IRS Revenue Procedure
2002-17

Code Secs. 446, 471, 472, 481



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


REV. PROC. 2002-17

SECTION 1. PURPOSE

This revenue procedure provides automobile dealers (as defined in
section 3 of this revenue procedure) with a safe harbor method of
accounting for their vehicle parts inventory. This safe harbor method
permits automobile dealers to approximate the cost of their vehicle parts
inventory using the replacement cost of the vehicle parts pursuant to the
replacement cost method described in section 4 of this revenue procedure.
This revenue procedure also provides procedures for automobile 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.

.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.

.05 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 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.

.06 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
section 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 section 1.263A-3(c)(1).

.07 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 section 1.472-8(e)(2)(ii)(a). The court further concluded that even
if the taxpayer had elected to use another proper method under section
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 section 472(b).

.08 Subsequent to the Mountain State Ford decision, the Service has
given 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 recordkeeping systems to determine the cost of such
inventory using actual cost.

(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.


Consideration of these factors has 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, a safe harbor method is provided in section 4 of this revenue
procedure and is available to automobile dealers that satisfy the
requirements of this revenue procedure. The Service also is willing to
consider requests of other industries for similar safe harbors if the
facts of those industries are similar to those described above.


SECTION 3. SCOPE

This revenue procedure applies to any taxpayer that is engaged in the
trade or business of selling vehicle parts at retail and that is
authorized under an agreement with one or more vehicle manufacturers or
distributors to sell new automobiles or new light, medium, or heavy-duty
trucks ("automobile dealer").


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 vehicle parts inventory. Under the replacement cost
method, a taxpayer must determine the cost of the vehicle parts in its
inventory by reference to the replacement cost of the vehicle 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
section 263A must include in inventory costs the additional amounts that
are required by sections 1.263A-1 and 1.263A-3 (e.g., freight costs).

.02 REPLACEMENT COST. Replacement cost means the amount provided in a
standard price list at which a vehicle part may be purchased by the
taxpayer on the date of the inventory. If, on the date of the inventory,
the vehicle 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 automobile
dealer industry and that is used by the taxpayer in the ordinary course of
its business to purchase the vehicle parts for which it is determining the
cost.

.04 BOOK CONFORMITY. A taxpayer satisfies the book conformity
requirement if it determines the cost of vehicle parts in its inventory
using the replacement cost of the vehicle 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.


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
March 12, 2002, may continue to use this safe harbor method for taxable
years ending on or after March 12, 2002, without filing a Form 3115,
Application for Change in Accounting Method. Such taxpayer's method of
using replacement cost to determine cost for its vehicle parts inventory
will not be raised as an issue in a taxable year that ends before December
31, 2001. Moreover, if such taxpayer's method of using replacement cost to
determine cost for its vehicle parts inventory is already an issue under
consideration in a taxable year that ends before December 31, 2001, the
issue will not be further pursued.


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 section 446 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 March 12, 2002, but wants to use this safe harbor method for
a taxable year ending on or after December 31, 2001, 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 (2002-3 I.R.B. 327) 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 December 31, 2001;

(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 section 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 December 31, 2001,
that before April 11, 2002, 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 December 31, 2001. This amended return must be filed no later
than September 9, 2002. 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) When filing the Form 3115, taxpayers must complete all applicable
parts of the form and, in lieu of the label required by section 6.02(4) of
Rev. Proc. 2002-9, are instructed to write "Filed under Rev. Proc.
2002-17" at the top of the form.


.03 AUDIT PROTECTION. If a taxpayer complies with the requirements of
this revenue procedure and changes its method of determining cost for its
vehicle 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 vehicle parts inventory
under section 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 December 31, 2001, and the
taxpayer's method of determining cost (other than by use of replacement
cost) for its vehicle parts inventory under section 471 or 472 is an issue
under consideration as of March 12, 2002, in a taxable year that ends
before December 31, 2001, 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 section 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 section 6001 and the
regulations thereunder, a taxpayer that uses the replacement cost method
should maintain records supporting all aspects of its inventory valuation
including, but not limited to, the price list described in section 4 of
this revenue procedure.


SECTION 8. EFFECT ON OTHER DOCUMENTS

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


SECTION 9. EFFECTIVE DATE

This revenue procedure generally is effective for taxable years ending
on or after December 31, 2001.


DRAFTING INFORMATION

The principal author of this revenue procedure is Scott Rabinowitz of
the Office of Associate Chief Counsel (Income Tax & Accounting). For
further information regarding this revenue procedure, contact Mr.
Rabinowitz at (202) 622-4970 (not a toll-free number).

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