Automobile dealers may use replacement-cost method to approximate vehicle-parts inventory cost.

• Author: Sair, Edward A.

Rev. Proc. 2002-17 provided certain automobile dealers a safe-harbor accounting method for vehicle-parts inventory. This method permits them to use the replacement cost of parts to approximate the cost of their vehicle-parts inventory. The procedure is generally effective for tax years ending on or after Dec. 31, 2001.

Background

In Mountain State Ford Truck Sales, Inc., 112TC 58 (1999), the Tax Court held that the IRS did not abuse its discretion when it determined that a truck dealer's use of the replacement-cost method to determine the current-year cost of its parts inventory under the LIFO method did not clearly reflect income. The court permitted the IRS to restore the taxpayer's LIFO reserve to income without terminating its LIFO election, because the taxpayer was unable to reconstruct the corrected reserve amount or provide evidence from which an estimate could be made.

The court concluded that the use of replacement cost to determine current-year cost under the dollar-value LIFO method contravenes the Sec. 472(b)(2) actual-cost requirement, which requires a taxpayer using the LIFO method to value inventory at cost. It reasoned that "cost" in Sec. 472(b)(2) has the same meaning as in Regs. Sec. 1.471-3 (i.e., actual cost or invoice price). Thus, the court concluded that a reseller using the dollar-value LIFO method must determine current-year cost by reference to actual invoice prices, not replacement cost.

The use of replacement cost to value parts inventory is prevalent among automobile dealers and others. As such, Mountain State Ford prompted discussions between the IRS and the National Automobile Dealers Association, attempting to reach an agreement on the use of the replacement-cost method. The IRS cited four unique industry circumstances warranting a departure from actual cost and permitting the use of replacement cost:

* The industry's long-standing use of replacement cost for financial accounting and Federal income tax purposes;

* Third-party (i.e., franchisor) requirements that automobile dealers use replacement cost;

* The substantial burden (i.e., expense) of converting existing record-keeping systems from replacement cost to actual cost; and

* The fact that replacement cost approximates actual cost in the industry (due to high turnover and low inflation).

The IRS expressed a willingness to consider the use of replacement cost in other industries, under similar facts.

Automobile Dealers

Scope. The Rey. Proc. 2002-17 safe...