Revenue Procedure 2015-56, released by the IRS on Nov. 19, 2015, provides a safe harbor that allows retailers and restaurants to deduct 75 percent of the costs to remodel or refresh qualified building property. The remaining 25 percent of qualified remodel-refresh project costs must be capitalized and recovered through depreciation. The safe harbor is meant to ease the administrative accounting burden for taxpayers and reduce controversies between the IRS and taxpayers with regard to remodel-refresh costs. The safe harbor also eliminates the need to apply separately to each building structure and each building system the improvement rules under the tangible property regulations.
A remodel-refresh project is a planned undertaking on a qualified building to:
- Alter its physical appearance or layout for purposes of maintaining a contemporary or attractive appearance
- More efficiently locate different functions and products
- Conform to current industry standards
- Standardize the customer experience
- Offer the most relevant goods, food, or beverages
- Address changes in demographics
The safe harbor of the revenue procedure is available to businesses with an applicable financial statement (generally an audited financial statement) engaged in the trade or business of:
- Selling merchandise to customers at retail, within the meaning of North American Industry Classification System (NAICS) codes 44 or 45
- Preparing and selling meals, snacks, or beverages to customer order for immediate on-premises or off-premises consumption, within the meaning of NAICS code 722
The safe harbor also is available to lessors who pay for repairs on behalf of tenants who are engaged in a restaurant or retail operation. Automotive dealers, other motor vehicle dealers, gas stations, manufactured home dealers, and nonstore retailers are not eligible to use the safe harbor.
The safe harbor method applies only to remodel-refresh project costs incurred on qualified building property subject to Internal Revenue Code (IRC) Section 1250. Remodel-refresh project costs attributable to nonbuilding property governed under IRC Section 1245 must be segregated from Section 1250 building costs for purposes of applying the safe harbor allocation ratio.
A taxpayer may not apply the safe harbor to the initial build-out of building property, to an adaptation of more than 20 percent of a qualified building to a new or different use, or to costs incurred during a temporary store or restaurant closing of more than 21 days.
The revenue procedure requires taxpayers adopting the safe harbor method to be compliant with the disposition regulations under Treasury Regulation Section 1.168-8. Taxpayers adopting the safe harbor method also are required to make a retroactive general asset account (GAA) election for all capitalized improvements to qualified building property and, therefore, are prohibited from making a partial disposition election or disposing of building improvements with regards to their qualified building property. Taxpayers who previously made a partial disposition election with respect to qualified buildings are required to adopt the safe harbor on a cut-off basis unless they revoke the election. The procedural guidance permits taxpayers to revoke a prior partial disposition with an amended tax return filed before the first taxable year that a qualified taxpayer uses the safe harbor, or with an automatic accounting method change.
Taxpayers using the safe harbor are required to follow specific documentation standards. The guidance requires taxpayers to maintain work papers that reconcile tax fixed-asset additions and remodel-refresh project costs to the capital expenditures reported in applicable financial statements. Work papers also should document the methods and procedures used to identify the tax fixed assets attributable to excluded remodel-refresh costs that are maintained within a fixed-asset system or separately tracked outside a fixed-asset system.
Accounting Method Changes
The revenue procedure establishes an automatic accounting method change for purposes of changing to the remodel-refresh safe harbor method, including making a late GAA election and revoking a partial disposition election. The method change requires a Section 481(a) adjustment unless a taxpayer previously made a partial disposition election and does not revoke the election. The revenue procedure also establishes an automatic accounting method change for purposes of revoking a previously partial disposition election. Taxpayers revoking the election must do so within their first or second taxable year beginning after Dec. 31, 2013.