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of costs between: (1) Activities subject to that section (either
taxpayer-produced property and property held for resale or long-
term contracts); and (2) “other activities”. See secs. 1.263A-
1(e)(3)(i), 1.451-3(d)(6)(ii), Income Tax Regs. Neither section
provides a definition of “reasonable allocation.”23 See secs.
1.263A-1(e)(3)(i), 1.451-3(d)(6)(ii), Income Tax Regs. Because
the rules for the first level allocation are the same, the result
will not differ depending on which section is applied first, as
respondent contends. Instead, the rules can be applied
simultaneously to a first level allocation.
After the first level allocation is complete, costs will be
separated between long-term contracts, taxpayer-produced property
or property held for resale, and if applicable, other property
not subject to either section. For the second level allocations,
section 1.263A-1(f) and (g), Income Tax Regs., will govern all
costs previously allocated to the taxpayer-produced property or
property held for resale. Section 1.451-3(d)(8)(iv), Income Tax
Regs., will govern all costs previously allocated to the long-
term contracts.
As applicable to the instant case, in its first level
allocation, Qwest must make a “reasonable allocation” of indirect
costs between its customer contracts and its retained assets.
23 Respondent contends that the reasonableness standard
found in sec. 1.263A-1(f)(4), Income Tax Regs., should apply to
the first level of allocation. This argument is addressed infra.
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