SECTION 7. AFSI — Internal Revenue Bulletin 2026-11

FOR ELIGIBLE MATERIALS AND SUPPLIES

.01 Purpose . In response to comments received on the CAMT Proposed Regulations, the Treasury Department and the

IRS anticipate that the forthcoming proposed regulations will include proposed regulations under § 56A(c)(15) and (e) consistent with the guidance provided in this section 7 to allow a CAMT entity to adjust AFSI for eligible materials and supplies. In addition, the Treasury Department and the IRS anticipate that the forthcoming proposed regulations will propose a modification to proposed § 1.59-2(c) to provide that, for purposes of applying the average annual AFSI test in § 59(k)(1)(B) or proposed § 1.59-2(c), AFSI is determined without regard to the AFSI adjustment provided in this section 7. .02 Definitions . For purposes of this section 7:

(1) Deductible eligible materials and supplies . The term deductible eligible materials and supplies means the eligible materials and supplies, as defined in section 7.02(2) of this notice, that are allowed as a deduction in computing taxable income.

(2) Eligible materials and supplies . The term eligible materials and supplies means amounts paid or incurred by a CAMT entity—

(a) To acquire tangible property that is described in § 1.162-3(c)(1)(iv) if such amounts otherwise meet the definition of materials and supplies in § 1.162-3(c)(1),

(b) That the CAMT entity treats as deductible in accordance with the applicable rules in § 1.162-3, and

(3) Eligible materials and supplies book COGS depreciation . The term eli- gible materials and supplies book COGS depreciation means any of the following items that are taken into account as part of cost of goods sold (or as part of the computation of gain or loss from the sale or exchange of property held for sale) in FSI with respect to eligible materials and supplies—

(a) Depreciation expense; (b) Other recovery of AFS basis (including from an impairment loss) that occurs either:

(i) Prior to the taxable year in which the complete disposition of the eligible materials and supplies occurs for AFS purposes, or

(ii) In the taxable year in which the complete disposition of the eligible materials and supplies occurs for AFS purposes; or

(c) Impairment loss reversal. (4) Eligible materials and supplies book expense . The term eligible materials and supplies book expense means any of the following items, other than eligible materials and supplies book COGS depreciation, that are taken into account in FSI with respect to eligible materials and supplies—

(a) Depreciation expense; (b) Other recovery of AFS basis (including from an impairment loss) that occurs either:

(i) Prior to the taxable year in which the complete disposition of the eligible materials and supplies occurs for AFS purposes, or

(ii) In the taxable year in which the complete disposition of the eligible materials and supplies occurs for AFS purposes; or

(c) Impairment loss reversal. (5) Eligible materials and supplies book inventoriable expense . The term eli- gible materials and supplies book invento- riable expense means any of the following items that are included in inventoriable cost (or capitalized as part of the cost of non-inventory property held for sale) in the AFS of a CAMT entity with respect to eligible materials and supplies—

(a) Depreciation expense; (b) Other recovery of AFS basis (including from an impairment loss) that occurs either:

(i) Prior to the taxable year in which the complete disposition of the eligible materials and supplies occurs for AFS purposes, or

(ii) In the taxable year in which the complete disposition of the eligible materials and supplies occurs for AFS purposes; or

(c) Impairment loss reversal. (6) Eligible materials and supplies tax COGS . The term eligible materials and supplies tax COGS means:

(a) The eligible materials and supplies capitalized to inventory under § 263A and recovered as part of cost of goods sold in computing gross income; and

(b) The eligible materials and supplies capitalized under § 263A to the basis of

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property described in § 1221(a)(1) that is not inventory and is recovered as part of the computation of gain or loss from the sale or exchange of such property in computing taxable income.

(7) Tax eligible materials and sup- plies section 481(a) adjustment . The term tax eligible materials and supplies section 481(a) adjustment means an adjustment (or portion thereof) required under § 481(a) for a change in method of accounting (other than a change in method of accounting described in section 7.02(8) of this notice) that impacts the timing of taking eligible materials and supplies into account in computing taxable income (for example, a change in method of accounting involving a change from deducting eligible materials and supplies to capitalizing such costs under § 263A or another capitalization provision, or vice versa).

(8) Tax eligible materials and supplies capitalization method change . The term tax eligible materials and supplies capi- talization method change means a change in method of accounting for regular tax purposes involving a change in the classification of eligible materials and supplies (for example, a change from treating eligible materials and supplies as inventory to treating the items as materials and supplies under § 1.162-3, or a change from capitalizing and depreciating eligible materials and supplies to deducting such eligible materials and supplies).

(9) Tax eligible materials and sup- plies capitalization method change AFSI adjustment .

(a) In general . The term tax eligible materials and supplies capitalization method change AFSI adjustment means an adjustment to AFSI that is required under section 7.03(6) of this notice if a CAMT entity makes a tax eligible materials and supplies capitalization method change and previously made an adjustment to AFSI under section 7 of this notice in a preceding taxable year. The tax eligible materials and supplies capitalization method change AFSI adjustment is computed separately for each tax eligible materials and supplies capitalization method change and equals the difference between the following amounts computed as of the beginning of the tax year of change:

(i) The cumulative amount of adjustments to AFSI under section 7.03 of this

notice with respect to the cost(s) subject to the tax eligible materials and supplies capitalization method change that were made with respect to the preceding taxable years beginning with the first taxable year for which the CAMT entity makes an adjustment to AFSI under section 7 of this notice, and beginning before the tax year of change; and

(ii) The cumulative amount of adjustments to AFSI under section 7.03 of this notice with respect to the cost(s) subject to the tax eligible materials and supplies capitalization method change that would have been made with respect to the preceding taxable years beginning with the first taxable year for which the CAMT entity makes an adjustment to AFSI under section 7 of this notice, and beginning before the tax year of change, if the new method of accounting for the cost(s) had been applied for regular tax purposes in those taxable years.

