The tangible property regulations have added increased complexity for many taxpayers. Although the new regulations are favorable to taxpayers in many instances, it can often be a headache to determine the correct treatment. In an effort to mitigate disputes regarding the deductibility and capitalization of remodel and refresh costs between the Internal Revenue Service (IRS) and taxpayers, the IRS has come out with a new Revenue Procedure 2015-56. This Revenue Procedure provides a safe harbor method of accounting for taxpayers engaged in the trade or business of operating a retail establishment or a restaurant. This method of accounting applies to a remodel or refresh of qualified buildings and provides for a simplified method to determine which costs are currently deductible or must be capitalized.
Under this new procedure, eligible taxpayers are permitted to deduct, in the year of remodel or refresh, 75% of the eligible costs and capitalize the remaining 25% without further analysis under the tangible repair regulations. A remodel-refresh project under this procedure is defined as a planned undertaking to alter a building’s physical appearance and/or layout. This includes an undertaking to maintain an attractive appearance, efficiently locate retail or restaurant functions/products, conform to current retail or restaurant building standards and practices, standardize the consumer experience, 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. A remodel or refresh project does not include solely repainting or cleaning the interior and/or exterior of a building.
The Revenue Procedure lists some specific activities that are considered remodel or refresh costs, but also notes that the list is not exhaustive. Below are some of the major and most common activities that are listed as qualifying costs:
- Painting, polishing, or finishing interior walls
- Changes to permanent floor, ceiling, or wall coverings
- Changes to kitchen fixtures
- Changes to signage or fixtures
- Relocating departments, eating areas, check-out areas, kitchen areas, management space, etc., within the existing footprint
- Moving, constructing, or altering walls within the existing footprint
- Replacing façade materials around windows and entrances
It’s important to note some common costs that will not qualify under this procedure as well. For instance, adapting more than 20% of the total square footage to a new or different use, the initial build-out of a leased building for a new lessee, the initial acquisition or lease of a building, costs associated with personal property (desks, counters, etc included in the layout), or costs to correct a material condition or defect that existed prior to the taxpayer’s acquisition or lease of a building. Again, this is not a complete list, but provides some of the most common costs that may apply.
One major limitation to this method of accounting is that only taxpayers with Applicable Financial Statements as defined by the IRS are eligible for electing this safe harbor. An Applicable Financial Statement means one of the following:
- A financial statement filed with the Securities and Exchange Commission (SEC)
- A certified financial statement that is accompanied by the report of an independent certified public accountant or
- A financial statement required to be provided to the federal or state government or agency
Further, once this election is made, taxpayers must continue to apply this method of accounting to future qualifying remodel and refresh projects. For these reasons, we don’t expect this safe harbor to be applied for the majority of small business taxpayers.
The tangible repair regulations are a complex area of the tax code and although this Revenue Procedure provides a simplified method of accounting, there are many nuances to be aware of before making a decision to apply this to your qualified remodel or refresh projects. If you think this may apply to your business or if you would like more detail, please contact us.