Why LIFO Might Be the Smart Move for Auto Dealerships Right Now
Published on by Chad Martin in Automobile Dealerships
Inventory level issues have impacted automobile dealerships at a historic rate – not only new vehicles for sale, but also used ones available. And yet dealerships are seeing record profit levels thanks to creative new ideas and strategic business practices.
One key idea that auto dealerships should consider now is converting to the Last In, First Out (LIFO) inventory method. In this post, we’re digging into where, why, and how this change might make sense.
The backstory
Automobile manufacturing slowed dramatically as the pandemic took hold and caused major supply chain issues still prevalent today with microchip shortages, and that made getting vehicles onto the auto dealers’ lots much more challenging. Dealers have struggled to find inventory – we see half-empty lots and front-line displays consisting of used vehicles. The scarcity has caused a lot of concern among buyers, who struggle to find the vehicle they want with the options they want in the color they want. That has driven up prices – and profit margins, as the need to offer incentives falls by the side of the road.
What that means for LIFO dealerships
The lower volume of new vehicles and inability to replenish inventory has meant a big LIFO recapture for dealers using the LIFO method as they’ve been forced to take high levels of income into a single year – but there’s help on the horizon as The National Automobile Dealers Association (NADA) is working with the U.S. Department of the Treasury to get some relief for these dealerships.
NADA has been advocating for the U.S. Department of Treasury and IRS to provide relief under Section 473 – foreign trade interruptions – which would allow dealerships multiple additional years to replenish inventory. They’re also discussing a retroactive adjustment that would eliminate the need to file an amended tax return. Essentially, the extra tax the dealerships paid on that LIFO recapture would be a prepayment of taxes for the following year. We’re watching the negotiations diligently, and keeping our dealership clients apprised.
Creativity and strategy shine through
Auto dealerships have been incredibly resilient through high inflation, rising interest rates, declining GDP over the first two quarters of 2022, and other factors that are driving consumers to hold onto their vehicles longer. The average age of vehicles on the road has been climbing as consumers have been unable or unwilling to replace them. That sounds like bad news for dealerships – but resilience and strategic business planning are shining through.
Core operations – service departments, body shops, financing – are at record levels. That makes sense because the average vehicle age is much older, but it’s more than simple business conditions: dealerships have been very creative in finding ways to be profitable. It’s just coming from different sources.
New life for LIFO
If you’re thinking of electing LIFO for your auto dealership, there are some factors you’ve got to consider. If you’re planning on selling the dealership in the near future, a switch to LIFO may not make sense because you’d have to take back all the tax savings you’ve had over the roughly three-to-five-year period that your business was operating before the ownership change.
But if you have a younger owner that really plans on growing the dealerships, electing LIFO can be a great way to minimize your tax burden.
Short-term pain. Long-term gain.
There’s a little more work involved in adopting LIFO, but if it’s the right fit for your business, the long-term gain more than makes up for the short-term pain through taxes and deductions you’ll be getting year after year. And why is now the right time? Because inventories are at an all-time low, and in the right situation, the advantages can be amazing.
Is LIFO right for your auto dealership?
Our auto dealership financial pros have more than 30 years of helping clients achieve amazing results. Whether you’re considering LIFO or have another issue you’re exploring, our team is here and ready to help. Contact us for a free consultation – we’re here to help you drive forward.