T.C. M em o . 2 0 2 1 -5 9

UNITED STATES TAX COURT

BRC OPERATING COM PANY LLC, BLUESCAPE RESOURCE COM PANY

L LC, TAX M ATTERS PARTNER, Pet i t i o n er v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t BLUESCAPE RESOURCES COM PANY LLC, BLUESCAPE RESOURCES INVESTORS LLC, TAX M A TTERS PARTNER, Pet i t i o n er v . COM M ISSIONER

OF INTERNAL REVENUE, Res p o n d en t

Do ck etNo s . 1 2 9 2 2 -1 6 , 1 2 92 3 -1 6
. 1 Fi l edM ay 1 2 , 2 0 2 1
.
Ch arl es W . Hal l , Ro bert C. M o rri s , An drew P. Pri ce, an d Ri ch ard L. Hun n, fo r p et i t i o n ers . J effreyB. Fi en b erg , Trav i s Van ce, J u l i e M . Ho l m es Ch ap el , an dAs h l ey Vau gh an Targ ac, fo r res p o nd en t .

1 OnAp ri l 1 2 , 2 0 17 , we co n so l id at edthes e cas es fo r t ri al , b ri efi n g , an d o p i n i o n . Served 05/12/21- 2
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[* 2 ] M EM ORANDUM OPINION PUGH, Ju d g e: Th es e co n s o l i d at edcas es are b efo re t h e Co urto n
res p o n d en t’ s m o t i o n fo r p art i al s u m m ary ju d g m en t , an d p et i t io n ers ’ m o t i o nfo r p art i al s u m

m ary ju d gm en t . Intwo n o t ices o f fi n al p art n ers h i p ad m i n i s trat i v e ad ju s t m en t(FPAA) d at ed M arch 7 , 2 0 16 , res p o n d en td i s al l owedrep ort ed co s t s o f g o o d s s o l dfo r t h e t ax y ears en d i n g Decem ber 3 1 , 2 0 0 8 (t ax y ear 2 0 0 8), an d Decem b er 3 1 , 2 0 09 (t ax y ear 2 0 0 9 ). Th e cru x o f t h e d i sp u t e rem ai n i n g b et ween th e p art i es i s wh et h er t h e eco n om i c p erfo rm an ce req u i rem en ti ns ect i o n4 6 1 (h )(1 ) 2 ap p li es t o , an d p recl u d es reco g n i t i o no f, th e es t im at eddri l li n g co st s rep o rt edas
co s t s o f g o o d s s o l dfo r the t ax y ears i ni s s u e. As we ex p lai nb el o wa res o l u t i o n o f th e p art i es ’ d i s p ut e wi th res p ectt o th e rep o rt edes t i m at ed dri l l i n g co s t s tu rn s o n a
m o re b as i c qu es t i on ab o u twh ena co s to f g o o d s s o l d o ffs etm ay b e reco g n i zed fo r t ax p u rp o s es . Back gro u n d Th e fo l l o w i n g fact s are fro m th e p art i es ’ p lead i ng s an do ther m at eri al s i n th e reco rdan dare n o ti n d i s p u t e, ex cep t as n o t ed
.

2 Un l es s o th erwi s e i n d i cat ed , al l s ect i o nreferen ces are t o th e In t ern al Rev enu e Co de (Co d e) i n effect fo r t h e y ears i ni s su e, an d al l Ru l e referen ces are t o th e Tax Co u rt Ru l es o f Pract ice an dPro cedu re. Al l m on et ary am ou n t s are ro u n dedt o th e n eares td o ll ar.- 3
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[* 3 ] BRC Op erat in g Co ., LLC (BRC), an dBl u es cap e Res o u rces Co ., LLC (Bl u es cap e), were o rg an i zed as Del aware l i m i t edl i ab i l i ty co m p an i es i n2 00 8
. Du ri n g the t ax y ears i n i s s u e BRC was wh o l ly o wn edb y Bl u es cap e an dwas cl as s ifi edas a d i s reg ard eden t i ty fo r Fed eral t ax p u rp o s es . Bl ues cap e was a p art n ers hi p fo r Fed eral t ax p u rp o s es an du s edan accru al m et h o d o f acco u n t i n g . Du ri n g t ax y ears 2 0 0 8 an d2 0 0 9 Bl u es cap e p ai dap p ro x i m at el y $ 1 8 0 m i l l i o n t o acq u i re h u n dred s o f t h o u s an d s o f acres o f m i n eral s an dl eas e i n t eres t s i nW es t Vi rg i n i a, Pen n s y l van i a, Oh i o , an dKen tu cky (l eas es ). Bl u es cap e p l an n edt o
ex p lo re fo r, m i n e, an dp ro duce n atu ral g as fo r s al e. Oni t s Fo rm s 1 06 5 , U.S. Retu rn o f Part n ers h i p In co m e, Bl u es cap e rep o rt ed , as co s t s o f g o o d s s o l d , es t i m at eddri l l i n g co s t s fo r n atu ral g as ex p l orat io nan d m i n i n g. Th e am o u n t s i n i s su e cl ai m edas co s t s o f g o o d s s o l dare $ 1 0 0 m i ll i on fo r t ax y ear 2 00 8 an d$ 6 0
m i l l io n fo r t ax y ear 2 0 0 9
. 3

3 Th es e am ou n t s refl ects t i p u l at i o n s b y the p art i es i nth e s t i p ul at io n o f s et t l edi s s u es fi l edSep t em b er 1 4 , 2 0 1 8 , atd o ck etNo . 1 2 92 3 -1 6
.- 4
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[* 4 ] Bl u es cap e d i dn otdri l l , recei ve d ri l l i n g s erv ices fro m th irdp art i es , o r recei v e d ri l l in g p ro p ert y

du ri n g th e t ax y ears i ni s s u e. 4 Bl u es cap e rep o rt edn o g ro s s recei p ts o r s al es du ri n g thes e y ears at tri b u t ab l e t o th e s al e o f n atu ral g as . 5 OnM arch 7 , 2 01 6 , res p on d en ti s su edtwo FPAAs t o Bl u es cap e Res o u rces In v es t o rs , LLC, as Tax M at t ers Part n er fo r Bl ues cap e, o n e fo r each o f t ax y ears 2 0 0 8 an d2 0 0 9 . Res p o n den td i s al l o wedth e cl ai m edco s t s o f g o o d s s o l di nth ei r
en t i ret y , d et erm i n i ng th at Bl u es cap e h adn o tes t ab l i s hedth ati ts at i s fi edthe al l

ev en ts t es tan dth e eco no m i c p erfo rm an ce req u i rem en ti n s ect i on 4 6 1 (h )(1 ). 6

4 Pet i t i o n ers al l eg e Bl u es cap e d ri l l ed two t es t wel l s i n2 0 0 9; res p o nd en t d o es no tex p l i ci tl y

s t i p u lat e t h atfactb u td o es n o tch al l en g e i t ei th er, an d p et i t i o n ers s t at ed atthe h eari ng th atth e t es twel l s were n otrel ev an tt o th e m o t i o ns .

