T.C. Memo. 2007-51
UNITED STATES TAX COURT
LOAD, Inc., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
COAD, Inc., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 7287-02, 7294-02. Filed March 6, 2007.
John F. Daniels III, Julio M. Zapata, and Eric J. Boyd, for
petitioners.
Charles B. Burnett, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined deficiencies in
petitioners’ Federal income taxes for their separate taxable
years ending September 30, 2000, as follows:
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Petitioner Deficiency
LOAD, Inc. $16,589
COAD, Inc. $23,954
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue.
The issue for decision is whether certain costs relating to
manufactured homes that petitioners owned and placed on retail
sales lots in order to assist local independent salespersons in
the sale of manufactured homes may be currently deducted under
section 162 as ordinary and necessary business expenses or
whether they should be included under section 263A in
petitioners’ inventory costs relating to the manufactured homes.
Petitioners and 18 other related corporations are either
subsidiaries of, or sister corporations to, Associated Dealers,
Inc. (ADI), a Nevada corporation.
ADI and 12 of ADI’s related corporations also have filed
petitions with the Court relating to the same expense versus
inventory issue that is involved herein,1 and respondent, ADI,
and the other related petitioners have agreed to be bound by the
final outcome of this issue in these two consolidated cases.
1
The related docket numbers are: 7283-02, 7284-02, 7285-
02, 7286-02, 7288-02, 7289-02, 7290-02, 7291-02, 7292-02,
7293-02, 7295-02, 7296-02, and 7297-02.
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Hereinafter, we generally use the acronym ADI
indiscriminately to refer to petitioners, to ADI, and to the ADI-
related corporations.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time the petitions were filed, both petitioners’
principal places of business were located in Reno, Nevada.
ADI and its related corporations buy and sell manufactured
homes in the same manner.
Manufactured homes are constructed at a factory location and
are then transported directly to homesites of retail purchasers.
ADI has been selling manufactured homes for more than 30
years, and ADI has become the largest seller of manufactured
homes in Arizona and one of the largest sellers of manufactured
homes in the Southwestern United States. In recent years, ADI
has expanded its sales of manufactured homes to 192 locations in
22 states.
From the 1970s through the late 1990s, ADI purchased
completed manufactured homes from unrelated manufacturers and
sold the manufactured homes directly to retail customers using
individual salespersons who worked for ADI as employees.
In the late 1990s, however, as a result of a significant
decline in business and excessive costs such as employee wages
and commissions, a number of manufacturers of manufactured homes
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closed factories, and many sellers of manufactured homes went out
of business.
To adjust to the changing market conditions and to reduce
costs, in approximately 1999 ADI adopted a revised business plan
and restructured its sales operation. Under ADI’s revised
business plan, ADI’s salespersons are given a more active role in
the sales activities and act as independent contractors vis-a-vis
ADI.2
Under the agreements ADI enters into with the independent
salespersons, ADI purchases from manufacturers a number of model
manufactured homes and places the model manufactured homes on
retail sales lots that ADI leases for the purpose of displaying
the manufactured homes to the public and to potential retail
customers.
The retail sales lots that ADI leases generally are located
in prominent, high traffic areas -- either the same sales lots
ADI had leased and used in prior years or new sales lots. These
lots are not leased by ADI as storage lots, but rather the lots
are leased by ADI as sales lots for the sale of manufactured
homes.
2
The independent salespersons who contract with ADI
generally incorporate their individual sales activities. For
purposes of our opinion, however, we refer only to the
independent salespersons, not to their corporations.
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ADI places the model manufactured homes on the sales lots to
attract public attention, to provide an opportunity for
interested retail customers to inspect the types of manufactured
homes that are available for purchase, and in order that the
independent salespersons have manufactured homes on the sales
lots to show to customers.
On any one sales lot, ADI generally places on display six to
seven model manufactured homes that ADI has purchased from
manufacturers, each with different features and floor plan.
During their inspection of ADI model manufactured homes,
retail customers generally are accompanied by one of the
independent salespersons who has contracted with ADI. The
independent salespersons discuss with customers the advantages of
manufactured homes, the various features of the model homes that
are on display and that can be custom ordered, and they seek to
convince the customers to purchase a manufactured home.
Once a retail customer decides to purchase a manufactured
home, the customer and the independent salesperson fill out a
written purchase agreement and bill of sale on which they
indicate which floor plan, appliances, and other features and
colors are to be included in the particular manufactured home
that is being purchased. On the purchase agreement and bill of
sale, the customer is shown as purchasing the manufactured home
from the independent salesperson. The independent salesperson
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then submits to ADI the customer’s purchase agreement and bill of
sale.
The retail selling prices of the manufactured homes appear
to range from approximately $30,000 to more than $115,000.
