Safe Harbor for Retail and Restaurants on When to Deduct/Capitalize Remodeling Costs

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Following up on the final tangible property regulations last year, the IRS has released Revenue Procedure 2015-56 that provides a safe harbor method for taxpayers engaged in the trade or business of operating a retail establishment or a restaurant. This safe harbor method may be used to determine whether costs paid or incurred to refresh or remodel a qualified building are deductible or capitalized. Many times, retailers and restaurants need to do a remodel to keep up with changes in demographics and consumer tastes. Since the final tangible regulations are difficult to apply to a retailer or restaurant, the safe-harbor allows certain remodel-refresh costs incurred by a taxpayer to apply a method of accounting to deduct 75% of remodel-refresh costs.

This is generally effective for tax years beginning on or after 1/1/2014. This is a change in accounting method, so a Form 3115 will need to be filed. A qualified taxpayer is a taxpayer that has an applicable financial statement, such as an audited financial statement, and either:

1. Is in the trade or business of:

a. Selling merchandise to customers at retail, or
b. Preparing and selling meals, snacks, or beverages to customer orders for immediate consumption, or

2. Owns, or leases, a qualified building that is leased by, or sublet to, a taxpayer described in the above trade or business.

The remodel and refresh costs do not include an initial build out of a qualified building and does not include equipment. The 25% capitalized portion must be depreciated as a separate asset. This favorable method of accounting will benefit retail and restaurant taxpayers, but these taxpayers should consult with a tax professional to comply with the requirements.

By Kelly Lynch, CPA