On November 19, 2015, the Internal Revenue Service issued Revenue Procedure 2015-56. Rev. Proc. 2015-56provides certain retailers and restaurants a safe harbor method of accounting for remodel or refresh expenditures on qualified buildings, and helps eliminate confusion around which costs may be deducted immediately and which must be capitalized and depreciated over time. Rev. Proc. 2015-56 also provides instruction for the method of obtaining automatic consent to convert to the safe harbor method of accounting. Under the safe harbor, retailers and restaurants with applicable financial statements are able to take 75 percent of qualifying expenditures as an immediate deduction. The remaining 25 percent is capitalized and depreciated over time. Rev. Proc. 2015-56 is effective immediately for tax years beginning on or after January 1, 2014.
A qualified taxpayer is defined as a party in the trade or business of: (1) selling merchandise to customers at retail, (2) preparing and selling meals, snacks, or beverages to customers for immediate on-premises and/or off-premises consumption, or (3) owning or leasing a qualified building to a taxpayer qualifying under (1) or (2). A qualified taxpayer must have an applicable financial statement (AFS). An AFS includes:
- A financial statement required to be filed with the SEC;
- A certified audited financial statement accompanied by the report of an independent certified public accountant; or
- A financial statement (other than a tax return) required to be provided to the federal or state government or any federal or state agency (other than the IRS).
An AFS does not include reviews or compilations of the company’s financial statements performed by an external CPA unless the financials qualify as an AFS under Item 3 above.
Taxpayers that primarily report or conduct any of the following activities are explicitly excluded from adopting the safe harbor:
- Auto or other motor vehicle dealers
- Gas stations
- Manufactured home dealers
- Nonstore retailers
- Hotels and motels
- Civic or social organizations
- Amusement parks, theaters, casinos, country clubs or similar recreational facilities
- Special food services, i.e., food service contractors, caterers and mobile food services
A remodel-refresh project is defined as a planned undertaking on a qualified building to alter its physical appearance and/or layout for one or more of the following purposes:
- To maintain a contemporary and attractive appearance
- To more efficiently locate retail or restaurant functions and products
- To conform to current retail or restaurant building standards and practices
- To standardize the consumer experience if a taxpayer operates more than one qualified building
- To offer the most relevant and popular goods in the industry
- To address changes in demographics by altering product or service offerings and their presentations
Rev. Proc. 2015-56 provides a listing of typical remodel, refresh, repair, maintenance, and similar activities that would qualify under the safe harbor, including:
- Painting, polishing or finishing interior walls
- Adding, replacing, repairing, maintaining or relocating permanent floor, ceiling or wall coverings or kitchen fixtures
- Adding, replacing or modifying signage or fixtures
- Relocating or changing the square footage of departments, eating areas, checkout areas, kitchen areas, beverage areas, management space or storage space within the existing footprint of a qualified building
- Moving, constructing or altering walls within the existing footprint of a building
- Adding, relocating, removing, replacing or re-lamping lighting fixtures
- Making non-structural changes to exterior facades
- Repairing, maintaining or replacing the roof or a portion of the roof within the existing footprint of a qualified building
Rev. Proc. 2015-56 also lists specifically excluded costs, such as:
- Section 1245 tangible personal property
- Land and land improvements
- Expenses to adapt more than 20 percent of a building’s total square footage to a new or different use
- Initial purchases or build-out costs, remodel-refresh costs incurred during a temporary closing and expenses to ameliorate a condition existing prior to the taxpayer’s acquisition or lease of the qualified building
- Expenses that increase or augment a building’s footprint or external structural aspects
- Rebranding activities incurred within two years of initial purchase or occupancy
A “qualified building” means each building used by a qualified taxpayer primarily for the direct sale of merchandise to retail customers or the preparation and sale of food or beverages to a customer’s order for immediate on- or off-premises consumption. In the case of leased space, shared ownership or partial ownership, the qualified portion of the building includes the portion of the building and its structural components to which the qualified taxpayer has ownership or occupancy rights.
Method of Adoption
To take advantage of this safe harbor, taxpayers must file Form 3115, Application for Change in Accounting Method. Taxpayers that adopt this safe harbor must use it for all qualifying costs and cannot change it without the IRS’s consent to use another method. In addition, Rev. Proc. 2015-56 has special rules for taxpayers that want to adopt the safe harbor and have elected partial disposition treatment for the same qualifying property under the repair regulations.
Rev. Proc. 2015-56 adds two new automatic change numbers:
- Change number 221 – “Revocation of partial disposition election under the remodel-refresh safe harbor described in Rev. Proc. 2015-16”
- Change number 222 – “Remodel-refresh safe harbor method”
In addition to filing a change in accounting method, use of the safe harbor requires detailed documentation standards, use of general asset accounts, and restrictions on the use of partial asset dispositions.
Daniel L. Mellor is an associate with the form. He earned his J.D. at the George Mason University School of Law in Arlington, VA and his Masters of Laws (LL.M.) in Taxation from the Temple University School of Law in Philadelphia, PA. Mr. Mellor serves on the Executive Committee of the New Jersey State Bar Association, Young Lawyers Division, as the Liaison to the Tax Law Section. Mr. Mellor’s particular areas of expertise include business transactions, estate planning, and probate litigation.