On November 20, 2015, the Internal Revenue Service released an advance copy of Revenue Procedure 2015-56.This revenue procedure provides relief for some taxpayers that own retail and restaurant properties. This relief comes in the form of a safe harbor accounting method where taxpayers are allowed to deduct 75 percent of the qualified costs of remodel-refresh projects instead of applying the facts and circumstances rules of the Tangible Property Regulations (“TPR”).
Who is Eligible?
To qualify for the safe harbor a taxpayer must meet three conditions:
Practical Tip: Unlike under the UNICAP rules, selling merchandise at retail includes the sale of identical goods to resellers if the sales to resellers are conducted in the same building and in the same manner as retail sales to non-reseller customers (for example, warehouse clubs or home improvement stores).
What is Eligible for the Safe Harbor?
Seventy-five percent of qualifying remodel-refresh costs that are paid by a qualified taxpayer for remodel, refresh, repair, maintenance, or similar activities performed on a qualified building as part of a remodel-refresh project are eligible for the safe harbor. The remaining 25 percent must be capitalized as a capitalizable improvement to the qualified building.
A qualified building means each building Unit of Property used by a qualified taxpayer primarily for selling merchandise at retail or as a restaurant. Just as under the TPR, there are special rules for condominiums, cooperatives, and leased property.
A remodel-refresh project is a planned undertaking to alter the physical appearance or layout of a qualified building for certain qualifying purposes. These qualifying purposes generally include maintaining a contemporary appearance, making the layout more efficient or conforming to current building standards or practices, standardizing the consumer experience across buildings, or offering the most relevant products or services based on popularity or changing demographics. A remodel-refresh project does not include planned projects involving only the repainting or cleaning of the interior or exterior of an existing qualified building.
Excluded remodel-refresh costs are amounts paid during a remodel-refresh project for §1245 property (tangible personal property), intangibles (including computer software), land or land improvements, the initial acquisition, construction, or lease of a qualified building (including the initial buildout for a new tenant), ameliorating pre-existing defects, casualty event restorations, adapting more than 20 percent of the total square footage of the qualified building to a new or different use, material additions to the qualified building or its building systems, rebranding the building within two years of the acquisition or initial lease of the building, remodel-refresh costs during a closure of the business for at least 21 consecutive days, and deductions under §179, §179D, or §190.
Practical Tip: The safe harbor requires a cost segregation analysis to identify §1245 property, land improvements, and other costs not subject to the safe harbor.
Caution: Use of the safe harbor delays the deduction of the deductible 75 percent of qualifying remodel-refresh costs until the year the capital expenditure portion is placed in service.
How is the Safe Harbor Applied?
A taxpayer may adopt the safe harbor by filing a Form 3115, Application for Change in Accounting Method using DCN 222. This change requires the adoption of the safe harbor method and the (late) election of General Asset Accounts for the qualified building and its improvements. If the taxpayer has prior year partial asset disposition elections or dispositions of qualified building components under the temporary TPR, the taxpayer may unwind those method changes and take the resulting positive §481(a) adjustment into account entirely in the year of change using DCN 221, which should be filed on the same Form 3115 as DCN 222 for the first or second taxable year ending after December 31, 2013. Unwinding these prior dispositions permits the taxpayer to conduct a lookback study using the safe harbor. If the prior dispositions are not unwound, the taxpayer must use a cut-off method to adopt the safe harbor and may not apply the safe harbor to any qualifying remodel-refresh costs from prior to the year of change. The final year of a trade or business and the five-year item eligibility rules do not apply to either of these changes for the first or second taxable year beginning after December 31, 2013. The remodel-refresh safe harbor method change is available only for taxable years beginning on or after January 1, 2014.
Practical Tip: Taxpayers who already have performed detailed facts-and-circumstances TPR studies that include partial asset dispositions, repairs, and improvements have the option of unwinding the prior partial asset dispositions. This would be advisable if the sum of the repairs and partial asset dispositions are less than 75 percent of the qualifying remodel-refresh costs.
Caution: The safe harbor requires the use of General Asset Accounts, which limits the ability of the taxpayer to make partial asset disposition outside of remodel-refresh projects.
Caution: The Safe Harbor for small taxpayers is not available for any remodel-refresh costs. The routine maintenance safe harbor is not available for any qualifying remodel-refresh costs or amounts not related to a remodel-refresh project.
The remodel-refresh safe harbor promises to greatly reduce IRS examinations of taxpayers in the retail and restaurant industries. For taxpayers who have expensed less than 75 percent of qualifying remodel-refresh costs, there is also an opportunity. The safe harbor does come with two primary limitations:
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