Loaner Vehicles Subject to Depreciation Under New IRS Interpretation
The IRS says loaner vehicles should be subject to the depreciation limitations for luxury vehicles imposed by Internal Revenue Code (IRC) Section 280F:
Limitation on depreciation for luxury automobiles. Dealers and manufacturers, especially those in the luxury category, could be negatively affected by this change.
“The IRS recently has taken the position that auto dealership service loaners qualify as ‘luxury vehicles,’ even though the law hasn’t formally changed,” says Jason Duffner, a dealership principal with LarsonAllen. “This redefinition severely limits the amount of depreciation on these vehicles, and as a result, dealers need to be able to show that loaner vehicles are for-profit business assets.”
Most dealerships have loaner vehicles available for customers to use while their vehicles are being serviced, and several luxury manufacturers require franchised dealerships to maintain loaner vehicles on site for this purpose. If the IRS applies section 280F of the IRC code to loaner vehicles, the depreciation deduction is significantly limited on vehicles with costs above the “luxury” vehicle cutoff. Recent tax depreciation incentives, such as the expanded expensing election under IRC Section 179 and bonus depreciation under IRC Section 168(k), would also be severely restricted and in some cases eliminated.
What does the IRS call a “luxury vehicle”?
“The IRS’s definition is a much lower priced vehicle than most people would associate with the word luxury,” Duffner says.
It generally defines a luxury vehicle as any car having a purchase price of $14,800 or any truck or SUV having a purchase price of $15,800. Based on this definition, a substantial number of loaner vehicles and dealerships could be affected.
Can I avoid these limitations?
Dealers need to be able to show that 1) the service loaner program is entered into with a profit motive, and 2) this portion of the dealership activity is more closely tied to a rental or leasing for-profit activity, if they hope to avoid the tax penalty.
“Loaner use as commonly structured in most dealerships will not be considered for-profit in many situations. You will be surprised at the IRS position on this,” Duffner says.
Under 280F, dealers need to prove they are “regularly engaged in the business of leasing” to avoid penalty.
“Based on informal discussions with the IRS, current thinking in the industry is that 'regularly engaged in the business of leasing' means that contracts to lease such property are entered into with some frequency over a continuous period of time and the loaner vehicles are held for profit,” says Dave Wiggins, a dealership principal with LarsonAllen. Thus, cars being continually rented or leased to customers would not be limited, but loaner vehicles frequently would. This is because most often the use of such vehicles is complimentary, based on repair work being performed or paid for by the manufacturer, such as repairs under warranty. In the IRS’s view, the amount reimbursed by the factory does not get treated as income. Occasional or incidental rental or leasing activity is insufficient.
Does your dealership fit these qualifications?
To avoid depreciation limitations, you have to prove the for-profit use of loaner vehicles. The following examples are ways, based on the IRS’s view, a dealership could demonstrate it has a loaner program with a profit motive:
- If a customer declined the use of a loaner vehicle, would you be willing to reduce the cost of the service being provided? If your dealership does so, then you have one of the indicators, from the IRS’s perspective, that the loaner vehicle program is more closely aligned with the business of leasing. This is seldom, if ever, how loaner programs are handled, but it shows the IRS’s uncommon perspective on this area.
- Does your manufacturer’s program offer cash incentives for meeting certain customer satisfaction standards, including the ability to drive a loaner vehicle? If yes, this may be another indicator that the loaner vehicle program is entered into with a profit motive.
“This interpretation of the law is difficult for most dealers to comply with and will probably be challenged by a taxpayer in the future,” Wiggins says. However, if this “regularly engaged in the business of leasing” exception can be met, your dealership should be able to continue claiming significantly increased amounts of tax depreciation deducted in any one year, compared to the tax depreciation allowed under the luxury auto limits of 280F.
“This change is effective now, and we can expect to be running into it in IRS audits immediately,” Duffner says.
How we can help
We can help you analyze your situation and assist you in structuring your loaner vehicle program in the best manner to be for-profit. For more information on this and other dealership tax strategies, contact Jason Duffner at
jduffner@larsonallen.com or 314-336-3665, or Dave Wiggins at
dwiggins@larsonallen.com or 314-336-3816, or a
dealership principal in your region.