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

(existing items) and non-comparable items vary in their characteristics and cost.
Since this is a facts-and-circumstances issue and the taxpayer is allowed to use reasonable
means to reconstruct, the examiner should make every effort to resolve this type of issue.
Another issue that has come up in this area is whether a taxpayer may retroactively
reconstruct the cost of a new item where the current year cost was used for that item as the
base-year cost when the returns were filed. In the particular case where this issue arose, the
taxpayer proposed this and requested a large refund during the examination.
How an item is valued would appear to be a method of accounting and any change in how that
item is valued would be a change in method of accounting. Treas. Reg.
section 1.446-1(e)(2)(ii)(a) states in part, "* * * Changes in method of accounting include
* * * a change involving the method or basis used in the valuation of inventories * * *."
A taxpayer in the business of manufacturing diamond rings reconstructed the base-year cost of
new diamonds by comparing them to a higher quality diamond. The Service held that the
correction of the base-year cost of an item constitutes a change in method of accounting that
could only be done prospectively. See IRC section 446 and the corresponding regulations,
Hamilton Industry, Inc., Successor of Mayline Company, Inc. and Subsidiary v.
Commissioner, 97 T.C. 120 (1991) and Rev. Rul. 90-38, 1990-1 C.B. 57.
The next few paragraphs reference the Motor Vehicles Industry Specialization Program’s
coordinated issue paper "Dollar Value LIFO – Definition of an Item". For more detail please
refer to the full text.
An item of inventory is defined, for purposes of calculating the value of the taxpayer's
inventory under the dollar-value LIFO method as authorized by Treas. Reg. section 1.472-8,
is defined by reference to a particular vehicle as to make, year, model, body style, standard
equipment, options, and other factors.
Treas. Reg. section 1.472-8(e)(2)(i) provides that under the double-extension method, the
quantity of each item in the inventory pool at the close of the taxable year is extended at both
base-year unit cost and current-year unit cost. Under the link-chain method, the quantity of
each item in the inventory pool at the close of the taxable year is extended at both the
beginning-of-the-year unit cost and the end-of-the-year unit cost. Neither the Code nor the
regulations define what constitutes an item.
The tax court in Wendle Ford Sales, Inc. v. Commissioner, 72 T.C. 447(1979), determined
that 1975 Fords with solid-state ignitions and catalytic converters were not new items when
compared to 1974 Fords that did not have solid-state ignitions and catalytic converters.
Whether or not a Ford had either of these features was determined by the manufacturer. Their
cost was never separately stated on the dealer's invoice. The court decided that the entire car
was the item and not the individual components or parts.
While it may not be possible to compare all of the aspects of vehicles on hand at the end of 2
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