Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

and accessories with profit center costing allocations. They often have related used car and truck
ventures usually resulting from trade-ins for new vehicles sold. These trade-ins may be accounted
for under the LCM method discussed previously. Certain items are accounted for under the
specific identification method due to rarity, such as repossessions. It is recommended that all
inventories be scrutinized as they have a material impact on taxable income and could be used
incorrectly.
Example 3
Jumbo Auto is a large new auto dealership (Form 1120S) that maintains a separate lot down
the street for used cars and trucks. These vehicles are acquired through trade in by customers
purchasing their new vehicles. The lot does not always have an attendant and the dealership
typically sells about 30 percent of the used cars to walk-ons and the other 70 percent to auto
auction companies. The books revealed a LCM write down in the year under audit of
$100,000 entered as an Adjusting Journal Entry at yearend. Supporting information was
requested which showed mark-downs conforming to "low" blue book. Car jackets were
requested to sample the vehicles and it was noted that most of them were sold in early January
to the auctioneer. The rest of the jackets were requested. Of the 50 vehicles in inventory, 40
were written down and 30 were sold in January of the subsequent year. The taxpayer stated
that mark-downs were done in accordance with Treas. Reg. section 1.471-2(c).
Although the mark-down was computed at the end of the taxable year when the vehicles were
in inventory, lower of cost or market from a valuation guide was used for the computation
when better information was available. Namely, the sales price. Given that the vehicles were
sold in an arms-length transaction, and that the sale occurred so close in proximity to the end
of the taxpayer’s taxable year when "valuation" occurred, the sales price represents market,
California Canneries Co., 2 B.T.A. 109 (1925), acq., for the prior period given that the
industry did not incur a major decline in the short period, Estate of Charles Stearns v.
Commissioner, 8 B.T.A. 884 (1927); Abbeville Cotton Mills v. Commissioner, 10 B.T.A.
646, (1928) acq; Willard Mfg Co. v. Kennedy, (1940, CA2) 109 F.2d 83, cert. denied, (1940,
S Ct) 311 U.S. 660 (1940). The LCM adjustment should be recalculated using the sales price
in lieu of the "low" blue book amount for the vehicles sold in January.
The various methods of inventory valuation and the authority for utilizing them are:
1. First-in, First-out (FIFO), Treas. Reg. section 1.471-2(d)(2)
2. Lower of Cost or Market (LCM), Treas. Reg. section 1.471-2(c)
3. Specific Identification, Treas. Reg. section 1.471-3
4. Last-in, First-out (LIFO), Treas. Reg. section 1.472
FIFO is only advantageous in a deflationary economy, and historically the United States economy
has exhibited inflationary tendencies. LCM on the other hand, offers an attractive method for
handling used vehicles since their value at the end of the year may be less. Most, if not all,
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