IRS issues safe harbor method of accounting for remodel-refresh costs for certain retailers

This Tax Alert includes an overview of the safe harbor method of accounting provided for remodel or refresh costs for certain retailers included within Revenue Procedure 2015-56 released Nov. 19, 2015.

Revenue Procedure 2015-56 provides certain taxpayers engaged in the trade or business of operating a retail establishment or a restaurant with a safe harbor method of accounting for determining whether expenditures paid or incurred to remodel or refresh a qualified building are deductible or must be capitalized as improvements.

Background

Taxpayers operating in the retail and restaurant industries regularly incur expenditures to remodel or refresh buildings to remain competitive and to improve the customer experience. Although the final repair regulations provide several examples related to remodel or refresh costs, applying the improvement rules can be complex because remodel-refresh projects vary so much in frequency, quality, and degree, resulting in frequent questions by taxpayers and the IRS regarding whether the costs for a particular project should be characterized as repairs and maintenance costs or capitalized as an improvement of the property.

Safe harbor method of accounting

Under the new safe harbor method of accounting, a qualified taxpayer must treat 75 percent of its qualified costs paid during the taxable year as deductible and must capitalize the remaining 25 percent of its qualified costs paid during the taxable year as improvements.

Qualified taxpayer

A qualified taxpayer must have an applicable financial statement (AFS). An AFS includes:

  • a financial statement required to be filed with the SEC;
  • a certified audited financial statement accompanied by the report of an independent certified public accountant; or
  • a financial statement (other than a tax return) required to be provided to the federal or state government or any federal or state agency (other than the IRS).

A qualified taxpayer must be in the trade or business of selling merchandise to customers at retail (but not including automotive dealers, other motor vehicle dealers, gas stations, manufactured home dealers; and nonstore retailers) or in the trade or business of preparing and selling meals, snacks, or beverages to customer order for immediate on-premises and/or off-premises consumption (except taxpayers primarily in the trade or business of operating hotels and motels; civic or social organizations; or amusement parks, theaters, casinos, country clubs, or similar recreation facilities; and special food services such as food service contractors, caterers, and mobile food services).

Qualified building

A qualified building means each building used by a qualified taxpayer primarily for selling merchandise to customers at retail or primarily for preparing and selling food or beverages to customer order for immediate on-premises and/or off-premises consumption. For these purposes, selling merchandise to customers 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, home improvement stores).

Remodel-refresh project

A remodel-refresh project is a planned project by a qualified taxpayer on a qualified building to alter its physical appearance and/or layout to maintain a contemporary and attractive appearance, to more efficiently locate retail or restaurant functions and products, to conform to current retail or restaurant building standards and practices, to standardize the consumer experience if a qualified taxpayer operates more than one qualified building, to offer the most relevant and popular goods within the industry, or to address changes in demographics by changing product or service offerings and their presentations.

The revenue procedure provides a listing of typical remodel, refresh, repair, maintenance, and similar activities that would qualify under the safe harbor as well as excluded remodel-refresh costs. Notable excluded costs include amounts for section 1245 property, activities to rebrand a qualified building performed within two taxable years, adapting more than 20 percent of the total square footage of a qualified building to new or different use or uses, and remodel-refresh costs incurred during a temporary closing.

Appendix A included in the revenue procedure provides a detailed description of the documentation standards required under the safe harbor method of accounting. Appendix B includes an example schedule of qualified costs subject to the remodel-refresh safe harbor.

The revenue procedure also provides the procedures for filing an automatic change in accounting method to change to the safe harbor method of accounting.

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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.