Many auto dealerships in the U.S. choose to use the LIFO inventory valuation method because they have found the benefits to be significant.

The benefits of using the LIFO method for auto dealerships include:

  • matching inventory costs to revenue,
  • reduction of income tax liability (deferment), and
  • minimizing write-downs of vehicles to fair market value because of decline in inventory costs.

The major reason LIFO calculations are so popular in the automotive industry is due to consistently increasing costs of vehicles which is at the heart of why the LIFO method may provide the dealership with significant income tax benefits and impact cash flows in terms of taxes paid.

Auto Dealerships: Trending “Lease Here, Pay Here” Services

New-Vehicle Leasing

New-vehicle leasing as a financing alternative for consumers has been a customary business practice for years, although its popularity has varied based on interest rates and expected residual values of the vehicles at the end of the respective leases. Leasing typically offers the customer lower monthly payments and provides the dealers with a predictable opportunity to return those customers to the dealerships to purchase or lease another vehicle.

Used-Vehicle Leasing

Used-vehicle leasing has also been an alternative for a number of years, but it has not been as popular with customers as new-vehicle leasing. A growing trend among independent dealers who provide “buy-here, pay-here” services for customers is a switch to “lease-here, pay-here” services. Dealers are making this transition for a number of reasons, which include:

  1. The ability to reduce and/or defer both state and federal taxes
  2. Cost savings with respect to customer bankruptcy and vehicle repossession
  3. Exemption from certain regulatory compliance required for financing transactions

A significant potential benefit to leasing vs. financing relates to sales tax.

Many states apply sales taxes to each lease payment received rather than requiring the collection of sales tax on the entire taxable amount at the time of the sale. Not only does leasing defer payment of the sales tax over time but it potentially eliminates the loss of the sales tax deduction on repossessions when the related finance contract has been sold to finance company. Dealers should fully understand the sales tax laws of their state prior to changing from financing to leasing. Further, since some customers may move to other states, sales tax filings could be required in the states where customers register their vehicles.

Federal and applicable state income tax savings may be obtained as well, through the deferral of the gross profit that would be realized on a traditional sale and finance transaction. The vehicles remain the property of the dealership and are depreciated over time, using accelerated methods for tax purposes. The use of a related finance company is eliminated, as is the need to book a tax loss on the sale of the lease.

Because the vehicles’ titles remain with the dealership, the dealership can be in a better position when a customer files for bankruptcy or when a vehicle is repossessed. Federal and state regulatory requirements are generally less onerous for leasing transactions than for financing transactions.

Are there any drawbacks?

Lease-here dealers can be exposed to lessor vicarious liability. While federal law has now virtually eliminated this risk, some states may still require minimum insurance coverage, and dealers should consider the potential exposure, as well as the cost of the insurance coverage. Dealers should also consider the need for liability coverage to cover product liability lawsuits and claims in the event a lessee fails to maintain the vehicle in proper working order.

Many dealers rely on lines of credit with financial institutions to finance both buy-here and lease-here operations. Lease accounting will significantly change the dealership’s financial statements and tax returns; dealers should ensure that financial covenants are not violated when considering the addition of lease-here to buy-here.

Compared with buy-here operations, lease-here operations can offer benefits; however, dealers should seek advice from knowledgeable CPAs, attorneys and financial advisers before changing from financing to leasing, to determine which operations model works best for them, the applicable sales tax laws and the tax implications of these transactions.

The IRS has created detailed guidance on how LIFO calculations should be performed and vehicle eligibility.

LBMC LIFO Solutions has taken the detailed guidance provided by the IRS to develop a software that tracks vehicle costs for eligible new and used vehicles and provides an easy-to-use platform to calculate LIFO reserves and indexes.

Automotive dealerships that follow the detailed guidance provided by the IRS can be confident that the calculation will withstand any IRS challenge. Further, calculations that are computerized, using a nationally recognized software vendor, are preferred by the IRS.

LBMC LIFO Solutions is an affordable, easy-to-use LIFO calculation software for auto dealers and CPA firms with auto dealer clients.

If you have questions about the LIFO method or our software, we are here to answer any questions you may have about our software or provide you with an estimate.