How to Convert LIFO to FIFO: Form 3115, Reserve, and 4-Year Spread

To convert from LIFO to FIFO, you file IRS Form 3115 under the automatic change procedures, calculate your LIFO reserve as a positive Section 481(a) adjustment, and pay tax on that deferred income ratably over four years beginning with the year of change. The switch is a formal change in accounting method, not a bookkeeping decision you can make quietly, and every dollar of income you deferred by using LIFO comes back into the tax base.

Calculate Your LIFO Reserve

The LIFO reserve is the difference between your inventory valued under LIFO and the same inventory valued under FIFO on the last day of the tax year before the change. LIFO keeps older, lower costs on your balance sheet while expensing newer, higher costs; FIFO does the opposite. The gap between the two valuations is the income you have deferred over the life of your LIFO election, and it becomes the taxable adjustment you report to the IRS.

Running the number is not a quick estimate. You restate every LIFO inventory layer using FIFO cost-flow assumptions, which usually means deflating LIFO values back to base-year costs and rebuilding them at FIFO prices. Each dollar-value pool is accounted for separately. If your LIFO election goes back decades, the layering history makes this the most labor-intensive piece of the whole conversion.

Keep detailed work papers showing every pool, every layer, and every price index you used. The IRS reviews these calculations in audits, and an error here drives penalties that dwarf the cost of getting the number right the first time.

Check Section 263A Compliance Before You File

Before changing inventory methods, confirm you are complying with Section 263A, the uniform capitalization rules. If your business is required to capitalize certain costs into inventory under Section 263A and has not been doing so correctly, the IRS generally requires you to fix that problem on the same Form 3115 you use for the LIFO change.¹

In practice, your Section 481(a) adjustment can carry two components: the LIFO reserve itself and any costs that should have been capitalized under UNICAP but were not. If you were already in full compliance, the adjustment is just the reserve. Either way, Form 3115 requires Schedule D, Part III detailing your cost allocation method under Section 263A.¹

Prepare Form 3115

The conversion runs on IRS Form 3115, Application for Change in Accounting Method.² A change from LIFO to FIFO is an automatic change, so you do not wait for individual IRS approval. You file the form, follow the procedures, and consent is granted automatically, subject to later review.¹

The Designated Change Number for this conversion is 56, which corresponds to a change from the LIFO inventory method under Section 472.³ Enter it on Line 1a of Schedule A. Older guides sometimes reference DCN 75, which applies to a different inventory change; using the wrong number can cause the IRS to reject or return your form.

The net Section 481(a) adjustment goes on Part IV, Line 26. For a LIFO-to-FIFO conversion this is a positive number. The form also requires Schedule D, Part II for the LIFO change and Part III for Section 263A details where applicable. In Part III you describe both the old LIFO method and the new FIFO method, attach work papers showing how you calculated the reserve, and include a statement revoking the LIFO election. No user fee applies to automatic change requests.¹

Filing While Under IRS Examination

Being under audit does not bar you from filing Form 3115, but the terms change. The four-year adjustment period for a positive Section 481(a) adjustment typically shrinks to two years, you may lose audit protection for the method being changed, and you must give a copy of the form to the examining agent. Narrow exceptions preserve the full spread and audit protection, including a three-month window running from the 15th day of the seventh month through the 15th day of the tenth month of the tax year after at least twelve consecutive months under examination. If the item you want to change is already an issue in the examination, those exceptions do not apply.⁴

Where and When to File

Automatic change requests require dual filing. Attach the original Form 3115 to your timely filed federal income tax return (including extensions) for the year of change. Then mail a signed duplicate copy to the IRS in Ogden, Utah.⁵ The mailing address is:

Internal Revenue Service
Ogden, UT 84201
Attn: M/S 6111

You can file the duplicate copy no earlier than the first day of the year of change and no later than the day you file the return with the original attached.¹ Missing either filing step can invalidate the automatic consent, and filing the return without the original Form 3115 attached leaves you with a problem that has no easy fix.

The year of change is the first tax year for which you compute income using FIFO. A calendar-year taxpayer switching for 2026 applies FIFO starting January 1, 2026, and attaches the original Form 3115 to the 2026 return.