5 Bl u es cap e rep o rt edn o g ro s s recei p t s o f an y k i n dfo r 2 0 08 an drep o rt ed $ 1 3 9 ,8 7 6 o f d el ay

ren t al p aym en t s fo r 2 0 0 9
. 6 Res p o n d en tal so i ss u edan FPAA t o BRC fo r t ax y ear 2 0 08 , p ro p o si n g an i d en t i cal ad

ju s tm en tt o 2 0 0 8 co s to f g o o d s s o l d fo r es t i m at eddri l l i n g co s t s . BRC arg u es th at , as a s i n g le-m em b er d is reg ard eden t i ty , i tcan n otb e cl as s i fi edas a p art n ers hi p fo r Fed eral t ax p u rp o s es an dth erefo re t h e FPAA i s i n v al i d . BRC d i d , h o wev er, fi l e a p art n ers h i p retu rn fo r t ax y ear 2 0 0 8
. Un d er s ec. 6 2 3 3 an ds ec. 3 0 1 .6 2 3 3 -1 , Pro ced . & Adm in
. Reg s ., res p o n d en tm ay treat BRC as a p art n ers h i p fo r t h e t ax y ear fo r p u rp o ses o f s ub ch ap t er C o f ch ap ter 6 3 o f t h e Co d e. See M arcy v . Co m

m is s i o n er, T.C. M em o . 2 0 1 8 -4 2 , at* 1 0 (“ Th e fi li n g o f a p art n ers h i p retu rn , ev en wh en an en t i ty i s n o t i nfacta p art n ers h i p , tri g g ers th e ap p l i cat i o n o f th e TEFRA p ro cedu res u n l es s t h e en t i ty (o r p u rp o rt eden t it y ) i s (o r wo u l dh av e b een ) a ‘ s m al l p art n ers h i p ’
. ”); s ee al s o Bed ro s i anv . Co m m is si o n er, 1 4 3 T.C. 8 3 , 1 0 4 (2 01 4 ) (n o t in g thatu nd er TEFRA an en t i ty wi l l n o tb e co n s i d ereda s m al l p art n ers hi p i f an y p art n er duri ng th e t ax ab l e y ear i s a “ pas s -t h rup art n er”, s u ch as (co n ti n u ed ...)- 5
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[* 5 ] Di s cu s s i on Res p o n d en t ’ s m ot i o n fo r p art ial s u m m ary ju d g m en tas ks u s t o s u s t ai nh i s d et erm i n at i o n s d i sal l owi n g Bl u es cap e’ s rep o rt edco s ts o f g o o d s s o l d , ad v an ci n g two al t ern at i v e t h eo ri es . Fi rs t , res p o n d en targ u es th atth e u n d is p u t edfact s s h o w th ateco n o m i c p erfo rm an ce u n der s ect i o n4 6 1(h )(1 ) d i d n o t o ccu r wi th res p ectt o th e rep o rt ed co s ts o f g o o d s s o lddu ri n g th e y ears i n i s s u e. Inth e al t ern at iv e
res p o n d en t arg u es thatthe rep o rt edco st s o f g o o d s s o l ds h ou l db e d i s al l o wed b ecau s e th ey

were d eri v ed fro m

Bl u es cap e’ s u s e o f a m etho do f acco u n t i n g t h at fai l edt o cl earl y

refl ect i n co m e. Pet i t i o n ers o b ject
. Pet i t i o ners ’ m o t i o n fo r p art i al s u m m ary ju dg m en t as k s u s t o ru l e t hatth e
eco n om i c p erfo rm an ce req u i rem en ti ns ect io n4 61 (h )(1 ) d o es n o tap p l y t o th e
am ou n t s cl ai m edas co s ts o f g o o d s s o l d fo r th e t ax y ears i ni s s u e. Res po n d en t
o b ject s .

6 (...co n t in u ed ) p art n ers hi p ), aff’ d , 9 40 F.3 d 4 6 7 (9 th Ci r. 2 0 1 9 ). Th e i d en t i cal ad ju s t m en ti s b efo re u s i n t h e FPAA t o Bl u es cap e, an dth erefo re o u r d eci si o no nth e v al i d i ty o f th e FPAA t o BRC h as n o p ract i cal co n s equ en ces . No r was th i s a p o i n to f co n ten t i o n b et w een th e p art i es . No n et h el es s we m u s td eci d e wh et h er we h av e juri s d i ct i o n o v er t h e FPAA t o BRC at i s su e i nd o ck etNo . 1 29 2 2-1 6 . W e co n cl u d e th atwe d o ; we co n cl ud e t hatthe FPAA t o BRC i s v al i d
.- 6
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[* 6 ] I. Su m

m ary J u d g m en tSt an d ard Th e p u rp os e o f s u m

m ary ju d g m en t i s t o ex p ed it e l i t i g at i o nan d av o i dco st l y , t i m e-co n s u m i n g , an du n n eces s ary tri al s . Fl a. Peach Co rp . v . Co m m i s si on er, 9 0 T.C. 6 7 8 , 6 8 1 (1 9 8 8 ). A m o ti o n fo r p art i al s u m m ary ju d g m en t m ay

b e g ran t ed wh ere t h ere i s n o g en u i n e d i s p ut e as t o an y m at eri al factan d a d eci s i o nm ay b e
ren d eredas a m at t er o f l aw. Ru l e 1 2 1 (a) an d(b ); s ee Su n ds tran dCo rp . v . Co m m i s s i o n er, 9 8 T.C. 5 18 , 5 2 0 (1 9 9 2 ), aff’ d , 1 7 F.3 d 9 65 (7 th Ci r. 1 9 9 4 ). Part ial s u m

m ary ad ju d i cat i o n i s p ro p er wh ere s o m e b u tn o t al l o f t h e i s s u es i nth e
cas e m ay b e d is p o s edo f s u m

m ari l y . Ru l e 1 2 1 (b ). Wh ere a m o t i o n fo r s u m

m ary ju d g m en th as b een p ro p erl y m ad e an d
s up p ort ed , th e n o nm o v i n g p art y “ m ay n o tres tup on th e m ere al l eg at i on s o r d en i al s
o f s u ch p art y ’ s p l ead i n g s ” b u t m u s t“ s etfo rt h s p eci fi c fact s s h owi n g th atth ere i s a g en ui n e d i s p u t e fo r t ri al ” b y affi d av i t s o r o th erwi s e. Ru l e 1 2 1 (d ); s ee Dah l s tro m
v . Co m m i s s i o n er, 8 5 T.C. 8 1 2, 8 2 0 -8 2 1 (1 9 85 ). Th e m o v in g p arty b ears th e b u rd eno f s h o wi n g th atth ere i s n o g en ui n e d i sp u t e as t o an y m at eri al fact , an dan y fact ual i n feren ces are d rawn i n a m an n er m o s t fav o rab l e t o th e p art y o p p os i n g
s u m m ary ju d g m en t . See Dah l s tro m v . Co m m i s s i o n er, 8 5 T.C. at8 2 1
. “ If t h ere
ex i s t s an y reas o n ab l e d o ub tas t o the [m at eri al ] fact s ati s s u e, t he m ot i o nm u s tb e d en ied .” Su nd s tran d Co rp . v . Co m m i s si o n er, 9 8 T.C. at 5 2 0.- 7
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[* 7 ] II. Bl u es cap e’ s Dri l l in g Co s t s as Co s ts o f Go o d s So l d Th e d i sp u t e rai s edb y

th e m o t i o n s i s wh ether t h e eco no m i c p erfo rm an ce req u i rem en ti n s ect i o n 4 6 1 (h )(1 ) ap p l i es t o Bl u es cap e’ s es t i m at eddri l l i n g co s t s rep o rt edas co st s o f g o od s s o l d . Res p o nd en targ u es y es , ci t i n g t h e reg u l at i o n s . E.g ., s ec. 1 .6 1-3 (a), In co m e Tax Reg s . (“ [A] nam o u n t can n o t b e t ak en i n t o acco u n t i n the co m

p u t at i o n o f co s t o f g o o d s s o l d an y earl ier t h anth e t ax ab l e y ear i nwh i ch
eco n om i c p erfo rm an ce o ccu rs wi th res p ectt o th e am o u nt [.] ”). Pet i ti o n ers arg u e th atth e eco n om i c p erfo rm an ce req u i rem en td o es n o tap p l y b ecau s e t h e reg u l at i o n s

