Dealership Flash offers up-to-date information on issues affecting retail dealers. This regular electronic communication from Crowe Horwath LLP features pertinent articles written by retail dealer specialists who have in-depth, practical knowledge about dealerships. To receive Dealership Flash via e-mail, please visit .

Estate Planning Ideas for a Down

Transferring ownership of a privately held dealership to family members has long been a tradition. Authors Richard Kotzen, Jeremy Noetzel, and Poonam Vaidya explain that despite the difficult environment for U.S. auto sales, dealers might want to consider transferring ownership to their children while valuation trends are favorable for gifting, interest rates are low, and before the government eliminates an important tax benefit for family owned businesses.

For owners of automotive dealerships, the past 12 months have been difficult, to say the least. An economic recession of historic proportions has pushed sales of new vehicles to such depths that two of Detroit's three bastions of automotive manufacturing have had to seek bankruptcy protection. As a result, hundreds of dealerships across the United States have begun to close and hundreds more will shut their doors during the next year and a half.

Dealerships that survive might have to wait months – or even years – for a full recovery of the market. While automotive dealers are riding out this economic storm, some have started to think about transferring ownership to the next generation. There are three good reasons to consider such a move now, before pricing multiples return to their traditional levels.

Dealership Valuations Are Conducive to Gifting

The first reason is lower dealership valuations. In recent months, dealership valuations have declined substantially, as have real estate prices. Lower valuations mean lower transfer taxes.

The Internal Revenue Service (IRS) generally requires that gift and estate filings be accompanied by a professional, third-party appraisal of a dealership's value. A typical industry-specific value is determined by adding net assets to "blue sky" (goodwill that is sometimes determined based on a multiple of normalized earnings).

  • Net assets are the assets that are transferred less any assumed liabilities.
  • Normalized earnings are pretax earnings adjusted for unusual occurrences, excessive personal expenses, or discretionary expenses.

Determining the blue-sky multiple is one of the most difficult decisions in the valuation analysis. As a rule of thumb, dealerships with a more secure future earnings stream or lower risk are valued with higher blue-sky multiples, and vice versa. In today's challenging credit market, the entire dealership industry has a higher risk rating because future earnings streams are in question. As a result, multiples are lower, reflecting the industry's systemic risk. In addition, the mergers and acquisitions market has gone cold, and few dealerships have been bought or sold in recent months.

Blue-sky multiples developed from comparable transactions will need further downward adjustments to reflect the lack of current data, just as thinly traded stocks are discounted in the public markets for similar reasons. In addition, appraisers must factor in the declining value of dealership real estate. Fortunately for owners who are intending to use this quiet time to focus on other important issues such as estate planning, the lower valuations translate into lower transfer taxes and more value received by transferees.

Benefiting From Low Interest Rates

The second reason to consider transferring ownership is the cost of money. When privately held businesses such as auto dealerships transfer from one generation to the next, the deal is typically structured as a term loan or note. The IRS requires that a minimum amount of imputed interest be returned to the seller, even if the seller makes the loan interest-free.

Each month, the IRS publishes the applicable federal rates (AFRs) for such transfers. These rates reached historic lows this past February, but are slowly climbing back to more traditional levels.

The IRS publishes three classes of AFRs:

  • Short-term rates for loans of less than three years;
  • Mid-term rates for loans of three years to nine years; and
  • Long-term rates for loans of more than nine years.

Short-term loans pull an excessive amount of cash out of a business over a short time period; as a result, exchange transactions are typically structured as mid- or long-term deals. However, mid-term AFRs frequently are much more attractive than long-term AFRs, as the following rates for June 2009 reveal:

  • Short-term AFR: 0.75 percent
  • Mid-term AFR: 2.25 percent
  • Long-term AFR: 3.88 percent

For a dealership worth $10 million, the difference, at these rates, between a mid-term loan and a long-term loan would be $163,000 in intereste payments per year, which would be taxable to the seller.

In some cases, dealers find that their children can't afford to purchase the business over nine years and that a 12- or even 15-year period is necessary. In such cases, if a dealer wants to take advantage of the mid-term AFR, he or she could set up a nine-year note with 12- or 15-year amortization and a lump-sum payment at the end, or an interest-only loan with a balloon payment at the end.

Auto dealers that are focusing on reducing expenses, downsizing staff, and streamlining inventory levels to survive the current economy should think about strategies for transferring ownership while IRS rates are comparatively low.

Minority Discounts: Here Today, Gone Tomorrow?

The third reason for considering an ownership transfer now is the strong possibility that the Obama administration might reduce or eliminate minority discounts for valuations of family owned businesses, a move that would raise estate taxes significantly.

