Proposed capital gains tax increase spurs car dealers to sell

The threat of nearly doubling the long-term capital gains tax rate is pushing some families to sell their dealerships now to try to avoid losing potentially millions of dollars in proceeds, buy-sell experts say.

"Fear causes a motivated seller," said Joe Ozog, president of Ozog Consulting Group in Scottsdale, Ariz.

On April 28, President Joe Biden in his American Families Plan proposed boosting the long-term capital gains tax rate to 39.6 percent, up from 20 percent today.

That jump would significantly reduce a dealer's after-tax sale proceeds, Erin Kerrigan, managing director for sell-side firm Kerrigan Advisors in Irvine, Calif., wrote in her first-quarter Blue Sky Report. Kerrigan said most dealers who have owned their stores for many years would have no tax basis in their dealerships. That means upon sale, nearly all of their blue-sky value — the intangible value of a dealership, including goodwill — would be subject to the capital gains tax, she said.

Using Kerrigan's average first-quarter dealership blue-sky figure of $8.5 million, dealers could possibly pay an additional $1.7 million in capital gains taxes under Biden's proposal, accountants say.

"An increasing number of dealers and dealer families who were considering a sale before the presidential election have fast-forwarded their plans and are actively seeking an exit in 2021, with the expectation that capital gains taxes will not increase until 2022," Kerrigan wrote in her report.

Some dealers have told Automotive News that the capital gains threat was a factor in their decision to sell stores this year.

"It is the ideal time, if you were ever on the fence about selling, to go ahead and head for the exit," said Stuart McCallum, who leads the automotive consulting and accounting practice for accounting firm Withum.

"You have the combination of record earnings, it's a red-hot buy-sell market out there for dealers, and now you potentially have a tax increase coming down the pike. So if they do decide that I want to sell next year, or the year after that, and the tax proposal does go through, then I'm going to be selling at a lower earnings amount and at a higher tax rate."

There's even a possibility a capital gains increase could be retroactive to some point in 2021, buy-sell experts say.

Congress hasn't taken action on Biden's plan, and some dealership accounting and buy-sell experts say it's too early to say what parts of the proposal will stick.

Just the possibility of the tax hike has been a motivating factor for some clients to sell — and get it done in 2021, said Alan Haig, president of Haig Partners, a buy-sell firm in Fort Lauderdale, Fla.
"They are intent to get the transaction done before the end of the year," he told Automotive News. "Nobody knows if there will be a tax increase or how much it will be. But I think there is a conviction that taxes are going to go up."

Brokers and dealership accountants also expect that higher capital gains and other taxes could cool the busy buy-sell market.

"Dealers planning to retire might choose to hold onto their dealerships for another couple of years to build up additional savings or hope that a change in government would lower taxes in the future," Haig wrote in his first-quarter Haig Report.

Brian Wallace, a tax partner focusing on automotive retail at Withum, of Princeton, N.J., agreed the proposed capital gains rate boost has the potential to dampen the buy-sell market.

"What we end up with is probably about 25 percent less in proceeds at the end of the day when you do the transaction," Wallace said. "If you've got somebody that is selling a dealership group for $80 million, and now they're getting $60 million, that potentially is a deal-breaker."

Brady Schmidt, president of National Business Brokers, a buy-sell firm in Irvine, Calif., said if capital gains tax hikes are approved by Congress, "I think that will drive a pause, a little bit of a slowing down of the market. If it doesn't happen in the beginning of 2022, then I think that the market will continue to be in a bit of a frenzy for the next 18 months."

Dan Murphy, managing member of D.T. Murphy & Co. in Glen Ridge, N.J., said he has been reaching out to potential sellers to discuss the threat of the capital gains tax hike and possible changes to the real estate like-kind exchange, known as a 1031 exchange because it falls under Section 1031 of the IRS Code.

It allows someone to exchange their real estate for other income-producing real property, and it's been a good strategy for dealers over the years, said Rick Parmelee, principal of retail dealerships for accounting firm CliftonLarsonAllen in West Hartford, Conn.

Biden's proposal calls for limiting 1031 like-kind exchanges above $500,000 in deferred capital gains, according to the nonprofit Tax Foundation.

Dealers should expect their taxes to increase next year, Parmelee said. He said he's seeing more interest from dealer clients in gifting stock in dealerships to family members by the end of the year. And he said his firm is talking with clients on ways to minimize taxes on buy-sells, such as through using opportunity zones, which allow investment in certain low-income areas of the U.S. and defer capital gains tax until 2026. This tool requires the dealer to reinvest the gain in qualified zones, Parmelee said.
And some dealers also are considering using an employee stock ownership plan, which allows a dealer to sell his or her stock in the store to an employee stock ownership plan entity.

Then if the dealer uses the proceeds to buy stock or bonds in a U.S. entity, the capital gains are deferred until they sell the securities, Parmelee said.

The difference between good and poor tax planning can be significant for dealers, said Marc Spizzirri, senior managing director of B. Riley Advisory Services in Irvine, Calif.
"They need to be more focused now, especially with this looming potential [capital gains tax] change, of not so much what they sell for, but how much they keep of what they sold for," he said.
One option is a deferred sales trust, allowed under the IRS Code Section 453. Spizzirri said a deferred sales trust would allow a dealer to defer capital gains taxes on the real estate and blue sky.

Proceeds can be distributed into another diverse portfolio, with income taken over time, he said.

Dealership sales must be approved by the manufacturer, which decides whether to transfer the franchise to a new owner, and that process takes time, noted McCallum, of Withum, and Buddy Dearman, managing partner of the dealership practice at accounting firm Dixon Hughes Goodman.

"Let's just say Biden is able to pull something out, and maybe it's not retroactive this year; let's just say it starts Jan. 1," McCallum said. "You may have a rush for the exit. But OEM approval of transactions, for most dealers, does not happen overnight. And so if every dealer decides they want to sell in October, what are the odds that they will be able to get OEM approval before Jan. 1?"

Dearman suggests dealers who know they're going to sell should "probably get started sooner rather than later."

"It's not like putting your house on the market and being able to get to close in 25 days," Dearman said.