Upon receipt by ADI of a customer’s purchase agreement and
upon approval of the customer’s financing, if any, ADI forwards
its own written purchase order to the specified manufacturer for
construction of the manufactured home that has been ordered.
Upon completion of the manufactured home -- generally within
2 to 3 weeks -- the manufactured home is shipped directly by the
manufacturer to the retail customer’s homesite for installation
and occupancy.
If a customer’s homesite is not ready for delivery (e.g., if
the occupancy permit has not been issued or if the utility
hookups for the home have not been completed), the completed
manufactured home may be delivered to one of ADI’s nearby sales
lots until the customer’s homesite is ready for installation of
the manufactured home. In this latter situation, the length of
time the completed and sold manufactured home remains on ADI’s
sales lots varies from a few days to several months depending on
how long it takes for the customer’s homesite to be completed.
Under the written contracts that are entered into (between
ADI and the manufacturers, between the independent salespersons
and ADI, and between retail customers and the independent
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salespersons), upon completion the manufactured homes are sold by
the manufacturers to ADI, by ADI to the independent salespersons,
and by the independent salespersons to the retail customers.
Of manufactured homes sold by ADI, approximately 90 percent
are custom ordered by retail customers based on the decisions and
selections customers make in their discussions and negotiations
with the independent salespersons and while inspecting ADI’s
model manufactured homes on the sales lots.
Approximately 10 percent of the manufactured homes sold by
ADI consist of the model manufactured homes that are purchased by
retail customers right off of the sales lots, after negotiating
with the independent salespersons.
ADI sells the manufactured homes to the independent
salespersons for the same wholesale price which ADI pays the
manufacturers for the manufactured homes. The independent
salespersons set the price markup at which the manufactured homes
are sold to retail customers, subject of course to negotiations
with the customers.
Generally, title to manufactured homes that are custom
ordered by retail customers and that are shipped directly to the
customers’ homesites is held by ADI and by the independent
salespersons only briefly. The record is not clear as to exactly
when title passes and as to who has title to the manufactured
homes during the delivery process.
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During the time they are located on the sales lots that ADI
leases, model manufactured homes are owned by and titled to ADI.
The independent salespersons, not ADI, are responsible for
local media advertising costs, wages, if any, paid to sales
assistants, sales commissions, sales taxes, and utility fees and
insurance premiums on the sales lot.
As indicated, ADI enters into the sales lot lease agreements
with owners of the real property, and ADI, not the independent
salespersons, makes the lease payments due on these leases.
Also, ADI pays some miscellaneous costs relating to the
model manufactured homes that are placed on the sales lots.
For the majority of its income relating to the purchase and
sale of manufactured homes, ADI receives various incentive
payments from the manufacturers and from lenders (e.g., on each
manufactured home sold ADI might receive a cash incentive payment
from the manufacturer of 10 percent of the total purchase price
paid to the manufacturer). Incentive payments that ADI receives
are referred to in the record as “retail” incentives, and it
appears that these payments represent incentives typically given
by manufacturers and lenders to retail sellers of manufactured
homes.
ADI also receives from the independent salespersons a $300
processing fee for each manufactured home sold.
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The independent salespersons do not receive wages, salary,
sales commissions, or other fees or incentives from ADI or from
the manufacturers or lenders relating to manufactured homes that
are sold. Rather, for their income the independent salespersons
retain 100 percent of the retail price markup from the
manufacturer’s wholesale price.
In the written agreements ADI enters into with the
independent salespersons, the independent salespersons expressly
give up their right to receive any of the manufacturers’ retail
incentive payments and acknowledge that ADI is to receive all
incentive payments.
On petitioners’ timely filed corporate Federal income tax
returns for their tax year ending September 30, 2000, petitioners
deducted, among other things, as section 162 ordinary and
necessary business expenses $243,350 in sales lot lease payments
and $22,387 in miscellaneous expenses incurred during the year.
The $22,387 miscellaneous expenses consist of $16,184 ADI paid to
ship model manufactured homes from closed sales lots to other
sales lots, $3,423 ADI paid to avoid a sheriff’s seizure relating
to delinquent State taxes a former independent salesperson had
not paid, $2,500 ADI paid for repairs on a model manufactured
home, and $280 ADI paid for cleaning a water-damaged carpet in a
model manufactured home.
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On audit, respondent determined that the above costs were
not currently deductible by petitioners under section 162 as
ordinary and necessary business expenses but instead should be
included under section 263A in petitioners’ inventory costs of
the manufactured homes.
OPINION
Generally, under section 263A(a) and (b), indirect costs
allocable to inventory acquired for resale are not currently
deductible and are to be included in inventory.3
Regulations promulgated under section 263A expressly include
transportation, rent, taxes, and repair and maintenance costs
relating to property held for resale as examples of indirect
costs to be included in inventory. Sec. 1.263A-1(e)(3)(ii)(G),
(K), (L), (O), Income Tax Regs.
