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adjustments were permitted to be spread over a certain number of
years to ease the burden of recognizing the entire section 481
adjustment in the year of the change. On the other hand, to
allow the taxpayer to make an S election before the extended
period expired without recognizing built-in gain would allow the
taxpayer to wipe out the unrecognized corporate income that
section 1374 was intended to capture.
Petitioners seek to distinguish this case from Argo Sales
Co. and Rondy, Inc. Petitioners’ primary argument is that the
accrual method rule in the regulations under section 1374 plus
the RRA’s required 4-year-ratable-inclusion period for the
adjustment compels a different result. We disagree.
Distinction Between “Items” and “Adjustments” Under the
Regulation
Petitioners argue the section 481 adjustment is not built-in
gain because, under the accrual method rule, petitioners as
accrual method taxpayers could not have included the section 481
adjustment in income before electing S corporation status. See
sec. 1.1374-4(b), Income Tax Regs. The accrual method rule
provides that built-in gain includes income properly taken into
account during the recognition period if an accrual method
taxpayer would have included the income before the recognition
period began (i.e. before electing S corporation status).
Petitioners argue that, because the 4-year-ratable-inclusion
period for section 481 adjustments began with the enactment of
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