Majority of Costs to Remodel or Refresh Retail Stores Are Deductible Under New Safe Harbor

Retail stores and restaurants regularly incur expenses to remodel or refresh the establishment in order to stay competitive and remain attractive to customers. However, because these projects often involve repairs and improvements to many different building components, analyzing what costs can be deducted and what should be capitalized can be a complicated task. Therefore, in Rev. Proc. 2015-56, the IRS is permitting taxpayers engaged in the trade or business of operating a retail establishment or a restaurant to use a safe-harbor method of accounting for determining whether expenditures paid or incurred to remodel or refresh a qualified building are deductible under Sec. 162(a) or must be capitalized under Sec. 263(a) or 263A.

Under the safe harbor, a “qualified taxpayer” will treat 75% of “qualified costs” paid during the tax year as deductible under Sec. 162 and the remainder as costs for improvements to a qualified building under Sec. 263(a) and as costs for the production of property for use in the qualified taxpayer’s trade or business under Sec. 263A.

A qualifying taxpayer must have an applicable financial statement and is defined as being in the trade or business of (1) selling merchandise to customers at retail (but excluding car dealers, gas stations, manufactured home dealers, and nonstore retailers), (2) preparing and selling meals, snacks, or beverages to customers for immediate on-premises and/or off-premises consumption (but excluding hotels, civic or social organizations, amusement parks, theaters, casinos, country clubs, and special food services, such as caterers and mobile food services), or (3) owning or leasing a qualified building to a taxpayer qualifying under (1) or (2).

“Qualified costs” are costs incurred in remodel/refresh projects, which include projects to maintain a contemporary and attractive appearance; locate retail or restaurant functions and products more efficiently; conform the space to current retail or restaurant standards and practices; standardize consumer experience if the qualified taxpayer operates more than one building; offer the most relevant and popular goods within the industry; or address changes in demographics by changing product or service offerings and their presentations. Remodel/refresh costs are costs incurred to remodel, repair, refresh, or maintain a building as part of a project. Costs to solely repaint or clean the building are not included.

To take advantage of this safe harbor, taxpayers must file Form 3115, Application for Change in Accounting Method. Taxpayers that adopt this method must use it for all qualifying costs and cannot change it without the IRS’s consent to use another method. In addition, the revenue procedure 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.  

—Sally P. Schreiber (sschreiber@aicpa.org) is a Tax Adviser senior editor.