Issue Date: Dealer Business Briefing Feb 1, 2010, Posted On: 2/5/2010
Tax issues with dealership loaners Most car dealers over the course of time have provided their customers with loaner vehicles for use while the customer's vehicle is being serviced. This became such an accepted practice in the industry that the OEMs instituted programs to provide vehicles to the dealers for the sole purpose of loaning them to customers while their personal vehicles were being serviced.
These factory programs required dealers to purchase vehicles for the purpose of having a fleet of vehicles available for their customers. These vehicles are financed and placed into loaner service for a period of twelve months or less. On the dealer's balance sheet these vehicles show up as either fixed assets or inventory and any interest on the note is expensed. It is a common practice for dealers to write down the loaners at 2% per month for tax purposes. At the end of the vehicle's loaner service, it enters the dealer's used car inventory.
From an accounting standpoint:
Should these loaner vehicles be recorded in inventory or should they be titled and placed into service as a fixed asset subject to depreciation?
If the loaner vehicles are fixed assets, should the vehicles' depreciable life be limited to the luxury auto depreciation limits of IRC Sec 280F?
The Internal Revenue Service's position is that the dealer is not in the business of providing loaner vehicles to its customers. Furthermore, the provision of complimentary loaner vehicles is not "the transportation of persons or property for compensation or hire" (Motor Vehicle Technical Advisor, January 2009). While the Code uses this language in accepting certain "trades or businesses" from the luxury automobile depreciation limitation it should not be all encompassing.
There is no question that an automobile dealer is in the business of selling of goods or services. The dealer is in the business of selling new and used vehicles, parts and service to its customers. As part of the business of servicing customer vehicles the manufacturer imposes on the dealer and the manufacturer measures the dealer's CSI (Customer Satisfaction Index), therefore, the lending of vehicles to its customers becomes part of the dealer's business.
Numerous issues arise when these vehicles are titled and considered company vehicles. The vehicles would be fixed assets subject to depreciation. In calculating each vehicle's depreciation the dealer must consider the vehicle's life (5 years), determine the vehicle's date placed in service and consider whether the vehicle is subject to depreciation limitations for passenger automobiles. In addition, as a fixed asset state jurisdiction would mandate that a sales/use tax should be paid on the value/cost of the loaner vehicle.
The potential for the dealership being sued is enormous should one of the dealership's customers driving a loaner vehicle be involved in an accident.
The loaner vehicles should be recorded as the dealer's fixed assets. The dealership may purchase the vehicles from the OEM and transfer them to a separate rental company, or the owners may create a new entity and obtain a floor plan for the purpose of purchasing the loaner vehicles directly from the manufacturer. The rental company receives the vehicles for use in its business of renting vehicles. In the hands of the rental company the vehicles are tangible personal property and should be depreciable for tax purposes.
Setting up a new entity to hold the dealership's loaner vehicles has three very important functions:
It opens a new profit center, that of a business operating as a rental company,
It saves the dealership the upfront layout of cash for sales tax when the vehicles are titled by the dealership, and
Avoidance of potential liability when these vehicles are rented to dealership customers.
Vehicles purchased exclusively for the purpose of renting are considered as purchased for resale and are exempt from sales tax. Only the amount charged the customer for the rental of the vehicle is taxable for sales tax.
The rental company would take the depreciation expense and offset it with rental income that it receives from the dealership and other outside sources. It is important that the rental company be treated as a totally separate business both in fact and in appearance in order to take advantage of these benefits.
Cars and light general purpose trucks as well as heavy general purpose trucks are classified as 5-year property and are depreciated under MACRS.
Internal Revenue Code Section 167 provides that "there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) (1) of property used in the trade or business, or (2) of property held for the production of income." Internal Revenue Code Section 168 provides the method of determination of the Section 167(a) depreciation deduction for tangible property such as automobiles.
Internal Revenue Code Section 280F provides three exceptions to the term "passenger automobiles:" (1) any hearse, ambulance or combination ambulance-hearse used in a trade or business, (2) any vehicle used by the taxpayer directly in the trade or business of transporting persons or property for compensation or hire and (3) under regulations, any truck or van.
In Rev. Rul. 75-538, 1975-2 C.B. 35, the taxpayer was a car dealer seeking to depreciate certain motor vehicles which were temporarily used as "demonstrators." The revenue ruling states that a taxpayer engaged in such a business is presumed to hold all vehicles for sale to customers in the ordinary course of the taxpayer's business. The ruling provides that to overcome this presumption it must be clearly shown that the vehicle was actually devoted to use in the business of the dealer and that the dealer looks to consumption through use of the vehicle in the ordinary course of business operations to recover the dealer's cost. The ruling also provides that a vehicle is not property used in the business if it is merely used for demonstration purposes, or temporarily withdrawn from stock-in-trade or inventory for business use.
For a real life example, Duval Motor Co. v. Commissioner is cited by the revenue ruling discussed above. Duval concerns automobiles removed from inventory by a car dealer and provided to company officials and salesmen for the purpose of stimulating interest in all of the dealer's cars, what the rest of us call "demos." The court concluded that at all times these demos were held primarily for sale to customers in the ordinary course of the car dealer's business and, therefore, were not depreciable. However, the court noted that if a car dealer takes cars out of inventory and puts them to the use for which a car is intended in the hands of its ultimate consumer, that is, transporting personnel, and commits them to that purpose in the operation of the business, the car dealer is entitled to depreciate the cars.
So don't place loaners into your regular dealership inventory. They must be placed into service as fixed assets subject to depreciation. Passenger vehicles when used in a rental business are personal tangible assets classified as 5-year property and are depreciated under MACRS rules without the limitations of Sec. 280F(a).
Irving Janowitz is a tax partner with the accounting and consulting firm of Mironov, Sloane & Parziale, LLC located in Edison, NJ.