How the Tax Hits: The Four-Year Spread

The LIFO reserve becomes taxable income through a Section 481(a) adjustment, which exists to prevent income from being counted twice or skipped entirely when a taxpayer changes methods.⁶ For a LIFO-to-FIFO conversion the adjustment is always positive, because LIFO deferred income that FIFO would have recognized.

The statute itself does not prescribe a four-year spread. Section 481(c) delegates that authority to the Treasury Secretary, and IRS guidance recognizes positive Section 481(a) adjustments ratably over four tax years: the year of change and the three following years.⁴ Negative adjustments, by contrast, come in entirely in the year of change.

A $600,000 LIFO reserve produces $150,000 of additional taxable income in each of four consecutive years. You report the annual amount on your return as other income, labeled as a Section 481(a) adjustment. It is ordinary income taxed at whatever rate applies to you that year, not a separate tax or penalty. Because the per-year burden depends on your rate that year, timing the year of change to line up with lower projected income can meaningfully reduce the total cost.

Events That Accelerate the Remaining Balance

Several events collapse any unpaid portion of a positive Section 481(a) adjustment into a single year:

Ceasing to engage in the trade or business before the four years run out. The entire remaining balance becomes taxable in the year you cease operations.⁴
Making an S corporation election effective for the year of the LIFO change or a subsequent year.
Certain Section 351 transfers within a consolidated group.⁴

Acceleration catches people off guard when it coincides with a sale or liquidation. Dissolve the business after year two of the spread, and the remaining half of the adjustment lands on the final return. If a sale or restructuring is on the horizon, plan around these triggers before filing.

A Separate Rule for C-to-S Conversions

If you are a C corporation on LIFO electing S corporation status, a different rule governs. IRC Section 1363(d) requires you to include the LIFO recapture amount — the excess of FIFO inventory value over LIFO inventory value at the close of the last C corporation tax year — in gross income on that final C corporation return. The resulting tax increase is payable in four equal installments: the first with the final C corporation return (without regard to extensions), and the next three with the S corporation’s returns for the three succeeding tax years. No interest accrues during the installment period if you pay on time.⁷

This recapture happens automatically on the S election; it is not the Form 3115 process. If you are a C corporation on LIFO weighing an S election, run the recapture calculation before filing Form 2553.

You Cannot Switch Back for Five Years

Once you convert from LIFO to FIFO, you cannot re-elect LIFO for at least five tax years beginning with the year of change, unless the Commissioner grants specific consent based on unusual and compelling circumstances.⁸ The underlying regulation treats a LIFO election as irrevocable once adopted, with any change away requiring the Commissioner’s authorization through Form 3115.⁹

If commodity prices fall sharply after the switch, you are stuck under FIFO for the lockout period with no path back to LIFO’s deferral benefits. That makes the decision one to model carefully before filing, not after.

Financial Statement and State Tax Effects

The LIFO conformity rule requires any business using LIFO for tax purposes to also use LIFO for financial reporting.¹⁰ Once you revoke the LIFO election for tax, that conformity requirement lifts, and your financial statements move to the new method as well. Under generally accepted accounting principles, the change is a change in accounting principle that generally requires retrospective application, restating prior-period statements as if FIFO had always been used. Your auditors will assess whether the change is preferable under the applicable standards. The disclosure requirements and adjustment mechanics on the financial reporting side are separate from the IRS process, even though both draw on the same inventory revaluation data.

State income tax treatment of the federal Section 481(a) adjustment varies. Some states conform to the federal four-year spread; others require the full adjustment in the year of change. Check conformity rules in every state where you file before assuming the federal spread travels with you.

1
Internal Revenue Service. Instructions for Form 3115 – Application for Change in Accounting Method
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Internal Revenue Service. About Form 3115, Application for Change in Accounting Method
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Internal Revenue Service. Revenue Procedure 2022-14
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Internal Revenue Service. 4.11.6 Changes in Accounting Methods
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Internal Revenue Service. Where to File Form 3115
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Office of the Law Revision Counsel. 26 USC 481 – Adjustments Required by Changes in Method of Accounting
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Office of the Law Revision Counsel. 26 USC 1363 – Effect of Election on Corporation
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Internal Revenue Service. Revenue Procedure 2024-23
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eCFR. 26 CFR 1.472-5 – Revocation of Election
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Internal Revenue Service. Practice Unit – LIFO Conformity