“ ex t en d i n g ” i tt o am o u n t s i ncl u d edi nco sto f g o o ds s o ldwen tt o o far. Pet i t i o n ers arg u e t h at , as an o ffs etag ai n stg ro s s recei p ts t o arri v e atg ro s s i n co m e, co s to f g o o d s s o l di s an “ i t em

o f g ro s s i n co m e” th e t i m i n g o f wh i ch i s g o v ern edb y
s ect i on 4 5 1 an d th e co rres p o nd i n g reg u lat i o n s , an dth erefo re t h e eco n o m i c p erfo rm an ce req u i rem en ti n s ect i o n4 6 1 d o es n o tap p l y . Aft er am p l e b ri efi n g o n t h i s d i s p u t e, th e Co u rts ch edu l eda h eari n g o nth e
m o ti o n s t o p o s e a b as i c ques t i on t o th e p art ies : Can Bl u es cap e reco g n i ze co s t s o f g o o d s s o l db efo re i th as an y gro s s recei p t s fro m th e s al e o f g o o d s ? Ino th er wo rd s d o we ev en reach th e qu es t i o n o f wh eth er co s ts o f g o o d s s o l dare s ub jectt o th e
eco n om i c p erfo rm an ce req u i rem en twh en th ere are n o g ro s s recei p t s t o o ffs ety et ? Atth e co n cl u s i o n o f t h e h eari n g we i n v i t edth e p art i es t o fi l e a m o t i o nfo r l eav e t o- 8
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[* 8 ] fi le s up p l em en t al m em o ran d a o nth i s i s s u e. Th e p art i es accep t edth e i n v i t at i o n , we g ran t edth ei r jo i n tm o t i o n , an deach p art y fi l ed a s upp l em en t al
m em o ran du m . Th e qu es ti o n b efo re t h e Co u rti s n o twh et her t he es ti m at eddri l l i n g co s t s can
ev er g i v e ri s e t o co st s o f g o o d s s o l db u t wh et h er t h ey can g iv e ri s e t o co s t s o f g o o d s s o l dfo r t h e y ears i n i s su e. Res p on d en targ ues th atBl u es cap e i s n o t en t i t l ed t o reco g n i ze co s t s o f g oo d s s o l dfo r t h e y ears b efo re t h e Co u rtb ecau s e i td i dn o t
s el l an y g o o d s o r h av e an y

g ro ss recei p t s rel at edt o t h e s al e o f n atu ral g as . Pet i t io n ers , fram i ng res p o n d en t ’ s p o s i t i o nas a “ cl ear refl ect i o no f i nco m e” arg u m en t , arg u e t h at“ m at ch i n g ” o f co s t o f g o o d s s o l dan d g ro s s recei pt s i s n o t req u i red . Thu s , p et i t i on ers arg u e, t h ey can reco gn i ze co s t o f g oo d s s o ld as s o o n as th ey as s u m e t h e o b li g at i o ns t o dri l l th e wel l s , g i v i n g ri s e t o a l o s s th at fl o w s th ro u g h t o th ei r p artn ers . W e s t arto u r an al y s i s o f t h i s qu es t io nwi th an o v erv i ew o f t h e co s t o f g o o d s
s o l do ffs et . Un d er t h e Si x t een th Am en d m en tt o th e Co n s t i tu t i o n , Co n g res s m ay t ax th e g ro ss i nco m e o f a p ro ducer o r res el l er, n oti t s g ro s s recei p t s . See Do y l e v . M i t ch el l Bro s . Co ., 2 4 7 U.S. 1 79 , 1 8 5 (1 9 1 8). Gro s s i nco m e i s cal cu l at edb y
s ub tract in g th e co s to f g o o d s s o l d fro m g ro s s recei p ts . Sec. 1 .6 1 -3 (a), In co m e Tax Reg s.- 9
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[* 9 ] Co s to f g o od s s o l d i n cl u d es th e “ co s t s o f acq u i ri n g i nv en t o ry , th ro ug h ei th er p u rch as e o r p ro duct i o n .” Pat i en t s M ut . As s i s t an ce Co l l ect i v e Co rp . v . Co m m i s s i o n er, 1 5 1 T.C. 1 7 6 , 2 0 5 (2 0 1 8), aff’ d, _

_ F.3 d _

_ , 2 02 1 W L 1 57 0 2 8 8 (9 th Ci r. Ap r. 2 2 , 2 0 2 1 ); s ee al s o Read i n g v . Co m m i s s io n er, 7 0 T.C. 7 3 0 , 7 3 3 (1 9 7 8), aff’ d , 6 1 4 F.2 d1 5 9 (8 th Ci r. 1 9 8 0); s ecs . 1 .6 1 -3 (a), 1
. 1 6 2 -1 (a), In co m e Tax Reg s . Th e co s t o f g o od s s o l do ffs etag ai n s tg ro s s recei p ts en s u res th atth ere i s
n o ta t ax o n th e ret u rn o f cap i t al . See Co m m is s i o n er v . W ei s m an , 1 9 7 F.2 d2 2 1 , 2 2 4 (1 stCi r. 1 9 5 2 ) (“ Th e ret u rno f cap i t al i s g u aran t eedb y th e ‘ co s t o f g oo d s ’
o ffs etag ai n s tg ro s s recei p t s an dth u s i s av o i d edth e ch arg e th ati ti s a t ax o n cap i t al an dn oto n i n co m e.”). Th u s , th e “ ‘ co s to f g o o d s s o l d ’ co ncep tem b races
ex p en d i tu res n eces s ary

t o acq u i re, co n s tru cto r ex tract a p h y s ical p ro du ct wh i ch i s t o b e s o ld ; th e s el l er can h av e n o g ai nu n t i l h e reco v ers th e eco n o m ic i nv es t m en t th ath e h as m ad e d i rect l y i n th e act u al i t em

s o l d .” Read in g v . Co m

m i s s i o n er, 7 0 T.C. at7 3 3 . Th e reg u lat i o n s refl ectth i s p ri n ci p l e. Sect i o n1 .6 1 -3 , In co m e Tax Reg s., p ro v i des i n p art :

