IRS issues retail and restaurant guidance on remodel and refreshment costs
TAX ALERT |
On Nov. 19, 2015, the IRS released Rev. Proc. 2015-56 (the guidance), which provides for the remodel-refresh safe harbor method of accounting for certain taxpayers in the retail and restaurant industry. The guidance provides for a simplified method of analyzing remodel and refresh costs where 75 percent of qualified costs are deductible as ordinary and necessary business expenses and 25 percent are capitalized as costs to improve a qualified building. The guidance also describes the manner in which taxpayers can elect this safe harbor method of accounting and change previously implemented provisions of the tangible property regulations under sections 162 and 263(a). In order to qualify for the safe harbor, the taxpayer must forgo dispositions (both full and partial) and place the buildings and improvements in a general asset account (GAA).
In order to qualify for the safe harbor method of accounting, taxpayers must fall into NAICS codes 44, 45 and 722. The safe harbor is not available to motor vehicle dealers, gas stations, manufacturing home dealers, non-store retailers, hotels, motels, amusement parks, casinos, country clubs, social organizations, theaters and taxpayers with a NAICS code 7223 (special food services). The taxpayer must also have an Applicable Financial Statement (AFS) to elect the safe harbor. An AFS includes a financial statement filed with the SEC (i.e., a 10-K), certified audited financial statement from an independent CPA firm, or a financial statement required to be furnished to a federal or state government or agency.
The costs incurred must be to a qualified building where the taxpayer sells merchandise to customers at retail or prepares and sells food or beverages to customers for immediate on‑premises and/or off-premises consumption. The building can be owned or leased, but the improvements must be a planned undertaking that:
- maintains a contemporary and attractive appearance;
- efficiently locates retail or restaurant functions and products;
- conforms to current retail or restaurant building standards and practices;
- standardizes the consumer experience if a qualified taxpayer operates more than one qualified building;
- offers the most relevant and popular goods within the industry; or
- addresses changes in demographics by changing product or service offerings and their presentations.
The guidance lists 18 nonexclusive examples of qualified remodel-refresh activity costs, 12 types of nonqualified costs, and 11 comprehensive examples of the safe harbor’s applicability. Pursuant to this guidance, taxpayers may have to modify the previously implemented accounting methods under the tangible property regulations. For example, a taxpayer may have to revoke prior partial disposition elections. The guidance outlines the time and manner of revoking a partial disposition election related to qualified property by having a limited time to file an amended return or by filing Form 3115, Application for Change in Accounting Method, for the taxpayer’s first or second year beginning after Dec. 31, 2013.
Another requirement is that taxpayers must now establish a GAA for the capital expenditure portion of a remodel-refresh activities subject to the safe harbor and any existing qualified building subject to MACRS.
Additionally, taxpayers electing the safe harbor method are excluded from applying the small taxpayer safe harbor for repair and maintenance expenditures as well as the routine maintenance safe harbor to any of the qualified remodel-refresh costs.
While this is welcomed relief and guidance to taxpayers in the retail and restaurant industries, taxpayers should review their existing accounting methods and consult their tax advisors in order to see if any existing policies require modification.