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Thursday, September 30, 2010


A taxpayer in the business of selling property holds it in inventory. A taxpayer that rents property does not. In many circumstances, rental treatment is superior to inventory treatment – such property can be depreciated (and thus generate depreciation deductions), and it can be swapped in tax-free exchanges under Code Section 1031 for other like-kind property.

What if the taxpayer BOTH sells and rents property? In a recent Chief Counsel Advice, the taxpayer acquired property. Pending sale of the property, it rented it out. In selling property, it would typically swap the property for other property so as to minimize gain recognition on the swaps. The question was whether the taxpayer could depreciate the property and use Code Section 1031, or must the taxpayer hold the property as inventory instead.

There is no fixed rule in these circumstances. Instead, the taxpayer should examine its PRIMARY PURPOSE for holding the asset to determine whether it is inventoriable. In the situation that was analyzed, the IRS concluded the property belonged in inventory. Some of the factors noted by the IRS that tipped the scales towards inventory were (1) 91% of the taxpayer’s income came from sales with only 9% from rental operations, and (2) much of the new equipment was sold before it could be rented out. Of course, in this situation it was probably in the IRS’ interest to conclude the property was inventory, so as to deny the depreciation deductions and the gain deferral under Code Section 1031. Nonetheless, per the above facts it was probably a reasonable conclusion as to the taxpayer’s PRIMARY purpose.

Chief Counsel Advice 201025049

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