KBKG Tax Insight: Retail/Restaurant Industry Safe Harbor Under Tangible Property Regulations

Transcription

1 KBKG Tax Insight: Retail/Restaurant Industry Safe Harbr Under Tangible Prperty Regulatins Authr: Jhn Hanning, CCSP, MBA C Authr: Lester Ck, CCSP, ASA The IRS recently issued Revenue Prcedure prviding a safe harbr fr certain taxpayers perating retail r restaurant establishments fr determining whether expenditures incurred t remdel r refresh their prperty can be expensed under the Tangible Prperty Regulatins released in Generally, the safe harbr benefits thse enhancing the physical appearance and layut f their building t maintain a cntemprary and attractive envirnment fr their custmers. Thrugh the adptin f the safe harbr, retailers and restaurateurs can nw take advantage f the ability t immediately deduct 75% f qualified amunts spent t refresh certain prperty and are required t capitalize the remaining 25%. KBKG Insight: Qualified prperty specifically excludes 1245 prperty, s a cst segregatin analysis f any remdeling r refreshing activity shuld be cnsidered. The new rules minimize the need t perfrm a detailed factual analysis t determine whether each cst incurred during a remdel refresh prject is fr repair and maintenance r fr an imprvement. In additin, because the new safe harbr methd applies t the entire building r entire leased space, it eliminates the need t apply the unit f prperty rules separately t each building structure and each building system designated under the capitalizatin rules. Mrever, the safe harbr eases the factual inquiry int determining whether csts incurred during a remdel refresh prject adapt prperty t a new r different use, requiring qualified taxpayers t exclude frm the safe harbr nly amunts that adapt mre than 20 percent f the ttal square ftage f the building t a new r different use. KBKG Insight: Rev. Prc is effective fr tax years beginning n r after January 1, Practitiners will want t review these rules if they have retail/restaurant clients that have recently incurred majr remdel refresh csts t identify any accelerated deductins. In rder t utilize the safe harbr, taxpayers must have an applicable financial statement, which fr many taxpayers means an audited financial statement. Backgrund The Tangible Prperty Regulatins intrduced the cncept f Unit f Prperty and building systems alng with the requirement t analyze capital expenditures related t a betterment, adaptatin, r restratin f the system rather than the entire building as a Unit f Prperty. Retailers have argued that refreshing type activities ften require wrk perfrmed n the building systems utlined within the Tangible Prperty Regulatins and that the requirement t apply a separate legal analysis t the different cmpnents f the buildings is especially difficult in their situatin. These prjects typically invlve a planned undertaking t alter the physical appearance and layut f the building t maintain a cntemprary and attractive envirnment, t mre efficiently lcate different functins and prducts, t cnfrm t current industry standards and practices, t standardize the custmer experience, t ffer the mst relevant gds, fd, r beverages, and t address changes in demgraphics by changing fferings and their presentatin. Typically, taxpayers als perfrm rutine repairs and maintenance during a remdel refresh prject. NATIONWIDE SERVICE KBKG Insights - Rev. Prc

2 Cde Sec. 162 generally allws a deductin fr all the rdinary and necessary expenses paid r incurred during the tax year in carrying n any trade r business, including the csts f repairs and maintenance. Cde Sec. 263(a) generally requires the capitalizatin f amunts paid t acquire, prduce, r imprve tangible prperty. Reg. Sec allws taxpayers t deduct amunts paid fr repairs and maintenance f tangible prperty if the amunts are nt therwise required t be capitalized. Reg. Sec (a) 3 generally requires taxpayers t capitalize amunts paid t imprve a unit f prperty. Reg. Sec (a) 3(d) defines imprvements as amunts paid that are fr betterment t a unit f prperty, that restre a unit f prperty, r that adapt a unit f prperty t a new r different use. In additin, Cde Sec. 263A requires the capitalizatin f the direct and allcable indirect csts f real r tangible prperty prduced by a taxpayer fr use in its trade r business r acquired fr resale. Thus, the rules under Cde Sec. 263A require taxpayers t apply an additinal analysis t their remdel refresh prjects t determine which csts must be capitalized. Because remdel refresh prjects frequently invlve wrk perfrmed n building structures and a variety f building systems, the tangible prperty regulatins generally require taxpayers perfrming remdel refresh prjects t apply separate legal analyses t many different cmpnents f the building. Cnsequently, taxpayers frequently encunter questins regarding whether the csts fr a particular remdel refresh prject shuld be characterized as repairs, maintenance, r an imprvement f the taxpayers' prperty, causing taxpayers t expend significant resurces n this factually intensive issue. T reduce disputes regarding the deductibility r capitalizatin f remdel refresh csts, Rev. Prc prvides a safe harbr apprach under which qualified taxpayers may determine the prtins f their remdel refresh csts that may be deducted r must be capitalized fr purpses f Cde Secs. 162(a), 263(a), and 263A(b)(1). KBKG Insight: Taxpayers wishing t avail themselves f the safe harbr must use the autmatic change prcedures in Rev. Prc Wh Qualifies t Use the Safe Harbr The Rev. Prc remdel refresh safe harbr applies t a qualified taxpayer that pays qualified csts in the curse f perfrming a remdel refresh prject n a qualified building. A qualified taxpayer is ne wh has an Applicable Financial Statement (as defined under Reg. Sec (a) 1(f)(4)), and in general: Is in the trade f selling merchandise, including gds t resellers such as warehuse clubs, hme imprvement stres. EXCLUDED: autmtive dealers, ther mtr vehicle dealers, gas statins, manufactured hme dealers, and nn stre retailers Is in the trade r business f preparing and selling meals, snacks, r beverages t custmer rder fr immediate n premises and/r ff premises cnsumptin. EXCLUDED: htels and mtels; civic r scial rganizatins; r amusement parks, theaters, casins, cuntry clubs, r similar recreatin facilities, special fd services, fd service cntractrs, caterers, and mbile fd services. NATIONWIDE SERVICE KBKG Insights - Rev. Prc

