We outsource fabrication but own the designs and materials. Are we a producer for inventory tax rules?
A business can be treated as producing property even when another company performs physical fabrication.
By AE Tax Advisors Team · Updated October 28, 2026
A business can be treated as producing property even when another company performs physical fabrication. Ownership and the benefits and burdens of the production arrangement matter under Section 263A. Outsourcing labor is therefore not enough to conclude that only reseller rules or no production capitalization applies.
A specific business-owner situation
A brand supplies raw materials and tooling to a contract factory and bears loss on defective units. It calls itself a distributor because it has no manufacturing employees.
Illustrative example, not a client result.
What to establish before filing
- Read ownership and risk provisions.
- Identify production-related expenditures the business incurs.
- Apply producer classification and exception rules.
Which fact changes the answer?
Buying completed goods from an independent vendor differs from arranging production while retaining ownership and production risk. The contract and actual conduct control.
A mistake to avoid
Do not classify the business solely by its industry code or employee job titles.
Records that support the decision
- Manufacturing agreement.
- Material ownership records.
- Reject and insurance policies.
The decision to document
Document the producer-versus-reseller conclusion before selecting which costs enter inventory.
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Related questions
- I manage production and sales. Does part of my compensation belong in inventory cost?
- We sell scrap generated during production. Is that separate revenue or a reduction of inventory cost?
Sources and editorial context
- Section 263A: inventory and production capitalization
- Treasury regulation 1.263A-1: cost allocation
- Treasury regulation 1.263A-2: produced property
General educational information prepared with AI assistance. No individual professional review is claimed. Apply the relevant tax-year rules to the actual records. Editorial policy · AI disclosure.