(a) In g en eral . Ina m an u fact u ri n g , m erch an d is i ng , o r m i n i n g b u s i n es s , “ g ro s s i nco m e” m ean s th e t o t al s al es , l es s t h e co s to f g o od s s o l d , p l u s an y

i n co m e fro m

i n v es t m en ts an dfro m

i n ci d en t al o r o u t s i d e o p erat io n s o r s o u rces . * * * Th e co s to f g o o d s s o l ds h o u l db e d et erm i nedi n acco rd an ce wi th the m et h o do f acco u n t in g co n s i s t en t l y u s edb y th e t ax p ay er. * * *- 1 0 -

[* 1 0 ] Th e p art ies d o n otd i sp u te--an d therefo re we as s u m e fo r p u rp os es o f t h e
m o ti o n s b efo re u s --wh et h er th e es t i m at eddri l l i n g co s t s s h o u ldb e i n cl u dedi nco s t s
o f g o od s s ol d ; th ey

d i s pu t e o n l y

wh en . Co s to f g o od s s o l d i s cal cu l at edas th e s u m o f th e co s to f b eg i n ni n g i n v en t o ry an dp u rch as es (an do th er acq ui s i t i o n o r p ro du ct i o nco st s ) du ri n g th e t ax y ear l es s th e co s t o f en di n g i n v en t o ry . Hu ffm an v . Co m m i s s i o n er, 1 2 6 T.C. 3 2 2 , 3 2 4 (2 00 6 ), aff’ d, 5 1 8 F.3 d3 5 7 (6 th Ci r. 2 0 0 8 ); s ee al s o Al t erm an v . Co m m i s s i o n er, T.C. M em o . 2 0 1 8 -8 3 (h o l d i n g t ax p ay er’ s m et ho do f co m p u t i n g
co s to f g o o d s s o l di m

p ro p er wh en t ax pay er co ns i d ered o nl y p u rch as e an d p ro duct i o n co s t s an dn o tb eg i n n i n g an den d in g i n v en t o ry ); s ee al s o s ecs . 1 .1 62 -1 (a), 1 .4 4 6 -1 (a)(4 )(i ), 1
. 4 7 1 -1 , In co m e Tax Reg s . 7 Th e t ax p ay er m u s tret ai n
reco rd s s u ffi ci en tt o s ub s t an t i at e t h e rep o rt edco s to f g oo d s s o l d . See s ec. 6 0 0 1 ; Newm an v . Co m

m i s s i on er, T.C. M em o . 2 0 0 0 -3 45 . Fo r i ns t an ce, th e Co u rth as d i s al lo wedco s to f g o o d s s o l d wh en a t ax p ay er fai l s t o p res en tev i d en ce o f n et
s al es , o r b eg in ni n g o r en d i n g i n v en t o ry . See Pet zo ld t v . Co m m i s si o n er, 9 2 T.C. 6 6 1 , 6 9 8 (1 9 8 9) (s u s t ai n i ng d is al l o wan ce o f co s to f g o o d s s ol d o ffs etwh en

7 An du n d er cert ai n ci rcu m s t an ces n otrel ev an th ere t h e t ax p ay er m ay v al u e cl o s i ng i n v en t o ry

atth e l o wer o f co s to r m ark et . See W .C. & A.N. M i l l er Dev
. Co . v . Co m

m i s s i o n er, 8 1 T.C. 6 1 9 , 6 3 2 -6 3 3 (1 9 8 3 ); s ecs . 1
. 4 7 1 -2 (c), 1 .4 7 1-4 , In co m e Tax Reg s .- 1 1 -

[* 1 1 ] t ax p ay er d i dn o tp ro v i d e reco rd s t o d et erm i n e n ets al es o r i n v en to ry ); Ch i co
v . Co m m i s s i o n er, T.C. M em o . 2 0 1 9 -1 2 3 , at* 2 5 (s u st ai ni n g d i s al l o wan ce o f co s t
o f g o od s s ol do ffs etb ecau s e t ax p ay ers p res en t edi n v o i ces fo r m at eri al s b u tn o i n fo rm at i o n reg ard i n g b eg i n n i n g an den d i ng i n ven t o ry ). Co s to f g o od s s o l d g en eral l y i s d et erm in edu n d er s ect io n4 7 1 an dth e
acco m pan y i n g reg u l at i o n s. See s ecs . 1 .4 7 1-3 , 1 .4 7 1 -1 1 , In co m e Tax Reg s . Pro ducers m

u s ti n cl u d e i n co s t o f g o o d s s ol d b o th th e d i rect an d i n d i rectco s t s o f creat i n g t h ei r i n v en to ry . See s ecs . 1 .4 7 1 -3 (c), 1
. 4 7 1 -1 1, In co m e Tax Reg s. Sect i o n 4 7 1 an d i t s reg u l at i o n s al s o d i rect t ax p ay ers t o s ect i o n 2 6 3A fo r ad d i t i o n al
ru l es . Un d er s ect io n 2 6 3A, a t ax p ay er i s n o t al l o wedt o d edu ctcu rren t l y th e d i rect
o r i n d i rect co s t s o f p ers o n al p ro p ert y p ro du cedb y

th e t ax p ay er. See s ec. 2 6 3 A(a)(1 ), (b )(1 ). In s t ead , th es e co s t s m u s tb e cap i t al i zedo r i n cl u dedi n i n v en t o ry co s t s. See i d . s ub s ec. (a)(1 ). Gen eral ly , co s t o f g o od s s o l di s n o t al l o w ab l e u n l es s , an du n t il , th e t ax p ay er actu al l y s el l s o r d i s p o s es o f g o od s . See Pat i en t s M u t . As s i s t an ce Co l l ect i v e Co rp . v . Co m m i s s i o n er, 1 5 1 T.C. at2 0 5 (“ Bu twh en acco un t in g fo r COGS * * * [as
o p p o s edt o d edu ct i o n s , t ax p ay ers ] h av e t o cap it al i ze an i t em ’ s co s ti nth e y ear o f acq u is i t io n o r p ro du ct io n an dei th er am o rt i ze i t o r wai tu n t i l the y ear t h e i tem ’ s
s o l dt o m ak e t h e co rres p o n d i n g ad ju s t m en tt o g ro s s i n co m e.”); s ee al s o J o n es v .- 1 2 -

[* 1 2 ] Co m

m i s si o n er, 2 5 T.C. 1 1 0 0 , 1 1 0 2 -1 1 0 4 (1 9 5 6 ) (h o l d i ng th atth e t ax p ay er
co u ldn o treco v er co s to f g oo d s s o l du n ti l th e g o o ds were s ol do r o therwi s e d i s p o s ed o f), rev ’ d o n o th er g ro u n ds , 2 5 9 F.2 d3 0 0 (5 th Ci r. 1 9 5 8 ). Th i s p ri n ci p l e i s i ll u s trat edb y

