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Tax Court Rejects Dealer's Use of Replacement Cost to Value LIFO Inventory

The IRS successfully challenged a dealer's use of the replacement cost of truck parts
purchased for resale, as opposed to actual cost, to value its LIFO inventory.

Tax Court Rejects Dealer's Use of Replacement Cost to Value LIFO Inventory

In 1980 Mountain State Ford, a heavy-duty truck dealer, adopted the LIFO (last in, first out) method of valuing its inventory of truck parts purchased from Ford for resale to the dealer's customers. In its LIFO election filed with the Internal Revenue Service, the dealer stated its intention to take parts inventory "at actual cost regardless of market value" and determine the cost of parts in the closing inventory on the basis of the most recent purchases method, which requires cost to be determined by reference to the actual cost of the goods most recently purchased. (Mountain State Ford Truck Sales, Inc. v. Commissioner of Internal Revenue, 112 TC 7)

However, after having elected the LIFO method, the dealer continued to use replacement cost (as opposed to actual cost) in valuing its parts inventory. Specifically, each part was valued at its replacement cost, i.e., the price shown on the dealer net price list published by Ford for that part as of the date of the physical inventory. Mountain State Ford continued to use replacement cost in valuing its parts inventory because it had used that method prior to adopting the LIFO method and this method was commonly used by the heavy truck dealer industry.

Following an audit in 1991, IRS found the dealer's method of using replacement cost, instead of actual cost, in determining the current year cost of its parts pool violated the tax code rules on valuing LIFO inventories and consequently this method did not clearly reflect income. As a result, the cost of goods sold reported in Mountain State Ford's 1991 tax return should be reduced, and ordinary income reported in that return should be increased, by $463,000 - - the amount of the LIFO reserve calculated over the period 1980 through 1990.

The U.S. Tax Court agreed with the IRS, finding no abuse of discretion in determining that Mountain State Ford's method of using replacement cost in valuing its parts inventory under the LIFO method did not clearly reflect income.

 

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