. 676. The Service stated in Rev. Proc. 2002-17 that it was willing to consider
requests of other industries for similar safe harbors if the facts of those industries
are similar to those described above.
.11 Subsequent to the publication of Rev. Proc. 2002-17, the heavy
equipment dealer industry asked the Service to provide a similar safe harbor that
would allow heavy equipment dealers to value their heavy equipment parts
inventories at replacement cost. The information submitted on behalf of the
heavy equipment dealers has led the Service to conclude that the circumstances
in the heavy equipment dealer industry are similar to those described in section
2.09 of this revenue procedure. Accordingly, the Service has concluded, for
reasons of administrative convenience and burden reduction, that a safe harbor
method of accounting to determine the cost of heavy equipment parts inventory,
using replacement cost to approximate actual cost, should be provided to heavy

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equipment dealers. The safe harbor method is provided in section 4 of this
revenue procedure and is available to heavy equipment dealers described in
section 4.05 of this revenue procedure.
SECTION 3. SCOPE

This revenue procedure applies to any heavy equipment dealer that is
engaged in the trade or business of selling heavy equipment parts at retail and
that is authorized under an agreement with one or more heavy equipment
manufacturers or distributors to sell new heavy equipment.
SECTION 4. REPLACEMENT COST METHOD

.01 In General. A taxpayer that is within the scope of this revenue
procedure is permitted to use the replacement cost method to approximate the
actual cost of its heavy equipment parts inventory. Under the replacement cost
method, a taxpayer must determine the cost of the heavy equipment parts in its
inventory by reference to the replacement cost of the heavy equipment parts as
defined in section 4.02 of this revenue procedure, determine the replacement
cost using a standard price list as defined in section 4.03 of this revenue
procedure, and satisfy the book conformity requirement as described in section
4.04 of this revenue procedure. Taxpayers within the scope of this revenue
procedure may use the replacement cost method in conjunction with either the
first-in, first-out inventory method or the LIFO inventory method. Taxpayers that
use the replacement cost method provided by this section 4 and that are subject
to the provisions of § 263A must include in inventory costs the additional
amounts that are required by §§ 1.263A-1 and 1.263A-3 (e.g., freight costs).

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.02 Replacement Cost. Replacement cost means the amount provided in
a standard price list at which a heavy equipment part may be purchased by the
taxpayer on the date of the inventory. If, on the date of the inventory, the heavy
equipment part is not provided in a standard price list, the replacement cost for
the part is equal to the last amount provided in a standard price list (i.e., the price
at which the part was last offered for purchase in a standard price list).
.03 Use of Standard Price List. A "standard price list" is a price list that is
widely recognized and used for business purposes in the heavy equipment
dealer industry and that is used by the taxpayer in the ordinary course of its
business to purchase the heavy equipment parts for which it is determining the
cost.
.04 Book Conformity. A taxpayer satisfies the book conformity
requirement if it determines the cost of heavy equipment parts in its inventory
using the replacement cost of the heavy equipment parts as defined in section
4.02 when it ascertains the income, profit, or loss of its trade or business for
purposes of its books, records, and reports (including financial statements) to its
shareholders, partners, other proprietors, beneficiaries, and creditors.
.05 Heavy Equipment Dealer Defined. For purposes of this revenue
procedure, a taxpayer is a “heavy equipment dealer” only if it sells new heavy
equipment under an agreement with one or more heavy equipment
manufacturers or distributors and earns a majority of its revenue from the sale, or
sale and lease, of new heavy equipment. Heavy equipment is defined as those

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items that fall within the Bureau of Labor Statistics Producer Price Indices
WPU111 and WPU112.
.06 Heavy Equipment Parts Inventory. For purposes of this revenue
procedure, “heavy equipment parts inventory” means goods held as inventory
that are, or could be, used to replace original parts on heavy equipment, are
necessary for the proper operation of that heavy equipment, and are not
accessories.
.07 Future Reconsideration of the Use of Replacement Cost. If the
Service later determines that circumstances have changed so that the
replacement cost of heavy equipment parts no longer approximates the actual
cost of heavy equipment parts, the Service may reconsider the safe harbor
replacement cost method provided in this section 4 of this revenue procedure
and may modify or revoke the method for future taxable years.
SECTION 5. AUDIT PROTECTION FOR TAXPAYERS CURRENTLY USING
THE REPLACEMENT COST METHOD

A taxpayer within the scope of this revenue procedure that is using the
replacement cost method provided in section 4 of this revenue procedure on
January 4, 2006, may continue to use this safe harbor method for taxable years
ending on or after April 30, 2005, without filing a Form 3115, Application for
Change in Accounting Method. Such taxpayer's method of using replacement
cost to determine cost for its heavy equipment parts inventory will not be raised
as an issue by the Service in a taxable year that ends before April 30, 2005.
Moreover, if such taxpayer's method of using replacement cost to determine cost
for its heavy equipment parts inventory is already an issue under consideration in