Bern ardv . Co m

m i s s io n er, T.C. M em o . 1 9 9 8 -2 0 , 1 9 9 8 W L 1 7 6 2 1 , an d W eav er v . Co m

m i s si o ner, T.C. M em o . 2 00 4 -1 0 8, 2 0 0 4 W L 9 3 8 2 9 3
. In Bern ardv . Co m

m i s s i o n er, 1 9 9 8 W L 1 7 6 2 1 , th e Co urth el dth ata t ax p ay er s t art i n g a m o del trai n s t o re was n o ten t it l edt o co s t o f g o o ds s o ldrep o rt ed
o n Sch edu l e C, Pro fi t o r Lo s s Fro m Bu s i n es s , b ecau s e t h e m o d el trai ns t o re h ad
n o ty etb eg u n s el l i ng g o o ds t o cu s t o m ers du ri n g th e t ax y ear i n i s s u e. In 1 9 9 4 th e t ax p ay er q u i th i s jo b t o s t art a m o d el trai ns t o re an dacq u i red$ 56 ,2 1 8 i ni n v en t o ry wi th th e h o p e o f b eg i n ni n g s al es du ri n g th e up co m i ng h o l i d ay s eas o n . Id . at* 1
. Becau s e o f d el ay s i n acq u i ri n g ret ai l s p ace, h e d i dn oto p enth e s t o re du ri n g 1 9 9 4
an d i n st eads to redth e i n v en t o ry i nh i s h o m e, s el l i n g o n l y a few i t em s t o fam i l y
an d fri en d s u n t i l h e co u l d fi n dret ai l s pace d u ri n g th e fo l l o wi n g y ear, 1 9 9 5 . Id
. Becau s e th e t ax p ay er d i dn ots el l an y g o o ds i n1 99 4 , th e Co u rth el dth at h e co u l d
n o treco v er co s t o f g o o d s s ol dfo r 1 9 9 4 . Id
. at* 2 . Th e Co u rtal so reject edh i s al t ern at i v e arg um en tfo r reco veri n g co sto f g o o ds s o l d --t h at the i nv en to ry b ecam e
wo rt h l es s du ri n g 1 9 9 4 --b ecau s e t h e t ax p ay er d i dn o to ffer t h e i n v en to ry fo r s al e o r- 1 3 -

[* 1 3 ] o th erwi s e p ro v i d e an y ev i d en ce t h at th e m ark etp ri ce fo r t h e y earen d i n v en t o ry was l es s t h an co s t . Id
. Si m i l arl y , i n W eav er v . Co m m i s si o n er, 2 0 04 W L 9 3 8 2 9 3, the Co u rt reject ed th e n o ti o n th ata t ax p ay er co ul d cl ai m co s to f g o od s s ol di n th e ab s en ce o f g ro s s recei p t s o r s al es o f g o o d s . Th ere, a m arri edco up l e rep o rt edo n a Sch edu le C fo r
an “ au t o m o b i l e co n s tru ct i o n” b u s i n es s zero g ro ss recei p t s o r s al es , $ 37 4 ,8 8 5 o f
co s to f g o o d s s o l d , an d$ 7 3 ,2 3 5 o f ex p en s es , fo r a t o t al l o s s o f $ 4 48 ,1 2 0 . Id
. at* 2 . Becau s e t h e b us i nes s d i d n ots el l an y g o o d s i nthe rel ev an ty ear, t h e Co u rt treat ed th e t ax p ay ers ’ cl ai m o f co s t o f g o o d s s o l das a cl ai m fo r ad d i t i o n al s ect i o n 1 6 2 b u s i n es s ex pen s e d edu ct i on s , ex p l ai n i n g : [E] v en wh ere o th erwi s e ap p ro p ri at e, co sto f g o o d s s o ldg en eral l y i s n o tal lo w ab l e wi th res p ectt o g o od s thath av e n otb een s o l do r o th erwi se d i s p os edo f duri n g t h e t ax ab l e y ear. J o n es v . Co m m is s i o n er, 2 5 T.C. 1 1 0 0 , 1 1 0 3 -1 1 0 4 , 1 9 5 6 W L 8 0 5 (1 9 5 6 ), rev d
. o n o th er g ro u n d s 2 5 9 F.2 d3 0 0 (5 th Ci r. 1 95 8 ); Bern ardv . Co m m is s i o n er, T.C. M em o . 1 9 98 -2 0
. Becau s e p et i t i on ers i nan y ev en trep ort ed n o g ro s s recei p t s fo r Sh ri k e Cars an do ffered n o ev i d en ce i n d i cat i n g th atan y g o o d s were d i s p o s ed o f b y th e v en tu re, an db ecau s e th e p art i es d i dn otd i s ti ng u i s h attri al o r o nb ri ef b etween th e v ari o us co m

p o n en t s o f t h e Sh ri k e Cars l o s s, we s h al l treat the $ 3 7 4 ,8 8 5 am o un tas a cl ai m fo r ad d i t i o n al b u s i n es s ex p en s es u n d er s ec. 1 6 2 . See Keeg an v . Co m m i s s io n er, T.C. M em o . 1 9 97 -5 1 1 (co n si d eri n g rep o rt edco s to f g o o d s s o l dt o b e a cl ai m fo r s ec. 1 6 2 ex p en s es ). Id . n . 2
.- 1 4 -

[* 1 4 ] Bern ard an d W eav er i l l u s trat e wh ati s o b v i o u s fro m th e p h ras e “ co s t o f g o o d s s o l d ” i t s el f: “ g o o d s s o l d ” are g en eral l y a p rereq u i s i t e t o reco g n i zi n g co s to f g o o d s s o l d . An dth es e cas es i ll u s trat e t h e b as i c fl aw i n p et i t io n ers ’ p o s i ti o n : Bl u es cap e h adn o g ro ss recei p t s fro m th e s al e o f g o od s t o o ffs et . Co s t o f g o o d s
s o l dd o es n o tex i s ti n a v acu um , as a s t an dal o ne d edu ct io ni n th e Co d e, b uts erv es
as an o ffs etag ai n stg ro s s recei pt s . See Su ll en g er v . Co m m i s s io n er, 1 1 T.C. 1 0 7 6 , 1 0 7 7 (1 9 4 8 ) (“ Sect i o n 2 3 [n o w s ect io n 1 62 ] m ak es n o p ro v i s i o n fo r t h e co s to f g o o d s s o l d , b u tth e Co m

m i s s i o n er h as al way s reco g ni zed , as i nd eedh e m us tt o
s t ay w i thi n th e Co n s t i tu t i o n , th atth e co s to f g o od s s o l dm u s t b e d edu ct edfro m g ro s s recei p ts i n o rd er t o arri v e at g ro s s i n co m e. No m ore t han g ro s s i n co m e can b e s ubject ed t o i n co m e t ax upo n an y th eo ry . ”); s ec. 1 .6 1 -3 , In co m e Tax Reg s . Pet i t i o ners d o n otci t e, n o r co u l dwe fi nd , an y cas es th atal lo wed an o ffs et fo r co s to f g oo d s s o l das a s t an dal o ne d educt i o ni n ad v an ce o f an y g ro ss recei p ts ; rat h er co sto f g o o ds s o ldwas al l o wedo n l y as an o ffs etag ai n s tg ro s s recei p t s fro m th e s al e o f g oo d s . 8 In d eed , thati s th e fo u nd at i o no n wh i ch p et i t i o n er’ s arg u m en t ag ai n s tap p l i cat i o n o f t h e eco n o m i c p erfo rm an ce req u i rem en tres t s . Th ati s , p et i t i o n ers arg u e t h atco s to f g oo d s s o l d i s n o ts ub jectt o t h e eco n o m i c p erfo rm an ce req u i rem en tu n d er s ect i o n4 6 1(h ) b ecau s e co sto f g o o ds s o ldo ffs et s

