New Remodel-Refresh Safe Harbor for Retail & Restaurant Taxpayers
Author: Shawn Loader
The IRS recently released Revenue Procedure 2015-56, which provides a safe harbor method of accounting for eligible remodel or refresh expenditures incurred by certain taxpayers operating retail or restaurant establishments.
Most of these taxpayers regularly remodel or refresh their spaces to remain competitive and improve the customer experience. Under the new safe harbor, an eligible taxpayer treats 75 percent of qualified costs paid during the year as deductible and capitalizes and depreciates the remaining 25 percent of qualified costs as improvements. Taxpayers choosing to adopt this safe harbor must file IRS Form 3115 to request an automatic change of accounting method.
The final repair regulations, effective for tax years beginning on or after January 1, 2014, included multiple examples to help taxpayers determine the tax treatment of remodel or refresh costs. However, applying the rules remains difficult due to the multiple levels of qualitative and calculated considerations. This safe harbor is intended to reduce conflict between taxpayers and the IRS regarding whether eligible refresh and remodel costs incurred by a qualified taxpayer represent a capital improvement or deductible repair.
A qualified taxpayer is involved in selling merchandise to customers in a retail environment or in the trade or business of selling made-to-order meals, snacks or beverages for on- or off-premises consumption. A building owner who leases or sublets space to an otherwise qualifying taxpayer also may adopt the safe harbor for qualifying expenses.
In addition, a qualified taxpayer must have an applicable financial statement (AFS) that includes:
- A financial statement required to be filed with the Securities and Exchange Commission (SEC)
- A certified audited financial statement, accompanied by the report of an independent CPA, that is used for any of the following:
- Credit purposes
- Reporting to shareholders, partners or similar persons
- Any other substantial nontax purpose
- A financial statement (other than a tax return) required to be provided to the federal or state government or any federal or state agencies (other than the SEC or IRS)
An AFS doesn’t include reviews or compilations of the company’s financial statements performed by an external CPA unless the financials qualify as an AFS under Item 3 above.
Taxpayers that primarily report or conduct any of the following activities are explicitly excluded from adopting the safe harbor:
- Auto or other motor vehicle dealers
- Gas stations
- Manufactured home dealers
- Nonstore retailers
- Hotels and motels
- Civic or social organizations
- Amusement parks, theaters, casinos, country clubs or similar recreational activities
- Special food services, i.e., food service contractors, caterers and mobile food services
A “qualified building” is one primarily used by the qualified taxpayer in the direct sale of merchandise to retail customers or the preparation and sale of food or beverages to a customer’s order for immediate on- or off-premises consumption. In the case of leased space, shared ownership or partial ownership, the qualified portion of the building includes the portion of the building and its structural components to which the qualified taxpayer has ownership or occupancy rights.
Qualified expenses for purposes of this safe harbor are incurred as part of a planned undertaking by the qualified taxpayer on a qualified building to alter its physical appearance or layout for one or more of the following purposes:
- Maintain a contemporary and attractive environment
- Increase efficiency by relocating products or functions
- Conform to industry standards and practices
- Standardize the customer’s experience across multiple locations
- Offer most relevant and popular goods within the industry
- Address changes in demographics by changing offerings or their presentation
The revenue procedure provides a list of typical remodel, refresh, repair, maintenance or similar activities that would qualify under the safe harbor as well as excluded remodel-refresh costs. Notable excluded costs include:
- Section 1245 tangible personal property
- Land and land improvements
- Expenses to adapt more than 20 percent of a building’s total square footage to a new or different use
- Initial purchases or build-out costs, remodel-refresh costs incurred during a temporary closing and expenses to ameliorate a condition existing prior to the taxpayer’s acquisition or lease of the qualified building
- Expenses that increase or augment a building’s footprint or external structural aspects
- Rebranding activities incurred within two years of initial purchase or occupancy
In addition to filing a change in accounting method, use of the safe harbor requires detailed documentation standards, use of general asset accounts and restrictions on use of partial asset dispositions.
While there are moving parts involved in adopting the provisions of this revenue procedure, the guidance provides a consideration that may prove beneficial for qualifying taxpayers involved in frequent remodel-refresh activities. If you have questions about the possible opportunities and risks of this new option, contact your BKD advisor.