W. C. & A. N. Miller Development Co. v. Commissioner, 86 T. C. 1346 (1986)

Real estate developers cannot use the LIFO method to inventory costs of homes they construct and sell.

Summary

W. C. & A. N. Miller Development Co. , a homebuilder, sought to apply the LIFO inventory method to account for the costs of constructing homes on developed lots. The Tax Court ruled that real estate, including homes built on lots, is not considered “merchandise” under section 471 of the Internal Revenue Code, thus prohibiting the use of LIFO. The court emphasized that real property costs must be capitalized rather than inventoried, aligning with established tax principles and the Commissioner’s discretion in determining accounting methods that clearly reflect income.

Facts

W. C. & A. N. Miller Development Co. was a Delaware corporation engaged in constructing and selling single-family detached homes in the Washington, D. C. area. Prior to 1974, the company used a job cost method to account for construction costs, which it argued was an inventory method. In 1974, the company applied to use the LIFO inventory method for its home construction costs, excluding land costs. The IRS disallowed this method, asserting that real estate development costs cannot be inventoried under sections 446, 471, and 472 of the Internal Revenue Code.

Procedural History

The IRS determined deficiencies in the company’s corporate income tax for the fiscal years ending September 30, 1974, 1975, and 1976, and denied the company’s use of the LIFO method. The company petitioned the Tax Court for a redetermination of these deficiencies. The Tax Court upheld the IRS’s determination, ruling that the company was not entitled to use the LIFO method for its home construction costs.

Issue(s)

1. Whether W. C. & A. N. Miller Development Co. was entitled to use the LIFO inventory method to account for the costs of homes it constructed and sold.

Holding

1. No, because real estate, including homes constructed on lots, is not considered “merchandise” under section 471, and thus cannot be inventoried using the LIFO method. The company’s prior method was deemed to be capitalization, not an inventory method, and the IRS did not abuse its discretion in denying the change to LIFO.

Court’s Reasoning

The court relied on the broad discretion granted to the Commissioner under sections 446 and 471 of the Internal Revenue Code to determine accounting methods that clearly reflect income. It cited the Atlantic Coast Realty Co. case, which established that real estate cannot be inventoried. The court reasoned that homes built on lots are improvements to real property, not merchandise, and thus cannot be inventoried under section 471. The court also noted that the company’s prior job cost method was a form of capitalization, not an inventory method. The Commissioner’s long-standing position that real property cannot be inventoried was upheld, and the court found no abuse of discretion in denying the company’s use of LIFO. The court rejected the company’s argument that its prior method was an inventory method, emphasizing that capitalization and inventory methods serve different purposes under tax law.

Practical Implications

This decision clarifies that real estate developers cannot use the LIFO inventory method for home construction costs, requiring them to capitalize these costs instead. This ruling impacts how similar cases should be analyzed, reinforcing that real property, including improvements like homes, falls outside the scope of inventory under section 471. Legal practitioners must advise clients in the real estate development industry to adhere to capitalization rules for tax purposes. The decision also upholds the broad discretion of the IRS in determining acceptable accounting methods, which may influence future cases involving changes in accounting methods. Subsequent cases, such as those involving other types of real estate developments, will need to consider this ruling when addressing inventory versus capitalization issues.