8 Th e ex cep t io n s --wh i ch we d i scu s s b el o w--i ll u s trat e t h i s b ro ad er p rem i s e.- 1 5 -

[* 1 5 ] g ro s s recei pt s fo r p urp os es o f co m p u t i n g g ro s s i n co m e u n d er s ect i o n 1 .6 1-3 (a), In co m e Tax Reg s., an dh en ce i s an “ it em ” o f g ro s s i nco m e, th e t i m i n g
o f wh ich i s g o vern edb y

s ect io n 4 5 1 . Pet i t i o n ers ’ o wnfo rm ul at i o nth u s co n fi rm s th atco s to f g o o d s s o l di s n o t a s t an dal o ne d edu ct i o nb u trat her s erv es as an o ffs et ag ai n s tg ro s s recei p t s . Pet i t i o ners ’ arg u m en tth atco s to f g o o d s s o l d n eedn o t“ m at ch ” g ro s s recei p t s can n o t b ri d g e t h e g ap i n th ei r l og i c. Fi rs t , p et i ti o ners ci t e Hezel v . Co m m i s s i o n er, T.C. M em o . 1 9 8 5 -1 0 , as an ex am p l e wh ere “ the [C] o u rtal l o weda t ax p ay er t o ad

j u s t* * * [co s to f g o o d s s o ld ] fo r l ab o r co s t s as s o ci at edwi th t h e t ax p ay er’ s b u s i n es s d es pi te t h e fact th at th e t ax p ay er d idn o t h av e an y s al es o f i n v en t o ry du ri ng th e t ax y ear i n i s s u e”. Th at i s n o ts o . InHezel th e t ax p ay er, an i n d i v i du al , p ai d$ 20 ,0 00 i n 1 9 7 7 t o acq u i re an o b s o l et e m ai l co n v ey er s y s t em i n
o rd er t o s al v ag e t h e eq u i p m en tan dres el l i t. In1 9 7 8 the t ax p ay er cl ai m ed ap p ro x i m at el y $ 1 5 , 0 0 0 o f co s to f g o o d s s o l dwi th o u trep o rt i n g an y s al es , an d i n i t i al l y , th e Co m

m i s s i o n er d i s al l o wedthe en t i re am o u n t . Bu taft er d i s co v ery , th e Co m m i s s i o n er co n ced eda d edu ct i o n o f ap p ro x i m at el y $ 1 ,3 0 0 fo r l ab or co s t s th at h ad b een cl ai m edb y

the t ax p ay er as a p arto f co s t o f g o o d s s o l d. Th us , th e l ab o r
co s t s were n o tev en b efo re t h e Co u rt . An d t h e Co u rt ru l edi n t h e Co m m i s s i o n er’ s fav o r wi th res pect t o th e cl ai m edco sto f g o o d s s o l drem ai n in g aft er co n ces s i o n s- 1 6 -

[* 1 6 ] (ap p ro x i m at el y

$ 1 3 ,7 0 0 fo r eq u i p m en t p u rch as es , s up p l i es , an di nv en t o ry
s h ri n k ag e). Pet i t i o ners al s o ci t e Van Pi ck eri l l & So n s , In c. v . Un i t ed St at es , 4 4 5 F.2 d 9 1 8 (7 th Ci r. 1 9 71 ), as p art o f t h i s arg u m en t th at th ey n eedn o t “ m at ch ” accru ed dri l l i n g co s t s t o g ro s s recei pt s fro m th e s al e o f g o o d s. Bu ti n t h atcas e t h e t ax p ay er av o i d ed“ m at ch i n g ” o f cert ai nco s t s t o s al es b y cl ai m i n g tho s e co s t s as
ex p en s e d educt i o ns , n o t as co s to f g o o d s s o l d . Sp eci fi cal l y , th e co u rtreject edth e Co m m i s s i o n er’ s p o s it i on th ata wh i s ky d is tri bu t o r m u stad dco s ts fo r s t o rag e, St at e t ax es , an di n s u ran ce p rem i u m s t o co s to f g o o d s s o l dan d o ffs etco s to f g o od s s o ld ag ai n s tg ro s s recei p t s at th e t i m e o f s al e o f t h e wh is ky . Th e t ax pay er s u cces s fu l l y arg u ed th ati t s p ract i ce o f cu rren tex p en si n g o f s uch co s t s was a p erm i s s i b l e
m et h o d o f acco u n ti n g . Cru ci al l y , th e “ t ax p ay er h i n g e[d ] h i s arg u m en to nth e i m p ro p ri et y o f ch aract eri zi n g t h e ch arg es as co s t s o f acq u is i t i o n[o f th e wh i s ky ] .” Id . at9 2 0 . Here, b y

co n tras t , p et i t i o n ers t ak e t he p o s i t i o nthatBl u es cap e’ s
es t i m at eddri l l i n g co s t s are n otd edu ct i b l e ex p en s es b utco s t s i n cl u d edi n co s to f g o o ds o l d --t h ati s , th atth e ex p en ses are p arto f t h e co s to f acqu iri n g th e n atu ral g as . Th i s p o s i t i o n i s h o w they cl ai m t o av o i dth e eco n om i c p erfo rm an ce req u i rem en t . Bu t i ti s al so wh atreq ui res th em t o wai t u n t i l th ere are g ro s s recei p t s- 1 7 -

[* 1 7 ] ag ai n s twh ich t o o ffs etco s to f g o o ds s o ld . VanPi ck eri ll & So n s th erefo re h i g h l i g h t s th e i n co n s is t en cy of p et i t io n er’ s p o s i t io n . Cas es p et i t i o n ers ci te i n vo l v i n g s t o l en o r wo rth l es s i n v en t o ry l ik ewi s e m i s s th e m ark . Fo r i n s t an ce, p et i t i o n ers ci t e Nat ’ l Ho m e Pro d s ., In c. v . Co m m is s i o n er, 7 1 T.C. 5 0 1 , 5 3 0 -5 3 2 (1 9 7 9 ) (h o l d i n g th at th e t ax p ay er co u l dredu ce i t s en d i n g i n v en t o ry i n th e co sto f g o o d s s o l d co m p u t at io nb y th e am o u n t o f s t o l eni n v en t o ry
an d th us cl ai m

the am ou n to f t he i n v en t o ry l os s as a p arto f i ts co s to f g o o d s s o l d ), C-O-Two Fi re Equ i p . Co
. v . Co m m is s i o n er, 2 1 9 F.2 d5 7 (3 dCi r. 1 9 5 5 ) (h o l d i n g th atth e t ax p ay er co u l do ffs eta l o s s i n1 9 4 6 fo r o b s o l et e i n v en t o ry o n a t o tal l y fai l edb u s i n es s v en tu re b y wri ti n g d own en d i n g i n ven t o ry fo r t h e y ear o f t h e l o s s ),
rev ’ g 2 2 T.C. 1 2 4 (1 9 5 4 ), an d Un i t ed St at es v . Ko ll m an , 1 0 5 A.F.T.R. 2 d 2 0 1 0 -1 3 3 1 (D. Ore. 2 0 1 0 ) (h o l d i n g th atth e t ax p ay er was en t i t l ed t o a d edu ct i o n fo r wo rt h l es s i n v en to ry

aft er Go v ern m en treg u l at i o n m ad e cert ai n i n v en t o ry
u n m ark et ab l e). Pet i t i o n ers al s o p o i nto u tth ata t ax p ay er m ay wri t e d o wnth e co s t
o f en d in g i n v en to ry

t o “ m ark et ” i ncert ai n s i tu at i o n s i f t h e t ax p ay er i s u s i n g th e l o wer o f co s to r m ark etm et h o d. See s ecs . 1 .4 7 1-2 (c), 1 .4 7 1 -4 , In co m e Tax Reg s .;
s ee al so Th o r Po wer To o l Co . v . Co m m i s s i o ner, 4 3 9 U.S. 5 2 2 , 5 3 3-5 3 7 (1 9 7 9 ) (d es cri bi n g th e l ower o f co s to r m ark etm et h o d ). Bu tp et i t i o n ers d i dn o tal l eg e- 1 8 -

