IRS Provides Replacement Cost Safe Harbor for Heavy Equipment Dealers

In January 2006, the IRS issued Rev. Proc. 2006-14, which provides heavy equipment dealers with a safe-harbor accounting method for using the replacement cost method for valuing heavy equipment parts inventory. The procedure also provides guidance on an automatic method change to the replacement cost method.

The guidance is the result of several years of industry analysis and controversy. In 1999, the Tax Court held in Mountain State Ford, 112 TC 58 (1999), that the use of replacement cost to value current-year inventory of heavy equipment parts was not a permissible method for a LIFO taxpayer. Subsequent to that decision, the IRS began considering circumstances specific to automobile dealers, such as industry practice, the use of replacement cost required by third parties, the administrative burden of switching to actual cost and the close correlation to replacement cost and actual cost in this industry. As a result, it released Rev. Proc. 2002-17, which permitted a safe-harbor method of using replacement cost to determine the cost of vehicle parts inventory for automobile dealers. Under the procedure, the Service was willing to consider similar requests from other industries to use a safe-harbor replacement-cost method.

Accordingly, the Service has concluded for reasons of administrative convenience and burden reduction that the use of replacement cost as an accounting method for determining the cost of heavy equipment parts in inventory is permissible.

A heavy equipment dealer is de-fined as a taxpayer who sells new heavy equipment under an agreement with one or more heavy equipment manufacturers or distributors, and earns a majority of its revenue from the sale (or sale and lease) of new heavy equipment. Replacement cost is defined as an amount provided in a standard price list at which a heavy equipment part may be purchased by the taxpayer on the date of the inventory.

A taxpayer within the scope of this revenue procedure and which is using the replacement cost method on Jan. 4, 2006 may continue to use it for tax years ending after April 29, 2005 without filing for a change in accounting method.

The revenue procedure does require book conformity. In addition, it provides audit protection for taxpayers using this safe-harbor method for tax years ending before April 30, 2005. If the issue is currently under consideration in an audit for tax years ending before April 30, 2005, the issue will not be further pursued by the Service.

Taxpayers within the revenue procedure’s scope and which are not currently using the replacement-cost method may do so for tax years ending after April 29, 2005, generally by requesting an automatic accounting-method change.

From Catherine M. Fox, CPA, MST, Dallas, TX, and John F. Salza, J.D., Milwaukee, WI