The deferral created by LIFO acts like a permanent interest-free loan from the government, retained as long as the business operates with stable or increasing inventory investments. Unlike LIFO, LCM’s tax benefits are short-lived and prone to recapture, making it less advantageous for long-term tax planning. Dollar-value LIFO, however, locks in deferrals that compound with inflation, providing materially higher, sustained benefits—often described as a “tax holiday” that grows with economic conditions. This is why many companies in inflationary sectors prefer LIFO.
A common misconception is that the LCM method is more beneficial than LIFO from a tax benefits perspective. Because of this misconception, companies are often misguided into thinking that LIFO would be a bad fit and should not be used. This misconception partially derives from the fact that LIFO taxpayers are required to value inventories at cost, and a change to the LIFO method triggers a recapture of the LCM reserve into income beginning in the year of adoption. This is because LIFO taxpayers must value inventory at cost, and existing LCM write-downs are ratably recaptured into income over a 3-year period beginning in the year LIFO is elected (LIFO taxpayers are allowed to maintain LCM reserves for financial reporting purposes, which many do since many businesses consider it essential to limit the size of slow-moving and obsolete goods).
Although using the LCM method to write down inventory values does create a tax benefit, it’s a short term one that essentially represents a timing difference between the time taxes are paid and when written down goods are sold or disposed of. Because of this, it’s nearly impossible for an LCM reserve to become anywhere close to the size of a LIFO reserve over a long-term period. To elaborate, consider these facts:
- There’s essentially a cap on the size of the LCM tax benefits for the following reasons:
- 100% of the tax benefit created from writing down each good is reversed or recaptured into income upon its sale or disposal
- Inventories can’t be written down more than 100%
- Most profitable companies seek to avoid carrying a material amount of slow-moving or obsolete goods, which will prevent the overall LCM reserve ratio and resulting tax benefits from materially increasing over a long period of time
- No cap exists on the size of the LIFO tax benefit for the following reasons:
- The tax benefit is derived from inflation, and the long-term inflation can compound to over 100% (which it has in many industries; see example below)
- None of the tax benefit from LIFO is recaptured upon the sale or disposal of the goods attributable to building the tax benefit as long as those goods are replaced
- It’s basically a foregone conclusion that prices will continue to rise over long periods of time, making it essentially a certainty for LIFO to create material long-term tax benefits
The first-year tax benefits of LIFO can also be higher than the LCM method when inflation & the resulting LIFO reserve is higher than the LCM reserve. For example, assume a company has $10M of inventory, a $500K or 5% LCM reserve and 10% inflation. If this were the case, the election year LIFO reserve of $1M ($10M inventory * 10% inflation) would be double the LCM reserve of $500K. This makes high inflation periods such as 2025 the most ideal time to switch from LCM to LIFO.
Many companies using LIFO utilize Bureau of Labor Statistics Producer Price Indexes or BLS PPIs to measure inflation (aka external index or IPIC method). More than 100% cumulative inflation has occurred over the last 20 years for the BLS PPIs shown below:
Get illustrative LIFO vs. LCM tax benefit comparative examples that include recapturing the LCM reserve in LIFOPro’s guide on this subject. Comparing LIFO Tax Benefits to Lower of Cost or Market Write-downs