[* 1 8 ] th atBl ues cap e h adi n v en t o ry th atwas s to l en o r l o st v al ue, o r t h ati t was
u s i n g th e l o wer o f co s to r m ark etm et ho d . Th erefo re, t h es e au th o ri t i es are n o h el p . 9 Th i rd , p et i t i o n ers ’ rel i an ce o nGart h v . Co m m i s s i o n er, 5 6 T.C. 6 1 0 (1 9 7 1 ), i s m i s p l aced . Pet i t i o ners ci t e Gart h as an ex am p l e wh ere “ th e t ax p ay er was al l o wed to cl ai m

th e co s ts o f rai s i n g ch i ck en s i ny ears p ri o r t o th e y ears i nwh i ch th e t ax p ay er’ s i n v en t o ry

o f ch i ck en eg g s o r ch i ck en s were s ol d ”. Bu tth e t ax p ay er i n Gart h was i n b u s i n es s fo r ap p ro x i m at el y fi v e y ears b efo re t h e t ax y ear i ni s s ue,
an d du ri n g th e y ear i n i s s ue t h e t ax p ay er was act i v el y en g ag edi n th e p ro du ct i o n
an d s al e o f eg g s an d h en s . Th ere i s n o i n d icat io n t h atth e t ax pay er i nGart h at t em p t edt o reco gn i ze co s to f g o o d s s o l d fo r a t ax y ear i nwh i ch th e t ax p ay er h ad
n o g ro ss recei p t s fro m th e s al e o f i n ven t o ry . Fi n al l y , p et i t i o n ers ’ at t em p t t o b l o ckp art i al s u m

m ary ju d g m en tb y

arg u i n g th atth is i s a fact -i n t en si v e “ cl ear refl ect i on o f i n co m e i s su e” n o tap p ro p ri at e fo r

9 W e d o n o t ex p res s an o p i n i o no nwh et h er a t ax p ay er wh o wri t es d own en d in g i n v en t o ry

fo r s t o len , wo rt h l es s , o r o bs o l et e g o o d s co u l dreco g n i ze co s to f g o o d s s o l di n th e ab s en ce o f g ro s s recei p t s fro m th e s al e o f g o od s . Nei th er d o we ex p res s an o p in io n o n wh et h er a t ax p ay er u s i n g th e l o wer o f co s to r m ark et m et h o d co u l dreco g n i ze co s to f g o o d s s o l d i nth e ab s en ce o f g ro s s recei p t s fro m th e s al e o f g oo d s . Th e fact s b efo re u s d o n o trai s e th es e i ss ues .- 1 9 -

[* 1 9 ] s u m

m ary j u d gm en ti s u n av ai l i n g . 1 0 Th e o n l y fact s m at eri al t o o u r an al y s i s
o f wh eth er th e co s t s i n i ss u e s h o u l db e reco g n i zedfo r t h e y ears i ni ss u e as p arto f
co s t s o f g o o d s s o l dare t h at Bl u es cap e d i dn o trecei v e o r rep o rt an y g ro s s recei p t s fro m th e s al e o f n atu ral g as o r o th er g o o d s o r i n v en t o ry du ri ng th e y ears i n i s s u e. An dthati s n o td i s p u t ed
. In arg ui ng th atp art i al s u m m ary ju d g m en ti s n o t av ai lab l e aft er cas t in g
res p o n d en t’ s p o s i t i o n as a cl ear refl ect io n ch al len g e, p et i t i o n ers as s ertth atth ey wi l l p res en tev i d en ce attri al b eari n g o n wh et h er thei r m etho d o f acco un t i n g

1 0 Un d er s ec. 4 4 6 (b ), the Co m m i s s io n er h as b ro adau th o ri ty t o ch al len g e a t ax p ay er’ s m et ho do f acco u n t i n g as fai l in g t o cl earl y refl ecti n co m e. See Th o r Po wer To o l Co . v . Co m

m i s s i o n er, 4 3 9 U.S. 5 2 2, 5 3 2 (1 9 7 9) (“ [I] ti s o b v i ou s th at o n th ei r face, § § 4 4 6 an d4 7 1 , wi th th ei r acco m p an y i n g Reg u l at i o n s, v es tth e Co m m i s s i o n er wi th wi d e d i s cret i o ni nd et erm i n i n g wh et h er a p art i cu l ar m et h o d o f i n v en t o ry acco u nt i n g s h o ul db e d is al l o wedas n o t cl earl y refl ect iv e o f i n co m e.”); Co m m i s s i o n er v . Han s en , 3 6 0 U.S. 4 4 6 , 4 6 7 (1 9 5 9 ) (“ Th e Co m m i s s i o n er h as b ro adp o wers i n d et erm i n i n g wh et h er acco u n t i n g m et h o ds u s edb y a t ax p ay er cl earl y refl ecti n co m e[.] ”); Ro ckwel l In t ’ l Co rp . v . Co m m i s s i o ner, 7 7 T.C. 7 8 0 , 8 0 8 (1 98 1 ) (“ Si n ce t h e Co m m i s s i o n er h as ‘ [m ] u ch l at i tu d e fo r d i s cret io n ,’ h i s i n t erp ret at io n o f t h e s t atut e’ s cl ear-refl ect io ns t an d ard‘ s h o u l d n o tb e i n t erfered wi th u nl es s cl earl y

u n lawfu l
. ’ ” (al t erat i o ni no ri g i n al ) (qu o t i n g Lu cas v . Am . Co d e Co ., 2 8 0 U.S. 4 4 5 , 4 4 9 (1 9 30 ))), aff’ d , 6 9 4 F.2 d6 0 (3 d Ci r. 1 98 2 ). Wh et h er a m et h o d o f acco u n ti n g cl earl y refl ect s i n co m e i s a qu es t i o n o f fact t o b e d et erm i n ed o n a cas e-b y -cas e b as i s . Ho wardHu g h es Co ., LLC v
. Co m m i s s io n er, 1 4 2 T.C. 3 5 5 , 3 7 6 (2 0 1 4), aff’ d , 8 0 5 F.3 d1 75 (5 th Ci r. 2 0 1 5); Fo rdM o t o r Co . v . Co m m i s s i o n er, 1 0 2 T.C. 8 7 , 9 1 -9 2 (1 9 9 4 ), aff’ d , 7 1 F.3 d 2 0 9 (6 th Ci r. 1 9 9 5 ). Co n s equ en t l y , we h av e h el d t h atcas es d eci di n g wh et h er a t ax p ay er’ s m eth o do f acco u n t in g fai l s t o cl earl y refl ecti n co m e g en eral l y are n o ts u i tab l e fo r s u m

m ary ju d g m en t . Dayt o n Hu d s o n Co rp . & Sub s . v . Co m m is s i o n er, 1 01 T.C. 4 6 2, 4 6 6 (1 9 9 3).- 2 0 -

