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New Safe Harbor for Remodeling-Refreshing Restaurants and Retail Stores

Berdon Tax Team 03.29.2016 | Client Alert

The IRS has released a Revenue Procedure1 that provides for a safe harbor in determining the tax treatment of the expenditures to remodel or refresh a restaurant or retail store.  A project can qualify for the safe harbor if it is intended to alter the physical appearance and/or layout of a restaurant or retail space. The safe harbor is designed to simplify and reduce the compliance costs for the tax treatment of remodel-refresh projects.

The safe harbor can also apply to the remodel-refresh expenditures of landlords that lease real property to restaurant and retail businesses. However, the safe harbor does not apply to the initial build-out for a new lessee and to qualified lessee construction allowances under Section 110.

Background

The tangible property regulations that generally came into effect in 2014 changed many of the factors and rules for determining whether costs should be capitalized or deducted. The restaurant and retail industries have been especially impacted by the complexity of the rules regarding the costs of remodeling and refreshing their businesses.

The regulations contain examples illustrating the correct treatment. Many actual remodel-refresh projects have involved complicated factual situations and the IRS received frequent inquiries as to the correct treatment.  Industry taxpayers were performing detailed factual analyses to determine whether the costs for each remodel-refresh project qualified as a repair and maintenance cost (deductible) or as an improvement (capitalized). The IRS issued the safe harbor in the hopes that it would reduce disputes and minimize the need for taxpayers to perform detailed factual analysis on a project-by-project basis.

Change for the Better

The new safe harbor rules only apply to taxpayers who have an applicable financial statement. Financial statements generally meet the requirements for the safe harbor if they are (i) audited by an independent CPA firm, (ii) filed with the SEC, or (iii) provided to a federal or state regulator.

The refresh-remodel safe harbor is a method of tax accounting that can be elected by qualifying taxpayers for 2014 and later tax years. The safe harbor itself is very complicated. Below is a summary of some of the significant features:

  • 75% of the costs are deductible and 25% of the costs are capitalized as a building improvement;
  • The capitalized portion is depreciated as well as other capitalized costs of the building under the rules for general asset accounts;and
  • Taxpayers are not permitted to take partial disposition deductions and need to revoke prior year elections.

One additional benefit of the safe harbor is that it applies for purposes of Section 263A,  the Uniform Capitalization (UNICAP) rules, which requires taxpayers to capitalize the direct and indirect costs of producing, improving, and acquiring business property. The tangible property regulations do not apply for purposes of Section 263A. The regulations specifically provide that items that would otherwise be deductible under the tangible property regulations may need to be capitalized under Section 263A.  Adopting the refresh-remodel safe harbor avoids having to perform a separate Section 263A analysis.

1 Revenue Procedure 2015-56, 2015-49 IRB 1

If you have questions, contact your Berdon advisor. Berdon LLP, New York Accountants

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