The seminal case in this area is Reliable Steel Fabricators. It’s a decent case, but not a great one, because the taxpayer didn’t produce any credible evidence as to the Inventory’s value. I would also note that that case involved a manufacturer and the inventory in question was WIP.
I totally see what you are saying and I have confronted this issue before. Although ultimate retail price might be relevant, that doesn’t tell the whole story. What we’re after here, when it comes to a willing buyer, as part of the willing buyer/willing seller analysis, is a buyer that is in the same business of the taxpayer. See the -7 Reg as to that point. So, Corrielee’s argument goes like this:
Inventory on client’s books is $500k. Let’s say it has a retail value of $750k. That doesn’t paint the real picture, because the willing buyer isn’t a multitude of retail customers. Rather, the willing buyer is a similarly situated reseller, someone just like the taxpayer. So, would another reseller really pay $750k for this inventory? I think not: The buyer/other reseller would certainly not pay $750k for inventory that he himself could only sell for $750k. That would be a 0% profit margin and would make no sense. The buyer/other reseller would go somewhere else and purchase the inventory for $500k, in my view, assuming he had the connections and capability to do so. But then again, the buyer/other reseller might be willing to pay something more than $500k for the inventory, but less than $750k if buyer could easily sell it or otherwise easily incorporate into his sales stream. It could also be that buying in bulk like this might reduce a bulk buyer’s purchasing costs. And it could be that selling in bulk might reduce some costs the seller would otherwise incur, thereby making the seller amendable to a bulk sale. At the end of the day, if we end up somewhere between $500k and $750k, the $250k profit basically gets split between your client and the buyer/other reseller. That position would mean that your client, and the buyer, would be willing to accept something less than full profit.
Also, in this example, even if the client could sell the inventory for $750k, that fact alone ignores all the selling costs that go into converting the inventory to cash. That is, even if client could make a $250k gross profit on it, the net margin would be much less, after overhead and selling costs. These costs should factor into the BIG calculation. Let’s say these costs are $100k, so the net profit would be $150k.
I’ll admit it’s a difficult issue and it’s one that many people just brush over without thinking it through. But I can say, in nearly even business sale I’ve been involved with, the inventory allocation is done on a dollar-for-dollar basis, despite all the theories out there.