3 A qualified cst remdel, refresh, repair, maintenance, r similar activity includes: Painting, plishing, r finishing interir walls; Adding, replacing, repairing, maintaining, r relcating permanent flr, ceiling, r wall cverings, including millwrk; Adding, replacing, repairing, maintaining, r relcating kitchen fixtures; Adding, replacing, r mdifying signage r fixtures; Relcating departments, eating areas, check ut areas, kitchen areas, beverage areas, management space, strage space, r similar areas, within the existing ftprint f the qualified building; Increasing r decreasing the square ftage f departments, eating areas, check ut areas, kitchen areas, beverage areas, management space, strage space, r similar areas within the existing ftprint f the qualified building; Adding, relcating, r remving a rm r rms (fr example, dressing rms, private dining space, frnt ffice space, r break rms) within the existing ftprint f the qualified building; Mving, cnstructing, r altering walls within the existing ftprint f the qualified building; Adding, relcating, remving, replacing, r re lamping lighting fixtures, r adding reflectrs, mirrrs, r ther similar devices t existing lighting fixtures; Repairing, maintaining, retrfitting, relcating, adding, r replacing building systems within the existing ftprint f the qualified building; Making nn structural changes t exterir facades; Relcating, replacing, r adding windws r drs within the existing ftprint f the qualified building; Repairing, maintaining, r replacing the rf r prtin f the rf within the existing ftprint f the qualified building; Replacing façade materials arund windws and entrances; Repair and maintenance t the qualified building that directly benefits r is incurred by reasn f a remdel refresh prject; Remval and demlitin, ther than demlitin subject t 280B, f structural cmpnents f a qualified building (fr example, insulatin, windws, drywall, and similar prperty) that directly benefit r are incurred by reasn f a remdel refresh prject; Obtaining permits r ther similar authrizatins that directly benefit r are incurred by reasn f a remdel refresh prject; and Architectural, engineering, and similar services that directly benefit r are incurred by reasn f a remdel refresh prject. Meaning, indirect csts incurred during a remdel refresh prject that are required t be capitalized shuld be included retail safe harbr calculatin (75%/25%). Specifically excluded remdel refresh csts include: Sectin 1245 Prperty (as defined in 1245(a)(3)); An intangible under 1.263(a) 4(b), including the creatin r maintenance f sftware Land, including nn depreciable land imprvements described in Asset Class 00.3 f Rev. Prc ; The initial acquisitin, prductin, r lease f a qualified building, including purchase price, cnstructin csts, transactin csts, and the csts f wrk perfrmed prir t the date that the qualified building is initially placed in service by the qualified taxpayer, The initial build ut f a leased qualified building, r a prtin theref, fr a new lessee; NATIONWIDE SERVICE KBKG Insights - Rev. Prc

