IRS Says Car Dealers May Use Replacement Cost Method For Vehicle Parts.

Rev. Proc. 2002-17

SECTION 1. PURPOSE

This revenue procedure provides automobile dealers (as defined in section 3 of this revenue procedure) with a safe harbor method of accounting for their vehicle parts inventory. This safe harbor method permits automobile dealers to approximate the cost of their vehicle parts inventory using the replacement cost of the vehicle parts pursuant to the replacement cost method described in section 4 of this revenue procedure. This revenue procedure also provides procedures for automobile dealers to obtain the automatic consent of the Commissioner to change to the replacement cost method.

SECTION 2. BACKGROUND

.01 Section 471 of the Internal Revenue Code provides that inventories must be taken on such basis as the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting income.

.02 Section 1.471-3(d) of the Income Tax Regulations provides that in any industry in which the usual rules for computation of cost are inapplicable, cost may be approximated upon such basis as may be reasonable and in conformity with established trade practice in the particular industry.

.03 Section 472(a) provides that a taxpayer may use the last-in, first-out (LIFO) inventory method. Under the LIFO inventory method, a taxpayer treats those goods remaining on hand at the close of the taxable year as being: First, those included in the opening inventory of the taxable year (in the order of acquisition) to the extent thereof, and second, those acquired in the taxable year. The change to, and use of, the LIFO inventory method must be in accordance with such regulations as the Secretary may prescribe as necessary in order that the use of such method may clearly reflect income.

.04 Section 472(b)(2) provides that a taxpayer using the LIFO inventory method must inventory its goods at cost.

.05 Section 1.472-8(a) provides that a taxpayer may elect to determine the cost of its LIFO inventories under the dollar-value LIFO method, provided such method is used consistently and clearly reflects the income of the taxpayer in accordance with the rules of that section.

.05 Section 1.472-8(e)(2)(ii) provides that the total current- year cost of items making up a dollar-value LIFO pool may be determined: (a) by reference to the actual cost of the goods most recently purchased or produced; (b) by reference to the actual cost of the goods purchased or produced during the taxable year in the order of acquisition; (c) by application of an average unit cost equal to the aggregate cost of all the goods purchased or produced throughout the taxable year divided by the total number of units so purchased or produced; or (d) pursuant to any other proper method which, in the opinion of the Commissioner, clearly reflects income.

.06 Section 263A generally requires direct costs and an allocable portion of indirect costs of certain property produced or acquired for resale by a taxpayer to be included in inventory costs, in the case of property that is inventory, or to be capitalized, in the case of other property. Section 1.263A-1(e)(2)(ii) provides that resellers must capitalize the acquisition costs of property acquired for resale. In addition, resellers must capitalize the indirect costs described in §1.263A-1(e)(3), which are properly allocable to property acquired for resale. These indirect costs often include purchasing, handling, and storage costs. See § 1.263A-3(c)(1).

.07 In Mountain State Ford v. Commissioner, 112 T.C. 58 (1999), the Tax Court held that a taxpayer that sold heavy truck parts and used the dollar-value LIFO method to account for its parts inventory was not entitled to determine the current-year cost of the parts in its ending inventory by reference to their replacement cost. In so doing, the court found that the taxpayer's replacement cost method was not in accordance with the method elected on its Form 970, Application to Use LIFO Inventory Method. The taxpayer's Form 970 indicated that it would determine the current-year cost of the items in its ending inventory by reference to the actual cost of the goods most recently purchased or produced in accordance with § 1.472- 8(e)(2)(ii)(a). The court further concluded that even if the taxpayer had elected to use another proper method under § 1.472- 8(e)(2)(ii)(d), it could not use the replacement cost of the parts to determine current-year cost because replacement cost does not determine current-year cost on the basis of, or by reference to, actual cost (or in some instances a reasonable approximation of actual cost) in accordance with § 472(b).

.08 Subsequent to the Mountain State Ford decision, the Service has given careful consideration to the following unique circumstances surrounding the use of replacement cost by automobile dealers:

This revenue procedure applies to any taxpayer that is engaged in the trade or business of selling vehicle parts at retail and that is authorized under an agreement with one or more vehicle manufacturers or distributors to sell new automobiles or new light, medium, or heavy-duty trucks ("automobile dealer").

