Most automobile dealerships value at least some part of their inventory using the Last-In-FirstOut (LIFO) accounting method. In periods of rising prices and stable inventory levels, LIFO usually results in a deferral of income by an increase in the cost of goods sold. When prices are falling and/or inventory levels decline, the opposite can happen – that deferral of income reverses; this is known as LIFO recapture. Historically low inventory levels brought on by the COVID-19 pandemic, subsequent recovery of demand and now chip shortages, coupled with the potential that low levels may persist through the end of 2021, are a potential threat for LIFO recapture this tax year. Depending on the magnitude of the inventory decrease from 2020 to 2021, this recapture could be significant. To prepare for this possible recapture, dealers can start modeling now to assess the materiality of the issue and their specific situation. During the onset of the COVID-19 pandemic, consumers were not buying new vehicles or trading in old ones. So, the market saw concurrent suppressed demand and supply in the dealership industry. At the same time, demand for consumer electronics swelled, and chip producers reallocated production to fill that need. Now that the U.S. economy is rebounding and shoppers are heading back to dealerships, the reallocation of production back to automotive supply chains is sluggish. Additional recent setbacks include a power outage, a production pause and a fire at various chip manufacturing plants. The fragility of the supply chain continues to plague dealerships. It is also possible that long-term reliance on outdated technology was triggered at the onset of the pandemic. Requests have been made to the Department of Treasury and the Internal Revenue Service to consider a LIFO “Holiday” to postpone LIFO recapture until inventory levels return to normal. Organizations like the National Automobile Dealers Association (NADA) are advocating for LIFO relief policies, specifically asking for Internal Revenue Code Section 473 relief by arguing that the COVID-19 pandemic has caused a qualified inventory interruption. Under Section 473, taxpayers would not What a Decrease in Inventory Means for Your LIFO Reserve By Jon Gee, Partner, DHG Dealerships 36
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