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with other tangible personal property, lost its separate identity
to become an integral and inseparable part of the real property
in the construction activity.9 Cf. Wilkinson-Beane, Inc. v.
Commissioner, 420 F.2d 352, 355 (1st Cir. 1970) (caskets sold as
part of undertaking establishment’s funeral service retain their
separate identity); Thompson Elec., Inc. v. Commissioner, T.C.
Memo. 1995-292 (lighting fixtures, which by definition do not
lose their separate identity, used with other materials in
taxpayer’s electrical contracting business). Thus, the materials
in this case are similar to the chemotherapy drugs in Osteopathic
Med. Oncology & Hematology, P.C. v. Commissioner, supra, which,
though not ephemeral in the sense that their usefulness would
disappear if not immediately used, when injected also lost their
identity separate from that of the patient. Materials that lose
their separate identity in these circumstances are not
merchandise within the meaning of section 1.471-1, Income Tax
Regs.; rather, they are supplies consumed in the provision of
service that are properly deducted under section 162.
Second, petitioner did not contract to sell materials to its
developer clients, and the clients had no interest in purchasing
materials from petitioner. Petitioner's contract with its real
9We note that the materials suppliers sent the California
Preliminary Lien Notices to the developer; the notices provided
that if the bill for the materials was not paid in full, a
mechanic’s lien could be placed against the developer’s real
property.
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