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Sec. 461(h); secs. 1.446-1(c)(1)(ii)(A), 1.461-1(a)(2)(i), Income
Tax Regs. Petitioners contend that AIM properly included the
$17,532 in its cost of goods sold for 1994 because AIM was an
accrual method taxpayer and the requirements of section 461(h)
were satisfied in that all events establishing the fact and
amount of the liability had occurred, and economic performance,
i.e., AIM’s payment of the $17,532, occurred in 1994.
Petitioners’ contention that AIM’s inclusion of $17,532 in
cost of goods sold in 1994 satisfies section 1.461-1(a)(2)(i),
Income Tax Regs., does not take into account section 263A.
Section 1.461-1(a)(2)(i), Income Tax Regs., provides that, under
section 263A, a liability that relates to the creation of an
asset having a useful life extending substantially beyond the
close of the taxable year must be capitalized in the taxable year
incurred. Section 263A requires the capitalization of all direct
and certain indirect costs properly allocable to property
produced or acquired for resale. Sec. 263A; sec. 1.263A-1(e)(1),
Income Tax Regs. The term “produce” means “construct, build,
install, manufacture, develop, or improve.” Sec. 263A(g)(1); see
sec. 1.263A-2(a)(1)(i), Income Tax Regs. AIM produced property
for Morton. “Direct costs” include “direct material costs and
direct labor costs.” Sec. 1.263A-1(e)(2)(i), Income Tax Regs.
In 1994, AIM had direct costs of $15,795.40 for labor and
$1,739.50 for materials. Thus, AIM must capitalize as direct
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