What Is the IRC 1013 Basis Rule for Inventory?
Learn how IRC Section 1013 provides a specific tax basis for inventoried property, establishing its value from the last inventory, not its original cost.
An asset’s value for tax purposes, known as its tax basis, is used for calculating the gain or loss when it is sold. While the basis of an asset is typically what it originally cost to acquire, the Internal Revenue Code (IRC) establishes different rules for specific situations. This article focuses on IRC Section 1013, which provides the basis rule for property that is, or should have been, included in a business’s inventory.
The Basis Rule for Inventoried Property
Internal Revenue Code Section 1013 states that if a property should have been included in a business’s last inventory, its basis is its last inventory value. This rule applies to property that qualifies as inventory, which are goods a company holds for the purpose of selling to customers. The “last inventory value” is the monetary amount assigned to that property at the end of the preceding taxable year.
This value is determined by the taxpayer’s chosen inventory accounting method, such as valuing inventory at cost or using the lower of cost or market (LCM) approach. The LCM method allows businesses to write down the value of inventory if its market price has fallen below the original cost.
A Practical Application of the Rule
To understand how this rule functions, consider a small retail business that sells electronics. The owner discovers a high-end speaker in the stockroom that was mistakenly overlooked and not included in the previous year-end inventory count. The speaker’s value at that time, based on the lower of cost or market, should have been recorded at $400.
The owner now sells this speaker to a customer for $700. To calculate the taxable gain, the business must use the basis from IRC 1013, which is the last inventory value of $400. The taxable gain is the $700 selling price minus the $400 basis, resulting in a $300 gain to be reported as income. This rule prevents a business from using a different basis for an item improperly omitted from its records and enforces consistency in inventory valuation.
How This Rule Differs from Cost Basis
The rule under IRC 1013 is a specific exception to the more generally known basis rule in IRC Section 1012. The standard rule, often called “cost basis,” states that an asset’s basis is the amount paid to acquire it, including purchase price, sales tax, and other acquisition-related fees. This is the default rule for most property, such as equipment, buildings, or investments, that are not held as inventory for sale.
IRC 1013 applies only to property that should have been part of a taxpayer’s inventory. By mandating the use of the last inventory value, the code ensures that the tax treatment of goods meant for sale aligns with established inventory accounting practices. This prevents businesses from applying the general cost basis rule to inventory items, which could lead to inconsistencies in how profit is reported.