As an Auto Dealer, Are You Paying Enough Rent?

As an auto dealer, you normally own the real estate you pay rent to. Let me ask you… are you paying enough? You might think it is left pocket, right pocket, but let us discuss why it is not.

Most dealers normally pay enough rent to cover their debt service on the property that is in another entity, and that is it. Here are a few things to consider when paying this rent:

• Rent should be paid based on fair market value, even though it is to a related party.
• The value of your dealership has probably increased over the past few years.
• Facility upgrades should be completed by the rental property entity because there are depreciation advantages. Therefore, the property might need some excess cash flow for the improvements.
• The real estate entity that owns your property can capitalize on the Tax Cuts and Jobs Act, if grouped correctly.
• Excess cash from your real estate property can be distributed to an owner in a very tax-efficient manner.
• Additional rental income can help with potential interest expense limitations that could be looming.

Let’s dive a little further into the potential interest expense limitation that could be looming. Under the Tax Cuts and Jobs Act (known as Trump’s tax cuts), an interest expense limitation rule was put into place.  Interest expense is limited to 30% of adjusted taxable income (ATI), which is like the EBITDA calculation. For tax years 2021 and prior, ATI includes an addback of depreciation and amortization. However, for years 2022 and later, the ATI calculation does NOT include an addback for depreciation and amortization. 

This potential limitation of expense could be significant. In a roundabout way, debt might have just gotten more expensive if a taxpayer cannot currently deduct its interest expense. Please keep in mind that the limited interest expense does carry forward indefinitely, but for how long?

Therefore, an increase in rent income on your rental entity can help with the ATI calculation for 2022 and beyond. If taxable income increases, the ATI does, too. We recommend planning for the tax year 2022 today. Being proactive with the tax law is your best approach.

To be completely thorough, there are a couple of items for your dealership to pay attention to -- the impact on your working capital and net worth requirements. You can reach out to Steve Barber or any of our SD Auto Advisors to discuss this further.