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a taxable year that ends before April 30, 2005, the issue will not be further
pursued by the Service.
SECTION 6. CHANGE IN METHOD OF ACCOUNTING
.01 In General. A change to the replacement cost method provided by this
revenue procedure is a change in method of accounting to which the provisions
of §§ 446 and 481 and the regulations thereunder apply. Therefore, a taxpayer
within the scope of this revenue procedure that does not use the replacement
cost method provided in section 4 of this revenue procedure on January 4, 2006,
but wants to use this safe harbor method may do so for a taxable year ending on
or after April 30, 2005, and must file a Form 3115.
.02 Automatic change to the replacement cost method. A taxpayer within
the scope of this revenue procedure that wants to change its method of
determining cost to the replacement cost method provided by this revenue
procedure must follow the automatic change in accounting method provisions of
Rev. Proc. 2002-9, 2002-1 C.B. 327, as modified and clarified by Announcement
2002-17, 2002-1 C.B. 561, modified and amplified by Rev. Proc. 2002-19, 2002-1
C.B. 696, and amplified, clarified, and modified by Rev. Proc. 2002-54, 2002-2
C.B. 432, with the following modifications:
(1) The scope limitations in section 4.02 of Rev. Proc. 2002-9 do not
apply to a taxpayer that wants to make the change for its first or second taxable
year ending on or after April 30, 2005;

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(2) A change to the replacement cost method under the provisions of
Rev. Proc. 2002-9 must be effected on a cut-off method. Thus, the change in
method of accounting is made without a § 481(a) adjustment;
(3) A taxpayer making a change under this section 6.02 of this revenue
procedure for its first taxable year ending on or after April 30, 2005, that before
February 3, 2006, filed its original federal income tax return for such year is not
required to comply with the filing requirement in section 6.02(3)(a) of Rev. Proc.
2002-9, provided the taxpayer complies with the following filing requirement. The
taxpayer must complete and file a Form 3115 in duplicate. The original must be
attached to an amended federal income tax return for the taxpayer's first taxable
year ending on or after April 30, 2005. This amended return must be filed no
later than July 3, 2006. A copy of the Form 3115 must be filed with the national
office (see section 6.02(6) of Rev. Proc. 2002-9) no later than when the
taxpayer's amended return is filed; and
(4) For purposes of Line 1a of Form 3115, the designated number for the
automatic accounting method change authorized by this revenue procedure is
“96.” A taxpayer making the automatic change in method of accounting
authorized by this revenue procedure and another automatic change in method
of accounting under § 263A for the same taxable year may file one Form 3115 to
make both changes, but must comply with the ordering rules of § 1.263A-7(b)(2),
and must enter the automatic accounting method change numbers for both
changes on Line 1a of Form 3115.

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.03 Audit Protection. If a taxpayer complies with the requirements of this
revenue procedure and changes its method of determining cost for its heavy
equipment parts inventory to the replacement cost method provided in section 4
of this revenue procedure, the taxpayer will receive audit protection for any
taxable year before the year of change with respect to the taxpayer's method of
determining cost for its heavy equipment parts inventory under § 471 or 472.
See section 7 of Rev. Proc. 2002-9. However, if this change in method of
accounting is made for the taxpayer's first or second taxable year ending on or
after April 30, 2005, and the taxpayer's method of determining cost (other than by
use of replacement cost) for its heavy equipment parts inventory under § 471 or
472 is an issue under consideration as of January 4, 2006, in a taxable year that
ends before April 30, 2005, the taxpayer will not receive audit protection.
SECTION 7. RECORD KEEPING

Section 6001 provides that every person liable for any tax imposed by the
Code, or for the collection thereof, must keep such records, render such
statements, make such returns, and comply with such rules and regulations as
the Secretary may from time to time prescribe. The books or records required by
§ 6001 must be kept at all times available for inspection by authorized internal
revenue officers or employees, and must be retained so long as the contents
thereof may become material in the administration of any internal revenue law.
Section 1.6001-1(e). In order to satisfy the record keeping requirements of
§ 6001 and the regulations thereunder, a taxpayer that uses the replacement
cost method should maintain records supporting all aspects of its inventory

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valuation including, but not limited to, the price list described in section 4 of this
revenue procedure.
SECTION 8. MODIFICATION OF REV. PROC. 2002-17
Rev. Proc. 2002-17 is amended by adding the following new section 4.05:
Future Reconsideration of the Use of Replacement Cost. If the Service later
determines that circumstances have changed so that the replacement cost of
vehicle parts no longer approximates the actual cost of vehicle parts, the Service
may reconsider the safe harbor replacement cost method provided in this section
4 of this revenue procedure and may modify or revoke the method for future
taxable years.
SECTION 9. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 2002-9 is modified and amplified to include this automatic
change in section 10.02 of the APPENDIX.
Rev. Proc. 2002-17 is modified.
SECTION 10. EFFECTIVE DATE

This revenue procedure generally is effective for taxable years ending on
or after April 30, 2005.
DRAFTING INFORMATION

The principal author of this revenue procedure is Richard Shevak of the
Office of Associate Chief Counsel (Income Tax & Accounting). For further
information regarding this revenue procedure, contact Mr. Shevak at (202) 622-
4930 (not a toll-free number).