By Ira Silver, CPA, CGMA, Principal, MBAF LLC
The resiliency of the auto industry as proven by the rebound experienced in the past few years has been very good for dealerships. According to the latest Wards Auto forecast, some 1.51 million light vehicles will be sold in December, putting the SAAR at 16.95 million units.
Such indications of solid growth have also had another effect on the overall rebounding economy — the attraction of outside investors who see the purchase of auto dealerships as a smart move.
While most buy-sell arrangements still occur dealer to dealer, increasingly high-net worth individuals, private equity firms, and even some well-known publicly traded entities, are looking to invest in retail dealerships. Outside investors are catching on to the fact that the auto retail sector has proven to be almost recession- proof, and is capable of generating tremendous wealth and high long-term returns on investment.
One of the most high-profile examples of these outside investor deals is the recent announcement of Warren Buffett’s Berkshire Hathaway Inc.’s agreement to purchase the country’s largest privately owned U.S. auto dealership group, the Van Tuyl Group. While the exact terms of the purchase were not disclosed, Buffet told CNN in an interview it would be an “all cash” deal.
In the same interview, Buffet said he full well expects to buy more dealerships over time. What usually attracts investors of Berkshire’s level is industries that can expand rapidly through M&A, which is something auto retail has proven in the currently robust buy-sell market.
Audits, Image Upgrades & Valuations
If all of the growth and success in auto retail is attracting a lot of cash from well-heeled investors, such transactions also attract the attention of the IRS.
The Internal Revenue Service understands that there are specific audit and valuation concerns relevant to particular industries. To deal with these, the IRS has in place a “Market Segment Specialization Program.” Under the guidelines of the program, IRS examiners are provided with specialized audit techniques, guidance, and key areas upon which to concentrate relevant to the given industry.
The attention of the program began targeting auto dealers approximately two years ago, which, not surprisingly, coincides with the start of the burgeoning M&A market. An examination guide for IRS auditors was issued which indicates the areas that auto dealers need to be concerned about should they ever be subject to an audit. Areas of concern are goodwill & real estate valuations for estate valuation purposes and real estate upgrade money paid by the manufacturer.
As the value of your property and blue sky increase, it’s certainly time to meet with your estate attorney or CPA and determine how to reduce any potential estate taxes in the future. It’s particularly important to meet prior to buying or selling your dealership.
Another area of particular concern has to do with the value of your dealership’s real estate, and what may be considered as “income” created by improvements to your property with money received by the manufacturer.
Manufacturers often incentivize, or reimburse dealerships for improvements that may be made for improving the “image” of your dealership or for building a new facility.
Furthermore, if your manufacturer pays you to relocate your dealership to a better neighborhood where it is assumed you will be more profitable, then the manufacturer intends to receive a “tangible benefit” from the move, and therefore in this case, that payment would be considered ordinary taxable income, not a reduction of the building or land cost.
As you can see this can be a complicated area of valuations and tax law, and one that IRS tax examiners are specifically trained to scrutinize.
It is not uncommon for a dealership to make image improvements prior to entering into a buy-sell arrangement. Despite the complexity, where there is no “gray area,” regardless of who is paying for your move, or for image upgrades and improvements, if they stand to get anything in return for their investment, then anything you receive is considered taxable income.
An IRS Memorandum issued on the subject in May of 2014 stated, “The dealerships, not the manufacturers, own the property that the dealerships construct or improve with payments. Under these facts, the dealerships receive payments to defray their expense for construction of, or improvements, to their property. Therefore, the dealerships have an accession to wealth over which they have complete dominion and control.”
With the eyes of the IRS Market Segment Specialization Program already focused on the auto retail sector, it only stands to reason that we can expect increased scrutiny ahead, especially now with all of the interest of third party investors in dealerships coming into the mix.
Conclusion
The bottom line is that growth, expansion and investments by third parties in the auto dealership arena is a good thing. However, where the investment money goes, so goes the scrutiny of the IRS, so now more than ever it is critically important to have a qualified tax attorney and CPA who specializes in your industry as part of your M&A team.
Ira Silver, CPA, CGMA, is a principal in the Tax and Accounting Department at MBAF and is the principal-in-charge of the firm’s Orlando office. Ira has been in the public accounting profession since 1982. He can be reached at (407) 781-0150 or isilver@mbafcpa.com