Also, costs associated with storing property held for resale
generally are to be included in inventory. Sec. 1.263A-
1(e)(3)(ii)(H), Income Tax Regs.
However, under section 1.263A-1(e)(3)(iii)(I), Income Tax
Regs., storage costs relating to inventory which are incurred by
3
Although residential homes constructed on-site for resale
generally are not treated as inventory and costs associated
therewith are to be capitalized under sec. 263A(a)(1)(B),
manufactured homes, as long as they have not become fixtures to
real property, are treated as personal property, and costs
associated therewith are subject to inventory treatment under
sec. 263A(a)(1)(A). See, e.g., Murray v. Zerbel, 764 P.2d 1158,
1161 (Ariz. Ct. App. 1988)
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a taxpayer at an “on-site storage facility” are excepted from
inclusion in inventory.
An on-site storage facility is defined in the regulations as
a storage facility that is physically attached to and that is an
integral part of a “retail sales facility”. Sec. 1.263A-
3(c)(5)(ii)(A), Income Tax Regs.
A “retail sales facility” is further defined as the location
at which merchandise is sold “exclusively to retail customers in
on-site sales”. Sec. 1.263A-3(c)(5)(ii)(B)(1), Income Tax Regs.
With an exception not here relevant, a retail customer is
defined as the final purchaser of merchandise and does not
include a person who resells the merchandise to others. Sec.
1.263A-3(c)(5)(ii)(E)(1), Income Tax Regs.
If a storage facility does not meet the above definition of
an on-site storage facility, it is considered an “off-site
storage facility,” and storage costs relating to property held
for resale are to be included in the taxpayer’s inventory. Sec.
1.263A-3(c)(5)(ii)(F), Income Tax Regs.
Under section 1.263A-1(e)(3)(iii)(A), Income Tax Regs.,
another exception is provided to the inventory requirement of
section 263A for “marketing, selling, advertising, and
distribution costs” relating to property held for resale.
ADI argues that the costs in question qualify as marketing,
selling, or distribution costs of property held for resale that
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are excepted from inventory and, alternatively, that by virtue of
its ownership and placement of model manufactured homes on the
retail sales lots ADI participates directly in the sales of the
manufactured homes to retail customers, and therefore that ADI’s
leased sales lots should be treated as “on-site” storage
facilities and the various costs in dispute should be treated as
on-site storage costs that are excepted from inventory.
Respondent argues that for ADI the costs in question do not
constitute deductible marketing, selling, or distribution costs,
and that (assuming the lot lease payments may be treated as
storage costs) the lot lease payments do not constitute “on-site”
storage costs because the manufactured homes are sold by ADI to
the independent salespersons and not “exclusively” to retail
customers.
We first address ADI’s alternative argument. As noted, the
applicable regulations relating to on-site storage costs
expressly state that to be excepted from inventory treatment on-
site storage costs must relate to property sold by a taxpayer
“exclusively” to retail customers. Sec. 1.263A-3(c)(5)(ii)(B),
Income Tax Regs.
On the record before us and although ownership of the
manufactured homes by the independent salespersons appears to be
brief and rather transitory, we are not prepared to overlook the
role of the independent salespersons who clearly have a
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significant role in the sales of the manufactured homes to retail
customers and who, at some point and for a period of time not
established in the record, actually take title to the
manufactured homes.
We conclude that although ADI participates in the sale of
the manufactured homes to the retail customers, ADI does not sell
the manufactured homes exclusively to the retail customers (i.e.,
ADI’s sale and title transfer occurs from ADI to the independent
salespersons). Accordingly, the costs in question do not qualify
for the section 1.263A-1(e)(3)(iii)(I), Income Tax Regs.
exception from inventory for on-site storage costs.
Further, we reject ADI’s attempt to recharacterize the costs
in question as deductible marketing, selling, or distribution
costs that would be excepted from inventory under section 1.263A-
1(e)(3)(iii)(A), Income Tax Regs.
The evidence establishes that the $243,350 in question
constitutes lot lease payments, the $16,684 in question
constitutes transportation costs, the $3,423 in question
constitutes State taxes, the $2,500 in question constitutes
repair expenses, and the $280 in question constitutes maintenance
costs, all specifically required to be included in inventory
under section 1.263A-1(e)(3)(ii)(G), (K), (L) and (O), Income Tax
Regs. None of the expenses in question constitutes a marketing
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or distribution expense, and none is currently deductible as an
ordinary and necessary business expense under section 162.
To reflect the foregoing,
Decisions will be entered
for respondent.