Robert Gordon, Managing Director and Anthony Davaransky, Senior Manager
The IRS is not typically viewed as an agency overflowing with sympathy for taxpayers. But from time-to-time, the IRS does acknowledge that taxpayers’ businesses may not fit into the neat pigeonholes that tax rules often require, and they issue guidance that actually makes life easier for those trying to comply with the tax laws. Such is the case with a recent revenue procedure(2015-56) modifying the complex tangible personal property regulations to accommodate how retailers and restaurants repair and refresh their stores in real life.
The revenue procedure provides qualified taxpayers in the retail and restaurant industry with a safe-harbor method for determining whether expenses paid or incurred to remodel or refresh (referred to as a “remodel-refresh project”) a qualified building are deductible under IRC section 162 or must be capitalized as improvements under sections 263(a) or 263A. The safe harbor also describes how depreciation and disposition of capitalized amounts are to be treated. Taxpayers who use the safe harbor can avoid the difficult and often-uncertain task of analyzing whether a particular expenditure is an “improvement” that must be capitalized or a “repair” that can be deducted currently.
The remodel-refresh safe harbor method of accounting allows a qualified taxpayer to deduct 75% of its qualifying remodel-refresh expenditures while capitalizing the remaining 25% for tax purposes. The capitalized portion may be treated as qualified leasehold improvement property, qualified restaurant property, or as qualified retail improvement property (depreciable over 15 years) as applicable and to the extent it can be substantiated; the remaining portion is classified as nonresidential real property depreciable over 39 years. The safe harbor also requires a qualified taxpayer to elect general asset accounts (GAA) to report its MACRS property and include the capitalized portion of the remodel-refresh expenditure in a GAA. The revenue procedure permits qualified taxpayers using the remodel-refresh safe harbor to make a late GAA election for assets previously placed in service and subject to the safe harbor method.
A “qualified taxpayer” under the revenue procedure includes only taxpayers in the retail and restaurant industries who conduct activities within certain NAICS codes and who have an applicable financial statement (AFS) as prescribed under Treas. Reg. § 1.263(a)-1(f)(1). In general, an AFS is an audited financial statement required to be filed with the SEC, used for credit purposes, or provided to any federal, state, local government agency (other than a tax authority).
A “qualified building” is a building or portion thereof used by qualified taxpayer primarily for selling merchandise to customers at retail or preparing and selling food or beverages to customers for immediate consumption on or off premises.
A “remodel-refresh project” is a planned undertaking by a qualified taxpayer on a qualified building to alter its physical appearance and/or layout for purposes of—
The revenue procedure identifies examples of remodel-refresh projects and identifies specific activities excluded from remodel-refresh activities. For example, a project solely to repaint or clean the interior or exterior of an existing qualified building is not a remodel-refresh project.
The remodel-refresh safe harbor method of accounting does not permit a partial disposition election under Treas. Reg. § 1.168(i)-8(d)(2). A taxpayer that previously made a timely or late partial disposition election to claim a loss on a retired building component must revoke that election by filing an accounting method change or filing an amended federal tax return. If the revocation is not made, an accounting method change to utilize the safe harbor is made on a cutoff basis.
The remodel-refresh safe harbor method requires a qualified taxpayer who previously recognized a gain or loss upon the disposition of a component of a qualified property before 2012 under MACRS must change its method of accounting to comply with disposition rules in Treas. Reg. § 1.168(i)-8 by redefining the asset disposed of and including the previously claimed loss in income in a single tax year as a positive section 481(a) adjustment.
The revenue procedure is effective for tax years beginning on or after January 1, 2014. A tax-payer must file an application for an accounting method change to use the safe harbor by filing form 3115 using the automatic change procedures with a designated change number of 222.
We are here to help
True Partners Consulting’s accounting methods experts are well-versed in the new tangible property regulations and are available to help you assess the impact that this revenue procedure (and the tangible property regulations generally) may have on your company. Please contact a member of our Federal Tax Team to learn more about how we can help.
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