(b) Coordination with proposed § 1.56A-15 . The amount of the tax eligible materials and supplies capitalization method change AFSI adjustment is adjusted, as necessary, to prevent the duplication of any adjustment to AFSI due to the tax materials and supplies capitalization method change also constituting a tax capitalization method change (as described in proposed § 1.56A-15(b)(10)).

.03 AFSI adjustment for eligible mate- rials and supplies costs . The AFSI of a CAMT entity for a taxable year may be adjusted as follows—

(1) Reduced by eligible materials and supplies tax COGS, but only to the extent of the amount recovered—

(a) As part of cost of goods sold in computing gross income for the taxable year, or

(b) As part of the computation of gain or loss from the sale or exchange of non-inventory property described in § 1221(a) (1) that is included in taxable income, or deducted in computing taxable income, respectively, for the taxable year;

(2) Reduced by deductible eligible materials and supplies, but only to the extent of the amount allowed as a deduction in computing taxable income for the taxable year;

(3) Adjusted to disregard eligible materials and supplies book COGS depreciation and eligible materials and supplies

book expense with respect to eligible materials and supplies acquired in any taxable year, including in taxable years ending on or before December 31, 2019;

(4) Reduced by any tax eligible materials and supplies section 481(a) adjustment that is negative, but only to the extent of the amount of the adjustment that is taken into account in computing taxable income for the taxable year;

(5) Increased by any tax eligible materials and supplies section 481(a) adjustment that is positive, but only to the extent of the amount of the adjustment that is taken into account in computing taxable income for the taxable year; and

(6) Increased or decreased, as appropriate, by any tax eligible materials and supplies capitalization method change AFSI adjustment in accordance with section 7.05 of this notice. .04 Determining eligible materials and supplies tax COGS adjustment and eligi- ble materials and supplies book COGS depreciation adjustment .

(1) In general . Except as provided in section 7.04(2) of this notice, a CAMT entity is required to—

(a) Apply the method(s) of accounting the CAMT entity uses for AFS purposes to determine the eligible materials and supplies book COGS depreciation adjustment under section 7.03(3) of this notice; and

(b) Apply the method(s) of accounting under § 263A that the CAMT entity uses for regular tax purposes (and, in the case of inventory property, the method(s) of accounting that the CAMT entity uses to identify and value inventories under §§ 471 and 472) to determine the eligible materials and supplies tax COGS adjustment under section 7.03(1) of this notice.

(2) Reasonable method . A CAMT entity is permitted to use any reasonable method to determine the eligible materials and supplies book inventoriable expense in ending inventory for AFS purposes for purposes of determining the eligible materials and supplies book COGS depreciation adjustment under section 7.03(3) of this notice, or to determine the eligible materials and supplies included in ending inventory for regular tax purposes for purposes of determining the eligible materials and supplies tax COGS adjustment under section 7.03(1) of this notice, or both, provided that such reasonable method is con

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sistent with and reflects the method(s) of accounting the CAMT entity uses for AFS purposes or regular tax purposes, as applicable. A reasonable method would include a method similar to the simplifying methods provided in proposed § 1.56A-15(d) (3)(ii)(A) through (C).

(3) Reporting requirement . If a CAMT entity makes the AFSI adjustment provided in section 7 of this notice for a taxable year, it must attach a statement to its Federal income tax return for such taxable year. The statement—

(a) Must be titled “AFSI adjustment for eligible materials and supplies”,

(b) Must include the CAMT entity’s name, address, and taxpayer identification number, and

(c) If a CAMT entity uses a reasonable method under section 7.04(2) of this notice, it must: include a statement whether the CAMT entity is using such a reasonable method to determine (i) eligible materials and supplies book inventoriable expense in ending inventory for AFS purposes for purposes of determining the eligible materials and supplies book COGS depreciation adjustment under section 7.03(3) of Notice 2026-7 for the taxable year, or (ii) eligible materials and supplies in ending inventory for regular tax purposes for purposes of determining the eligible materials and supplies tax COGS adjustment under section 7.03(1) of Notice 2026-7 for the taxable year, or (iii) both; describe such reasonable method(s) used; and certify that such reasonable method(s) used are consistent with, and reflect, the method(s) of accounting the CAMT entity uses for AFS purposes or regular tax purposes, as applicable.

.05 Adjustment period for tax eligi- ble materials and supplies capitalization method change AFSI adjustment . The adjustment period for a tax eligible materials and supplies capitalization method change AFSI adjustment is determined consistent with the proposed rules provided in proposed § 1.56A-15(d)(4) (adjustment period for tax capitalization method change AFSI adjustments with respect to section 168 property).

.06 Consistency requirement . If a CAMT entity relies on section 7 of this notice and makes the adjustment to AFSI provided in section 7.03 of this notice for a taxable year, it must continue to make the adjustment provided in section 7.03 of

this notice for all subsequent taxable years until all eligible materials and supplies are disposed of for AFS purposes or such time as prescribed by the Treasury Department and the IRS in regulations or guidance published in the Internal Revenue Bulletin.

.07 Determining applicable corpo- ration status . For purposes of applying the average annual AFSI test in § 59(k) (1)(B) or proposed § 1.59-2(c), AFSI is determined without regard to the AFSI adjustments provided in section 7.03 of this notice.