NADA, along with the help of dealership and CPA firm representatives, was successful in obtaining a uniform capitalization (UNICAP) victory for automobile dealerships. This victory came November 9, 2010 in the form of Revenue Procedure 2010-44, which provides two safe harbor methods for capitalizing costs related to inventory.
This is a big win for dealers because the new safe harbor methods resolve many contentious tax issues raised by a 2007 IRS technical advice memorandum (TAM 200736026) that could have cost dealers thousands of dollars in additional taxes.
Background on UNICAP
The original tax law that was enacted in 1986 generally required retailers and producers to capitalize certain direct and indirect costs related to inventory. Costs required to be capitalized included direct acquisition costs, as well as indirect purchasing, handling and storage costs. The original law did not provide clear guidance on the subject for automobile dealerships. This lack of guidance led to years of scrutiny by the IRS and the ultimate issuance of the 2007 TAM stating the IRS’s position on dealership UNICAP.
New Safe Harbors
Revenue Procedure 2010-44 now provides dealerships two safe harbor UNICAP methods: (1) the retail facility safe harbor method and (2) the reseller without production activities safe harbor method.
The “retail facility safe harbor” method provides that a dealership may treat its entire sales facility from which it normally and routinely conducts on-site sales to retail customers, including any lot that is an integral part of its sales facility and that is routinely visited by retail customers, as a retail sales facility. Accordingly, a dealership using the retail sales facility safe harbor can elect to deduct (versus capitalize) all storage and handling costs incurred at such dealership facility.
Under the “reseller without production activities safe harbor” method, a dealership may treat itself as a reseller without production activities. Specifically, the revenue procedure provides that activities that a dealership performs on dealership-owned and customer-owned vehicles are handling activities that would be deductible to the extent they are incurred at the dealership retail sales facility. As a result, dealerships would be able to deduct the cost of all labor performed by the dealership on customer and dealer-owned vehicles. In addition to this election, a dealership is also allowed to make a correction to exclude the amount of “internal profit” remaining in inventory at year-end, i.e., internal mark-ups on parts and service work on new or used inventory.
In addition to making the elections for the current-year costs, a dealership would get a one-time deduction for any cumulative handling and storage costs capitalized in prior years.
Who Should Elect
All dealerships should elect the new safe harbor methods even if their current UNICAP method is consistent with the treatment in the new rules. Without a properly filed election, a future IRS audit could subject a dealership to the harsh methods outlined in the 2007 TAM.
How and When to Elect
Dealerships can elect the new safe harbor methods for the tax year 2010 by filing a Form 3115, Application for Change in Accounting Method, with the IRS. Under the automatic consent provisions, dealerships would attach one copy of the form to their filed 2010 tax returns (generally filed by March 15, 2011, or later if extended) and send one copy separately to the IRS. There is no filing fee due with the form.
For dealerships using a current method not consistent with the new safe harbor methods, it might be beneficial to file a Form 3115 before December 6, 2010, which is the date the IRS’s current audit suspension on UNICAP ends.
Once a Form 3115 has been properly filed, a dealership will have audit protection for the current year’s and all previous years’ UNICAP calculations.
Other Items to Consider
Is the Dealership Subject to UNICAP?
Small resellers whose average gross receipts do not exceed $10 million for the three taxable years preceding the tax year in which they acquire personal property for resale are exempt from the UNICAP rules. The term “gross receipts” means the total received from all of the dealership’s trades or businesses. This amount is not reduced by any sales returns or allowances, nor does it include investment income, proceeds from the sale of capital assets, or other receipts from transactions not in the ordinary course of business. If your dealership is a member of a controlled group of corporations, the gross receipts test will be applied to the total gross receipts for the group. Be sure to take advantage of this UNICAP exemption if your dealership does qualify as a small reseller.
Capitalizing Purchasing Costs
Although the new safe harbor methods eliminate the need to capitalize storage and handling costs for retail sales facilities, dealerships might still be required to capitalize purchasing costs. A review of the purchasing costs rules and special methods available, i.e., one-third/two-thirds rule, should be made to see what costs, if any, the dealership is required to capitalize.
Under the one third/two-thirds rule, if less than one-third of a person's activities relate to purchasing, 100 percent of that person's labor costs must be treated as non-purchasing. If two-thirds or more of a person's activities relate to purchasing, then 100 percent of that person's labor costs must be treated as purchasing (inventoriable) costs. In all other cases (one-third to two-thirds), an allocation must be made. This formula is entirely elective; once made, however, this election is binding upon the dealership for all future periods. The result of the election is that in any given year a dealership might not have any purchasing costs to capitalize if no person spends more than one-third of his or her time in purchasing activities.
Lastly, dealerships might still be required to capitalize storage and handling costs if they do not qualify as a “retail sales facility” under the new methods. This might be the case if a dealership has a storage lot facility, for example, that is not routinely visited by retail customers.
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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.