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taxpayer pursuant to a long-term contract. Sec. 263A(c)(4).
Under section 263A, as relevant to the present case, the
direct costs and certain indirect costs allocable to real or
tangible personal property produced by the taxpayer must be
capitalized. Sec. 263A(a)(1); sec. 1.263A-1(a)(3), Income
Tax Regs.21 Direct costs that must be capitalized include
direct material and direct labor costs. Sec. 1.263A-
1(e)(2), Income Tax Regs. Indirect costs that must be
capitalized are those costs that are properly allocable to
the property produced when those costs directly benefit or
are incurred by reason of the production activities. Sec.
1.263A-1(e)(3)(i), Income Tax Regs.
Like the regulations under section 451, the regulations
under section 263A provide for two levels of allocation for
indirect costs. See sec. 1.263A-1(e)(3)(i), (f)(4), (g)(3),
21 Though not called to our attention by the parties, the
current regulations under sec. 263A apply to taxable years
beginning after Dec. 31, 1993. Sec. 1.263A-1(a)(2)(i), Income
Tax Regs. The current regulations provide that, for taxable
years beginning before Jan. 1, 1994, a position taken on a tax
return when applying sec. 263A will be considered reasonable if
consistent with the temporary regulations. Sec. 1.263A-
1(a)(2)(ii), Income Tax Regs.; see also sec. 1.263A-1T, Temporary
Income Tax Regs., 57 Fed. Reg. 12419 (Apr. 10, 1992). Therefore,
the temporary regulations are relevant to the first year in
issue, and the current regulations apply to the last 2 years in
issue. While the temporary and current regulations differ in
structure, the rules provided therein are essentially the same.
Because the difference in structure does not impact our
rationale, the temporary regulations will not be discussed
further.
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