SECTION 4. REPLACEMENT COST METHOD

.01 In General. A taxpayer that is within the scope of this revenue procedure is permitted to use the replacement cost method to approximate the actual cost of its vehicle parts inventory. Under the replacement cost method, a taxpayer must determine the cost of the vehicle parts in its inventory by reference to the replacement cost of the vehicle parts as defined in section 4.02 of this revenue procedure, determine the replacement cost using a standard price list as defined in section 4.03 of this revenue procedure, and satisfy the book conformity requirement as described in section 4.04 of this revenue procedure. Taxpayers within the scope of this revenue procedure may use the replacement cost method in conjunction with either the first-in, first-out inventory method or the LIFO inventory method. Taxpayers that use the replacement cost method provided by this section 4 and that are subject to the provisions of § 263A must include in inventory costs the additional amounts that are required by §§ 1.263A-1 and 1.263A-3 (e.g., freight costs).

.02 Replacement Cost. Replacement cost means the amount provided in a standard price list at which a vehicle part may be purchased by the taxpayer on the date of the inventory. If, on the date of the inventory, the vehicle part is not provided in a standard price list, the replacement cost for the part is equal to the last amount provided in a standard price list (i.e., the price at which the part was last offered for purchase in a standard price list).

.03 Use of Standard Price List. A "standard price list" is a price list that is widely recognized and used for business purposes in the automobile dealer industry and that is used by the taxpayer in the ordinary course of its business to purchase the vehicle parts for which it is determining the cost.

.04 Book Conformity. A taxpayer satisfies the book conformity requirement if it determines the cost of vehicle parts in its inventory using the replacement cost of the vehicle parts as defined in section 4.02 when it ascertains the income, profit, or loss of its trade or business for purposes of its books, records, and reports (including financial statements) to its shareholders, partners, other proprietors, beneficiaries, and creditors.

SECTION 5. AUDIT PROTECTION FOR TAXPAYERS CURRENTLY USING THE REPLACEMENT COST METHOD

A taxpayer within the scope of this revenue procedure that is using the replacement cost method provided in section 4 of this revenue procedure on March 12, 2002, may continue to use this safe harbor method for taxable years ending on or after March 12, 2002, without filing a Form 3115, Application for Change in Accounting Method. Such taxpayer's method of using replacement cost to determine cost for its vehicle parts inventory will not be raised as an issue in a taxable year that ends before December 31, 2001. Moreover, if such taxpayer's method of using replacement cost to determine cost for its vehicle parts inventory is already an issue under consideration in a taxable year that ends before December 31, 2001, the issue will not be further pursued.

SECTION 6. CHANGE IN METHOD OF ACCOUNTING

.01 In General. A change to the replacement cost method provided by this revenue procedure is a change in method of accounting to which the provisions of § 446 and the regulations thereunder apply. Therefore, a taxpayer within the scope of this revenue procedure that does not use the replacement cost method provided in section 4 of this revenue procedure on March 12, 2002, but wants to use this safe harbor method for a taxable year ending on or after December 31, 2001, must file a Form 3115.

.02 Automatic change to the replacement cost method. A taxpayer within the scope of this revenue procedure that wants to change its method of determining cost to the replacement cost method provided by this revenue procedure must follow the automatic change in accounting method provisions of Rev. Proc. 2002-9, 2002-3 IRB 327, with the following modifications:

SECTION 7. RECORD KEEPING

Section 6001 provides that every person liable for any tax imposed by the Code, or for the collection thereof, must keep such records, render such statements, make such returns, and comply with such rules and regulations as the Secretary may from time to time prescribe. The books or records required by § 6001 must be kept at all times available for inspection by authorized internal revenue officers or employees, and must be retained so long as the contents thereof may become material in the administration of any internal revenue law. Section 1.6001-1(e). In order to satisfy the record keeping requirements of § 6001 and the regulations thereunder, a taxpayer that uses the replacement cost method should maintain records supporting all aspects of its inventory valuation including, but not limited to, the price list described in section 4 of this revenue procedure.

SECTION 8. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 2002-9 is modified and amplified to include this automatic change in section 10.02 of the APPENDIX.

SECTION 9. EFFECTIVE DATE

This revenue procedure generally is effective for taxable years ending on or after December 31, 2001.

DRAFTING INFORMATION

The principal author of this revenue procedure is Scott Rabinowitz of the Office of Associate Chief Counsel (Income Tax & Accounting). For further information regarding this revenue procedure, contact Mr. Rabinowitz at (202) 622-4970 (not a toll-free number).