Retail and restaurant industry guidance for tangible property regulations

IRS provides tangible property safe harbor for refresh-remodel costs

Feb 29, 2016

Many restaurants and retail stores are planning to upgrade their locations in 2016 to better align their facilities with consumer preferences and build brand loyalty. For retail stores, omnichannel strategies to more effectively integrate their web presence with their brick-and-mortar footprints are often driving these moves. Many restaurants are looking to create more efficient, even smaller, spaces to improve cash flow while still maintaining their brand identities. Appropriately accounting for the associated costs is, therefore, a key issue.

Rev. Proc. 2015-56 provides qualified taxpayers in the retail or restaurant industries with a safe-harbor accounting method for remodel or refresh expenses on qualified properties. This guidance will help qualified taxpayers because, prior to this guidance, complying with the numerous regulations involved in determining appropriate treatment of these expenditures put considerable strain on taxpayer’s accounting resources while still leaving a very real possibility of conflict with the IRS. Following the new safe-harbor provisions may minimize the chance of a dispute with the IRS.             

The safe-harbor rules allow a qualified taxpayer to deduct 75 percent of qualified costs as ordinary and necessary business expenses in the tax year incurred. Taxpayers must then capitalize the remaining 25 percent.

Qualified expenses fall into six categories—expenses incurred to:

  • Maintain a contemporary and attractive appearance
  • More efficiently locate retail or restaurant functions and products
  • Conform to current retail or restaurant building standards and practices
  • Standardize the consumer experience if a qualified taxpayer operates more than one qualified building
  • Offer the most relevant and popular goods within the industry
  • Address changes in demographics by changing product or service offerings and their presentations

For chain restaurants and stores, this guidance will be especially useful, as the associated benefits will be multiplied by the number of locations where remodel or refresh efforts are undertaken. Unfortunately, some smaller retail or restaurant operators may not benefit, as Rev. Proc. 2015-56 requires audited financial statements before taxpayers can take advantage of the safe harbor rules.

Also, there are certain costs that are excludible from the safe harbor and require application of the rules under the regulations.  The types of excluded costs include:

  • Tangible personal property
  • Intangible property
  • Land and land improvement (for example, sidewalks, parking lots, depreciable landscaping)
  • The initial acquisition, production or lease of a qualified building
  • The initial build-out of a leased building
  • Certain activities to rebrand performed within a two taxable years
  • Activities performed to correct a material defect
  • Material additions
  • Restoration after a casualty loss
  • Certain expenditures to adapt to new or different use
  • Expenditures incurred during a temporary closing (closing building for more than 21 consecutive calendar days)
  • Certain property for which taxpayer has credits under sections 179, 179D or 190

The benefits of the safe harbor will depend on your particular facts and circumstances.  The IRS has stated on various industry panels that Large Business & International division of the IRS negotiated with only large taxpayers and that the safe harbor is generally meant for the big box retailers with hundreds of locations.  While the safe harbor is not right for every taxpayers, the safe harbor could apply to your situation.

For more detail on Rev. Proc. 2105-56, including details on which taxpayers, properties and activities qualify, download our whitepaper Retail and restaurant industry guidance for tangible property regulations.