4 Activities t rebrand a qualified building perfrmed within tw taxable years fllwing the clsing date f: 1. The acquisitin r initial lease f the qualified building by the qualified taxpayer r persn related, r 2. The acquisitin by the qualified taxpayer r a persn related t the qualified taxpayer f a cntrlling interest in the qualified building r in a lease f the qualified building; Activities perfrmed t amelirate a material cnditin r defect that existed prir t the qualified taxpayer s acquisitin r lease f the qualified building r that arse during the prductin f the qualified building, regardless f whether the qualified taxpayer was aware f the cnditin at the time f acquisitin r prductin; Material additins t the qualified building, including the building systems; Restratin caused by damage t the qualified building fr which the qualified taxpayer is required t take a basis adjustment as a result f casualty lss; Adapting mre than twenty percent f the ttal square ftage f a qualified building t new r different uses; Remdel refresh csts incurred during a temprary clsing lasting mre than 21 cnsecutive calendar days; The cst f any prperty fr which the qualified taxpayer has claimed deductin under 179, 179D, r 190. What Qualifies t Use the Safe Harbr A qualified building is each building unit f prperty used by a qualified taxpayer, as defined in (e)(1), and its structural cmpnents, as defined in (e)(2), and in general: Fr cndminiums the building unit f prperty is each individual unit wned by the qualified taxpayer. Fr Cperatives the building unit f prperty is the prtin f the building in which the qualified taxpayer has pssessry rights. Fr Leased buildings the building unit f prperty is the building and its structural cmpnents subject t the lease. Meaning the UOP is applied t a prtin f a building such as a stre, a flr, r certain square ftage as defined by the lease. A remdel refresh prject in general means, a planned undertaking t alter the stres/restaurants physical appearance and/r layut fr ne r mre f the fllwing purpses: T maintain a cntemprary and attractive appearance; T mre efficiently lcate retail r restaurant functins and prducts; T cnfrm t current retail r restaurant building standards and practices; T standardize the cnsumer experience if a qualified taxpayer perates mre than ne building; T ffer the mst relevant and ppular gds within the industry; r T address changes in demgraphics by changing prduct r service fferings and their presentatins. KBKG Insight: A remdel refresh prject des nt include a planned undertaking slely t repaint r t clean the interir r exterir f an existing qualified building. These are ften referred t in NATIONWIDE SERVICE KBKG Insights - Rev. Prc

5 the industry as Preventative Maintenance Prgrams and are generally expensed in full as repair and maintenance csts. Hw t Cmpute the Safe Harbr Subject t certain exceptins, the remdel refresh safe harbr applies t all f the qualified taxpayer's qualified csts paid during the tax year, and in general a taxpayer wh uses the remdel refresh safe harbr is required t use the methd fr all f its qualified csts as defined later in this analysis. T use the remdel refresh safe harbr, the qualified taxpayer must cmply with six separate requirements. 1. The qualified taxpayer must treat 75% f its qualified csts paid during the tax year as amunts deductible under Cde Sec. 162(a) ("the deductin prtin") and must treat the remaining 25% f its qualified csts paid during the tax year as csts fr imprvements t a qualified building under Cde Sec. 263(a) and as csts fr the prductin f prperty fr use in the qualified taxpayer's trade r business under Cde Sec. 263A ("the capital expenditure prtin"). 2. The qualified taxpayer must dcument its qualified csts in a manner substantially similar t the standard set frth in Appendix A f Rev. Prc The capital expenditure prtin must be charged t a capital accunt. The capital expenditure prtin fr each qualified building is a separate asset r assets fr depreciatin purpses and is depreciated under Cde Secs. 167 and 168 beginning when the capital expenditure prtin is placed in service by the qualified taxpayer. The qualified taxpayer must make an electin t include the capital expenditure prtin in a general asset accunt (GAA). 4. A qualified taxpayer must nt make the partial dispsitin electin under Reg. Sec (i) 8(d)(2) fr any prtin f an riginal qualified building r any prtin f any imprvement r additin t an riginal qualified building. If a qualified taxpayer had previusly made the partial dispsitin, prir t the first tax year that the qualified taxpayer uses the remdel refresh safe harbr, the qualified taxpayer must revke that partial dispsitin electin. 5. If a qualified taxpayer recgnized a gain r lss upn the dispsitin f a cmpnent f a qualified building, a structural cmpnent f a qualified building, r a cmpnent f such structural cmpnent (1) under Reg. Sec (i) 1T r Reg. Sec (i) 8T that cmpnent r structural cmpnent is nt an imprvement r additin, r (2) in a tax year beginning befre January 1, 2012, that cmpnent r structural cmpnent is MACRS prperty, such qualified taxpayer must change its present methd f accunting t be in accrd with Reg. Sec (i) 1(e)(2)(viii) r Reg. Sec (i) 8(c)(4) (determinatin f asset dispsed f), n r befre the first tax year that the qualified taxpayer uses the remdel refresh safe harbr, and take the entire amunt f the Cde Sec. 481(a) adjustment int accunt in cmputing the qualified taxpayer's taxable incme fr that year f change. 6. A qualified taxpayer must make a general asset accunt electin under Cde Sec. 168(i)(4) and Reg. Sec (i) 1(l) t include in a general asset accunt any asset that is MACRS prperty and that cmprises a qualified building. NATIONWIDE SERVICE KBKG Insights - Rev. Prc