[* 2 0 ] cl earl y

refl ect edi n co m e, i n cl u d in g : th e p reci s e t erm s o f t h e l eas es ; s ev eral act i on s t ak en i n 2 0 0 8 an d 2 0 0 9 t o “p res erv e an den han ce” t h e v al ues o f t h e l eas es , i n cl u d i n g dri l l i n g two t es twel ls i n2 0 0 9 an di n fras tru ctu re d ev el op m en t ; wo rk d o n e b y th i rdp art y

en g i n eeri n g co m

p an i es t o ev al u at e t h e t es twel l s i n 2 00 9 ; g en eral l y accep tedp ri n ci p l es fo r t h e p art i cu l ar t rad e o r b us i n es s ; an d h ow Bl u es cap e’ s m et h o do f acco u n t i n g was co n si s t en t l y ap p l iedo v er t h e y ears . Bu t
n o n e o f t h es e fact s i s m at eri al t o th e i ss u e o f wh ether Bl ues cap e h adan y g ro s s recei p t s fro m

the s al e o f g o o ds du ri n g the y ears i ni s s ue. In Bern ardan dW eav er, d i s cu s s edab o v e, we reject ed --wi th ou treferen ce t o cl ear refl ect i o no f i nco m e--t h e arg u m en tth ata t ax p ay er m ay reco v er co s t o f g o o d s s o l d wh en th e t ax p ay er h adn o g ro s s recei p ts fro m

th e s al e o f g o o d s . Pet i t i o n ers can no tfen do ff p art i al s u m m ary ju d g m en to n th i s fu n d am en t al l eg al qu es t i o nb y i n v ok i n g cl ear refl ect i o n o f i n co m e; wi th ou td i s p u tedm at eri al fact s th is b eco m es a redh erri n g . 1 1 In s u m , we co n cl u d e t h att o reco v er co s t o f g o o d s s o l da t ax pay er g en eral l y
m u sth av e s o m e g ro s s recei p t s fro m th e s al e o f g o o d s t o o ffs et . Becau se

1 1 To b e cl ear, res po n d en td i d arg u e i n h is m o t i o n , as an al tern at i v e t o h i s s ec. 4 6 1(h )(1 ) arg u m en t , th at Bl u es cap e’ s rep o rt edco s t s o f g o o d s s o l ds h o u l db e d i s al lo wedb ecau s e i tu s eda m et h o do f i n v en to ry acco u n t i n g t h atfai l ed t o cl earl y refl ecti n co m e. W e n eedn o treach th atarg u m en t h ere b ecau s e we h o l dth at , wi th o u tg ro s s recei p t s fro m th e s al e o f g o o d s , Bl ues cap e m ay n o treco v er i t s es t i m at eddri l l i n g co s t s as co st s o f g o o ds s o ld
.- 2 1 -

[* 2 1 ] Bl ues cap e h adn o g ro s s recei p t s fro m th e s al e o f n atu ral g as fo r t h e y ears i n i s su e, t h e es ti m at eddri l li n g co st s rep o rt ed as “ co s to f g o o d s s o l d ” are n o t al l o wab le as a co s t o f g o o d s s o l do ffs ett o g ro s s recei p t s. Acco rd i ng l y , we s u s t ai n res p o n d en t ’ s d i s al l o wan ce o f Bl u es cap e’ s
es t i m at eddri l l i n g co s t s rep o rt edas co s t s o f g o o d s s o l dfo r t ax y ears 2 0 08 an d 2 0 0 9 . W e d o n o treach th e p art i es ’ d i s p u t e o ver wh et h er t h e eco n o m i c p erfo rm an ce req u i rem en ti n s ect i o n4 6 1 (h )(1 ) ap p l i es t o Bl u es cap e’ s es t i m at ed dri l l i n g co s t s . 1 2 Th erefo re, we wi l l d en y p et i t i o n ers ’ m o t i on as m o o t . III. Co n cl u s i o n In s u m , we wi l l d en y p et i t i o n ers ’ m ot i o nfo r p art i al s umm ary ju d g m en t b ecau s e Bl u es cap e’ s rep o rt edes t i m at ed dri ll i n g co s ts are n o t co s t s o f g o o d s s o l d

1 2 W e n o t e t h atp et i t i o n ers ’ p o s it i o n i s thatBl u es cap e s h o ul db e ab l e t o t ak e i n t o acco u n ti t s es t i m at eddri ll i n g co s t s as co s ts o f g o o d s s o ldfo r t ax y ears 2 0 0 8 an d 2 0 0 9 an dwe h av e co n fi n edo u r an al y s i s t o th i s qu es t i on . Pet i ti o n ers d o n o t arg u e t h atth o s e co s t s s h o ul dg i v e ri s e t o s ec. 1 6 2 d edu ct i o n s. An do nb ri ef p et i t i o n ers b el ab o r t h e d i s t i n ct i o n s b et ween co s t s o f g o o d s s o l d “ o ffs et s ” t o g ro s s recei p t s an d d edu ct io n s ag ai n s tg ro s s i n co m e i n arg u i n g th ats ec. 4 6 1 (h )(1 ) s h o u l d n o tap pl y t o co s t s o f g o o d s s ol d . W e d o n o treadth ei r al tern at i v e arg u m en tth at th ey s at i s fy th e eco no m i c p erfo rm an ce req u i rem en tt o ch an ge t h ei r ch aract eri zat i o n o f t he ex p en s es as co s t s o f g o o d s s o l d . W e t h erefo re wi l l n o t co n si d er rech aract eri zi n g Bl u es cap e’ s rep o rt edco s ts o f g o o d s s o ldas cl ai m s fo r s ec. 1 6 2 d educt i o n s i n th e s am e am o u n t s, as th e Co u rtd idi n W eav er v . Co m m i s s i o n er, T.C. M em o . 2 0 0 4 -1 0 8
.- 2 2 -

[* 2 2 ] fo r Fed eral t ax l aw p u rp o s es . Th erefo re, we n eedn o tco n s i d er p et i t i o n ers ’ arg u m en t s co n cern in g the ap pl i cat i o no f s ect io n 4 6 1 (h )(1 ) t o co s t o f g o o d s s o l d
. W e wi l l g ran tres p o n d en t ’ s m o t i o nfo r p art ial s u m m ary ju d g m en t b as edo n th e reas o n i n g i n thi s o p i n i o n. On th e b as i s o f t h e u n d i s pu t ed fact s b efo re u s , p et i t i o n ers were n o t en t it l edt o reco g n i ze co st o f g o o d s s o l dfo r t ax y ear 2 0 0 8 o r 2 0 0 9
. To refl ectthe fo reg o i n g , Anap p ro p ri at e o rd er wi ll b e i s s u ed
.