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Remodeling or Refreshing Your Restaurant or Retail Establishment? You May be Able to Deduct Costs through a Safe Harbor
Posted on Jan 19, 2016
By Julie Eisenhauer, CPA
With the start of a new year, many restaurant and retail businesses create budgets and develop plans to refresh their facilities to meet the changing needs of consumers.
If your establishment is among those planning (or already undertaken) a remodel or refresh, I have some good news for you.
The Internal Revenue Service has recently issued a revenue procedure that provides a safe harbor method of accounting for certain expenditures incurred in remodeling or refreshing of restaurant and retail establishments.
The safe harbor clarifies which costs may be deducted immediately and which must be capitalized and depreciated over time. It reduces the need to perform a detailed factual analysis to determine if a cost is a repair or an improvement.
Who qualifies for the safe harbor?
1. A taxpayer that has an Applicable Financial Statement (AFS) which is defined as:
A financial statement filed with the Securities and Exchange Commission (SEC)
A certified audited financial statement
A financial statement required to be provided to the federal or state government or agency (other than the SEC or IRS)
2. And is in the business of selling merchandise to customers at retail or is in the business of preparing and selling meals to customers for consumption.
Exceptions: There are specific exceptions, such as gas stations, mobile food services, and those primarily in the business of operating hotels, country clubs or similar recreation facilities.
3. And owns or leases a building used primarily for selling merchandise at retail or preparing and selling meals to customers for consumption.
What is considered a remodel or refresh project?
A remodel or refresh project is a planned undertaking by a qualified taxpayer 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 within the industry
To address changes in demographics by changing product or service offerings and their presentations
A remodel or refresh project does not include a planned undertaking to repaint or to clean the interior or exterior of an existing building, which would likely be expensed in full as repair and maintenance costs. Examples of other excluded remodel or refresh costs include furniture and equipment, intangibles, land and land improvements and initial build-out costs of a leased building.
How do you account for the qualified costs under the safe harbor?
The taxpayer must treat 75% of its qualified remodel or refresh project costs as deductible during the taxable year (the “deduction portion”) and must treat the remaining 25% of its costs paid during the taxable year as costs for improvements to a building (the “capital expenditure portion”).
The “deduction portion” of the remodel and refresh costs paid are deducted in the taxable year when the “capital expenditure portion” is placed in service. The capital expenditure portion is depreciated over time beginning on the date it is placed in service.
For example: a taxpayer, who qualifies under the safe harbor (defined above) and in the business of operating a restaurant, undertakes a planned remodel and refresh project to alter the physical appearance and layout of its facility in order to maintain a contemporary and attractive environment and reflect the changing demographics of its customers. The taxpayer pays $3 million for these activities. Of the $3 million, $1 million is used to purchase furniture and equipment. That $1 million is excluded remodel-refresh costs because it was used to purchase furniture and fixtures, and the remaining $2 million is considered qualified costs. Under the safe harbor of accounting, 75% of the $2 million of qualified costs ($1,500,000) is treated as deductible in the year the property is placed in service, and the remaining 25% of the $2 million ($500,000) is capitalized and depreciated.
What is the effective date?
The revenue procedure is effective immediately for tax years beginning on or after January 1, 2014.
Important Note: This article is a brief overview of the revenue procedure that provides for a safe harbor method of accounting for certain remodel and refresh expenditures. The revenue procedure documents specific criteria that must be met to qualify. We recommend you discuss your specific situation with your tax adviser or Clark Nuber to determine if this safe harbor method of accounting could benefit you.
This article or blog contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.
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