6 Q&A Sectin with KBKG Experts Questin If I elect t apply the retail safe harbr can I d that n a prject by prject basis? Answer N, a qualified taxpayer within the scpe f this revenue prcedure wh uses the remdelrefresh safe harbr is required t use the methd fr all f its qualified csts until the qualified taxpayer secures permissin frm the IRS t use anther methd f accunting. Questin Hw d I treat the capitalized prtin f the cst? Answer The qualified taxpayer must make an electin t include the capital expenditure prtin in a general asset accunt under 168(i)(4) and 1.168(i) 1. In establishing a general asset accunt (GAA), all assets that are MACRS prperty, that cmprise qualified buildings, that are placed in service in the same taxable year, and that meet the requirements in 1.168(i) 1(c)(2), must be gruped in the same general asset accunt (GAA). Questin Is a retail/restaurant taxpayer required t place all capitalized items int general asset accunt (GAA)? Answer N, nly t the extent that the taxpayer is utilizing the Retail Safe Harbr. Questin Can I treat the remaining nn qualified cst (25%) as Qualified Leasehld Imprvements (QLI), Qualified Restaurant Prperty, r Qualified Retail Prperty t accelerate the recvery perid? Answer Yes, but the taxpayer must supprt that psitin under thse rules. If it cannt be supprted, the balance is treated as nnresidential real prperty recvered ver 39 years. Remember, all assets placed in service in a given year must be placed int a GAA at the MACRS asset class level. Questin If a taxpayer utilizes the Retail Safe Harbr, must they place the riginal cnstructin in a GAA? Answer Yes; hwever, if a qualified taxpayer has multiple qualified buildings, the qualified taxpayer may have separate general asset accunts fr the riginal cst f each riginal qualified building, including the riginal structural cmpnents f that building. Fr example, Stre #A was riginally cnstructed in 2010 and the cst was capitalized as 39 year prperty. Subsequently, a remdel tk place in 2016 fr which the retail safe harbr is applied resulting in $200k f Qualified Leasehld Imprvements recvered ver 15 years. In rder fr the taxpayer t use the Retail Safe Harbr they are required t file a late GAA Electin n Frm 3115 t include all riginal cst in a general asset accunt fr any asset that is MACRS prperty. Questin Are indirect csts incurred during a remdel refresh prject required t be capitalized? If s, are these cst included in the retail safe harbr calculatin? Answer Yes t bth parts Questin What if a taxpayer mved ut f a leased space, culd they take a full dispsitin fr the abandned asset in that tax year? Answer Yes, the dispsitin limitatin applies when the dispsitin f an imprvement is a result f a remdel refresh. In this case the remdel refresh prject des nt cnstitute a qualifying dispsitin under 1.168(i) 1(e)(3)(iii)(B)(3). Questin Can a taxpayer take a dispsitin f a capitalized amunt in a later tax year? Answer Yes, but the taxpayer must make a full dispsitin f this cst. NATIONWIDE SERVICE KBKG Insights - Rev. Prc

7 Fr example, Stre #A was remdeled in 2016 fr which the retail safe harbr was applied resulting in $200k f Qualified Leasehld Imprvements recvered ver 15 years. Stre A was remdeled again in 2020 remving all finishes installed during the 2016 remdel. In this case the taxpayer can take a full dispsitin under Accunting Methd Change #205/#206 t recver the un depreciated balanced. Questin Can a taxpayer using the safe harbr take a Partial Dispsitin f a capitalized amunt in a later tax year? Answer N, a taxpayer cannt make the partial dispsitin electin. Fr example, Stre A was remdeled in 2016 fr which the retail safe harbr was applied resulting in $200k f QLHI recvered ver 15 years. Stre A was remdeled again in 2020 remving nly a small prtin f the finishes installed during the 2016 remdel. In this case the taxpayer cannt take a partial dispsitin. Questin What if the taxpayer already made a partial dispsitin electin in a prir year? Answer The taxpayer must revke the partial dispsitin electin, in rder t use the safe harbr rules fr the year in which the dispsitin was taken. There are tw ways t cmplete this. 1) Amend the return (subject t limitatins stated in R.P ) r 2) file an Autmatic Accunting Methd Change filed n later than the secnd taxable year beginning after 12/31/2013. What if they d nthing? In this case the taxpayer may nly utilize the remdel refresh safe harbr n a cut ff basis fr the qualified building t which the unrevked partial dispsitin electin pertains. Questin If my client elects the safe harbr fr small taxpayers under 1.263(a) 3(h) can they apply the remdel refresh safe harbr? Answer N, in general these rules apply t taxpayers with audited financial statements (AFS) and a taxpayer may nt elect t apply the safe harbr fr small taxpayers under 1.263(a) 3(h). Questin Can I use Statistical Sampling in cnjunctin with the remdel refresh safe harbr? Answer Yes, a qualified taxpayer changing its methd f accunting under this sectin may use statistical sampling in determining the 481(a) adjustment nly by fllwing the sampling prcedures prvided in Rev. Prc , I.R.B NATIONWIDE SERVICE KBKG Insights - Rev. Prc