On November 20, 2015, the IRS released Revenue Procedure 2015-56, providing certain “qualified taxpayers” engaged in the trade or business of operating a retail establishment or a restaurant a safe harbor accounting method for costs incurred related to remodeling and refreshing of their “qualified buildings.” “Qualified taxpayers” include those conducting activities within NAICS codes 44 or 45, but specifically exclude motor vehicle dealers and gas stations, among others.
KBKG Insight: The Tangible Property Regulations introduced the concept of “Unit of Property” and “building systems” along with the requirement to analyze capital expenditures related to a betterment, adaptation, or restoration of the system rather than the entire building as a Unit of Property. Retailers and restaurateurs have argued that refreshing type activities often require work to be performed on the building systems outlined within the Tangible Property Regulations and the requirement to apply a separate legal analysis to the different components of the buildings are especially difficult in their situation. Through the adoption of the safe harbor, retailers and restaurateurs can now take advantage of the ability to immediately deduct 75% of the “qualified” amount spent to refresh the applicable property leaving the remaining 25% to be capitalized and depreciated.
Generally, qualified costs include amounts incurred during the course of performing a remodel-refresh project but specifically do not apply:
- To excluded remodel-refresh costs under Rev Proc 2015-56, Sec. 4.06 i.e., amounts paid during a remodel-refresh project for:
- Section 1245 property
- An intangible under Reg. § 1.263(a)-4(b), including the creation or maintenance of computer software
- The initial acquisition, production, or lease of a qualified building, including purchase price, construction costs, transaction costs, and the costs of work performed prior to the date that the qualified building is initially placed in service by the qualified taxpayer
- The initial build-out of a leased qualified building, or a portion thereof, for a new lessee
- Activities to rebrand a qualified building performed within two tax years following the closing date of certain acquisitions of a lease or interest in a qualified building
- Activities performed to ameliorate a material condition or defect that existed prior to the qualified taxpayer's acquisition or lease of the qualified building or that arose during the production of the qualified building (generally, an unusual event in the retail or restaurant business), regardless of whether the qualified taxpayer was aware of the condition or defect at the time of acquisition or production;
- Material additions to a qualified building, including the building systems
- Restoration caused by damage to the qualified building for which the qualified taxpayer is required to take a basis adjustment as a result of a casualty loss, or relating to a casualty event
- Adapting more than 20% of the total square footage of a qualified building to new or different use or uses, as part of a remodel-refresh project
- Remodel-refresh costs incurred during a temporary closing (i.e., for more than 21 consecutive calendar days); and
- The cost of any property for which the qualified taxpayer has claimed a deduction under Code Sec. 179, Code Sec. 179D, or Code Sec. 190.
- To de minimis costs defined under Rev Proc 2015-56, Sec. 5.05(1) (dealing with the safe harbor for small taxpayers under Reg. § 1.263(a)-3(h));
- To remodel-refresh costs that, if capitalized, are not depreciated by the qualified taxpayer under Code Sec. 168;
- To expenditures treated as qualified lessee construction allowances under Code Sec. 110 and its regs;
- If the qualified taxpayer made a partial disposition election under Reg. § 1.168(i)-8(d)(2), Prop Reg § 1.168(i)-8(d)(2), or section 6.33 of the Appendix of Rev Proc 2011-14, or section 6.33 of Rev Proc 2015-14 for any portion of a qualified building;
- If the qualified taxpayer recognized a gain or loss upon the disposition of a component of a qualified building under Reg. § 1.168(i)-1T or Reg. § 1.168(i)-8T and hasn't changed its tax year and taken adjustments into account as specified; or
- To any direct or allocable indirect costs of acquiring property described in Code Sec. 1221(a) for resale (and so subject to capitalization).
KBKG Insight: “Qualified” property specifically excludes 1245 property, so a cost segregation analysis of any remodeling or refresh activity should be considered before applying the safe harbor.
A “qualified taxpayer” for this purpose must have an Applicable Financial Statement and
- be in in the trade or business of selling merchandise to customers at retail, for which the taxpayer reports or conducts activities within NAICS codes 44 or 45,
except: those taxpayers that primarily report or conduct activities within the following codes: Code 4411 (automotive dealers); Code 4412 (other motor vehicle dealers); Code 447 (gas stations); Code 45393 (manufactured home dealers); and Code 454 (nonstore retailers); or
- is in the trade or business of preparing and selling meals, snacks, or beverages to a customer order for immediate on-premises and/or off-premises consumption, for which the taxpayer reports or conducts activities within NAICS code 722,
except: (a) those taxpayers that are 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 (b) those taxpayers that primarily report or conduct activities within code 7223 (special food services, i.e., food service contractors, caterers, and mobile food services);
- owns, or leases, a qualified building that is leased, or sublet, to a taxpayer that meets the requirements of (1) or (2), above, and incurs remodel-refresh costs.
A “qualified building” means each building unit of property used by a qualified taxpayer primarily for selling merchandise to customers at retail or primarily for preparing and selling food or beverages to a 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).
A thorough analysis of Revenue Procedure 2015-56 outlining items such as “qualified taxpayers” and “qualified” property is forthcoming from the KBKG team. In the interim, please visit IRS Revenue Procedure 2015-56. If you have any questions, please contact us.
Author: Lester Cook, CCSP, ASA | Co-Authors: John Hanning, CCSP, MBA; Gian Pazzia, CCSP
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