Tax Court Capitalizes Model Home Display Costs

By David O’Driscoll, J.D., LL.M.

The issue is whether the costs of placing model manufactured homes on retail sales lots to assist local independent salespersons may be currently deducted or should be included in inventory under Sec. 263A.


A and its related corporations buy and sell manufactured homes, constructed at a factory location and transported directly to the homesites of retail purchasers. Under agreements with independent salespersons, A purchases model manufactured homes and places them on retail sales lots that it leases to display the homes to the public and potential retail customers. Approximately 10% of A’s sales consist of homes purchased by retail customers right off the sales lots, after negotiating with the salespersons.

A sells the manufactured homes to the salespersons for the same wholesale price A pays the manufacturers. The salespersons set the price markup for sales to retail customers. While they are located on leased sales lots, the homes are owned by and titled to A. The salespersons are responsible for local media advertising costs, wages (if any) paid to sales assistants, sales commissions, sales taxes and utility fees and insurance premiums on the sales lots.

A deducted the sales lot lease payments, costs to ship model manufactured homes from closed sales lots to other sales lots, and expenses for repairs and maintenance on the model manufactured homes. However, the IRS determined the costs were not currently deductible as ordinary and necessary business expenses and had to be included in A’s inventory costs under Sec. 263A.


Generally, under Sec. 263A(a) and (b), indirect costs allocable to inventory acquired for resale should be included in inventory. Regulations expressly include transportation, rent, taxes and repair and maintenance costs for property held for resale as examples of indirect costs to be included in inventory; see Regs. Sec. 1.263A-1(e)(3)(ii)(G), (K), (L) and (O).

On-Site Storage Exception

Storage costs associated with property held for resale generally must be included in inventory under Regs. Sec. 1.263A-1(e)(3)(ii)(H). However, under Regs. Sec. 1.263A-1(e)(3)(iii)(I), storage costs at an “on-site storage facility” are excepted from inclusion in inventory. This is a storage facility that is physically attached to and an integral part of a retail sales facility. A “retail sales facility” is the location at which merchandise is sold “exclusively to retail customers in on-site sales” (Regs. Sec. 1.263A-3(c)(5)(ii)(B)(1)). A retail customer is the final purchaser of merchandise and does not include a person who resells the merchandise to others (Regs. Sec. 1.263A-3(c)(5)(ii)(E)(1)).

Here, A participates in the sale of the manufactured homes to the retail customers, but does not sell the manufactured homes exclusively to them. Although ownership of the homes by the independent salespersons appears to be brief and rather transitory, they clearly have a significant role in the sales of the manufactured homes to retail customers. At some point, and for a period not established in the record, they actually take title to the homes. Accordingly, the costs in question do not qualify for the Regs. Sec. 1.263A-1(e)(3)(iii)(I) exception from inventory for on-site storage costs.

Marketing/Distribution Costs

Another exception to the inventory requirement, under Regs. Sec. 1.263A-1(e)(3)(iii)(A), is “marketing, selling, advertising, and distribution costs” relating to property held for resale.

The lot lease payments, transportation costs, state taxes, repair and maintenance expenses are all specifically required to be included in inventory under Regs. Sec. 1.263A-1(e)(3)(ii)(G), (K), (L) and (O). None of the expenses in question constitutes a marketing or distribution expense, and none is currently deductible as an ordinary and necessary business expense under Sec. 162.

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