The IRS released Revenue Procedure 2015-56 which provides a safe harbor method of accounting for costs incurred in remodel and refresh projects. The safe harbor will allow taxpayers to deduct 75% of qualified costs under Internal Revenue Code Section 162 and capitalize the remaining 25% under section 263(a). The safe harbor method will apply to restaurants, retailers, and taxpayers that own or lease a building and lease or sublease the building to a restaurant or retailer. The new rules are designed to provide more clarity for treatment of remodel and refresh costs in the restaurant and retail industries.
Remodel and refresh costs are classified as amounts paid by a qualified taxpayer for remodel, refresh, repair, maintenance or similar activities performed on a qualified building as part of a remodel refresh project. It is important to note that remodel-refresh costs are not taken into account until the capital expenditure portion of the safe harbor method is placed into service.
Following are examples of remodel, refresh, repair, maintenance, activities:
Painting, polishing, or finishing interior walls;
Adding, replacing, repairing, maintaining, or relocating permanent floor, ceiling, or wall coverings, including millwork;
Adding, replacing, repairing, maintaining, or relocating kitchen fixtures;
Adding, replacing, or modifying signage or fixtures;
Relocating departments, eating areas, check-out areas, kitchen areas, beverage areas, management space, storage space, or similar areas, within the existing footprint of the qualified building;
Increasing or decreasing the square footage of departments, eating areas, check-out areas, kitchen areas, beverage areas, management space, storage space, or similar areas within the existing footprint of the qualified building;
Adding, relocating, or removing a room or rooms (for example, dressing rooms, “private” dining space, front office space, or break rooms) within the existing footprint of the qualified building;
Moving, constructing, or altering walls within the existing footprint of the qualified building;
Adding, relocating, removing, replacing, or re-lamping lighting fixtures, or adding reflectors, mirrors, or other similar devices to existing lighting fixtures;
Repairing, maintaining, retrofitting, relocating, adding, or replacing building systems defined in § 1.263(a)-3(e)(2)(ii)(B) within the existing footprint of the qualified building;
Making non-structural changes to exterior facades;
Relocating, replacing, or adding windows or doors (including replacing a manual door with an automatic door) within the existing footprint of the qualified building;
Repairing, maintaining, or replacing the roof or portion of the roof within the existing footprint of the qualified building;
Replacing façade materials around windows and entrances;
Repair and maintenance to the qualified building that directly benefits or is incurred by reason of a remodel-refresh project;
Removal and demolition, other than demolition subject to § 280B, of structural components of a qualified building (for example, insulation, windows, drywall, and similar property) that directly benefit or are incurred by reason of a remodel-refresh project;
Obtaining permits or other similar authorizations that directly benefit or are incurred by reason of a remodel-refresh project;
The following are examples of excluded remodel-refresh costs:
Section 1245 property (as defined in § 1245(a)(3));
An intangible under § 1.263(a)-4(b), including the creation or maintenance of computer software;
Land, including nondepreciable land improvements, or depreciable land improvements described in Asset Class 00.3 of Rev. Proc. 87-56, 1987-2 C.B. 674 (for example, sidewalks, parking lots, depreciable landscaping);
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 taxable years following the closing date of (1) an acquisition or initial lease of the qualified building by the qualified taxpayer or a person related, within the meaning of § 267(b) or § 707(b), to the qualified taxpayer or (2) the acquisition by the qualified taxpayer or a person related, within the meaning of § 267(b) or § 707(b), to the qualified taxpayer of a controlling interest in the qualified building or in a lease of the qualified building;
Material additions to a qualified building, including the building systems defined in § 1.263(a)-3(e)(2)(ii)(B). Solely for purposes of this revenue procedure, additions mean enlarging, expanding, or extending the square footage of the qualified building, or enlarging, expanding, or extending the building systems in conjunction with enlarging, expanding, or extending the square footage of the qualified building;
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 under § 165, or relating to a casualty event described in § 165, subject to the limitation in § 1.263(a)-3(k)(4);
Adapting more than twenty percent (20%) of the total square footage of a qualified building to new or different use or uses, as described in § 1.263(a)-3(l), as part of a remodel-refresh project. For this purpose, square footage is measured based on the total square footage of the qualified building prior to the remodel-refresh project at issue;
Remodel-refresh costs incurred during a temporary closing. A temporary closing is closing the qualified building during normal business hours for more than 21 consecutive calendar days. (12) The cost of any property for which the qualified taxpayer has claimed a deduction under § 179, § 179D, or § 190;
Taxpayers who elect to use the remodel-refresh safe harbor must treat 75% of its qualified costs paid during the taxable year as amounts deductible under § 162(a) and must treat the other 25% of its qualified costs during the year as building improvements under § 263(a). The capital expenditure portion is treated and depreciated as qualified leasehold improvement property, restaurant property, and retail improvement property under code sections 167 and 168. If costs satisfy the requirements the capital expenditure portion may be depreciated on a straight-line basis over 15 years if the asset is placed in service before January 1, 2015. Other amounts that are included in the capital expenditure portion are classified as nonresidential real property may be depreciated over 39 years. Also, taxpayers making the safe harbor election will need to make an accounting method change on form 3115 for the qualified taxpayer’s first or second taxable year after December 31, 2013.