Under current IRS regulations, privately held businesses are entitled to a marketability discount because there is no clear market for establishing a sales price. In addition, when the owners of privately held businesses sell a minority interest in their company, that minority interest is usually discounted to reflect the lack of control of the minority owner. The amount of the minority discount typically ranges from 10 to 25 percent, and, in some limited cases, can exceed 30 percent.

For example, if the owner of a dealership with an estimated value of $10 million were to sell 49 percent of the dealership to his or her children, he or she would not sell the dealership to the children for $4.9 million. Instead, he or she would sell the dealership to them for a considerably lower amount.

The owner would first take a minority discount of 25 percent (for the lack of control that the 49 percent owners would have), reducing the sales price by $1.225 million. The minority discounted sales price of $3.675 million would then be discounted another 20 percent (or $735,000) for lack of marketability. The total minority and marketability discounts of $1.96 million reduce the 49 percent interest in the dealership from $4.9 million to $2.94 million, for a total reduction of 40 percent of the sales price.

Without the availability of the minority discount, the owner would only be able to take a 20 percent marketability discount, reducing the value of the 49 percent interest only by $980,000. Using the minority discount, the owner is able to discount the value of the dealership by an additional $980,000. Using both discounts in the calculation of the value of the 49 percent interest results in an associated estate-tax savings of $441,000.

President Barack Obama's 2010 budget contains language that calls for modifying the rules on valuation discounts and specifically mentions discounts for family owned businesses. In addition, Congress is considering a bill – " Certain Estate Tax Relief Act of 2009 " (HR 436) – that would eliminate the minority discount. Whether or not HR 436 or another bill like it passes this year, it is an indication that the days of the minority discount are numbered.

A Window of Opportunity

Owners of privately held dealerships who are thinking about transferring business ownership to their children should consider the advantages of acting sooner rather than later. Lower estate taxes, low IRS interest rates, and the strong possibility that the minority discount benefit for family owned businesses will be eliminated are three reasons to consider transferring ownership to the next generation sooner rather than later.

Cash for Clunkers

The Supplemental Appropriations Act, 2009 includes the Consumer Assistance to Recycle and Save (CARS) Act of 2009 – also known as "Cash for Clunkers." The Cash for Clunkers portion of the CARS Act, signed by President Barack Obama on June 24, indicated that the U.S. Treasury Department will provide details and requirements relating to the program – including a comprehensive list, by make and model, of new fuel-efficient vehicles meeting the requirements of the voucher program – within 30 days of the enactment date. Following is a general overview of the program, in advance of the forthcoming details from the Treasury.

Cash for Clunkers provides a cash incentive for individuals and businesses to trade in older, gas-guzzling vehicles for new, more fuel-efficient vehicles. The incentive is a voucher of $3,500 or $4,500, depending on the type of vehicle traded in and the fuel efficiency of the vehicle purchased. The dealership handles submitting the required information to the National Highway Traffic efficiency of the vehicle purchased. The dealership handles submitting the required information to the National Highway Traffic Safety Administration, which reviews and approves the submission and issues the dealership a financial credit. The new vehicle purchase (limited to vehicles that carry a manufacturer's suggested retail price of $45,000 or less) must be completed between July 1, 2009, and Nov. 1, 2009.

The voucher amounts will be part of the sales price reported by the dealership and will not be treated as gross income for the person purchasing the new vehicle. For example, a customer who is entitled to a $3,500 voucher and purchases a new vehicle from a dealer at an agreed price of $30,000 will pay $26,500 out-of-pocket, and the dealer will receive a $3,500 voucher from the Treasury Department. The dealer will report the sales price as $30,000. The dealer must use the voucher in addition to any other rebate or discount that it advertises or the manufacturer offers. The voucher cannot be used to offset a rebate or discount. The dealer will face other restrictions, including having to scrap the trade-in vehicle. If a customer's trade-in vehicle has a higher value than the voucher amount, it would be better to complete the transaction as a straight trade-in.

Passenger Cars

To qualify for a $3,500 voucher, the new vehicle has to have a combined fuel efficiency (CFE) of at least 22 mpg and a CFE of at least four miles per gallon (mpg) higher than that of the trade-in vehicle, meaning the trade-in vehicle cannot have a CFE of more than 18 mpg. A $4,500 voucher requires an increase in CFE of at least 10 mpg.


The qualification rules for trucks are more complex. Generally, for light trucks and sport utility vehicles, the new vehicle has to have a CFE of at least 18 mpg and provide at least a 2 mpg CFE improvement to qualify for a $3,500 voucher. A $4,500 voucher requires a 5 mpg CFE improvement.

More information on the program is expected from the Treasury. State issues to be resolved include sales tax treatment, which might vary from state to state. Although the program is effective as of July 1, 2009, dealers and consumers might want to wait until all the details and requirements of the program are released around July 24, 2009.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.