On September 19, 2016, the IRS released 14 Frequently Asked Questions (FAQs) related to the remodel-refresh safe harbor method of accounting provided in Revenue Procedure 2015-56, 2015-49 I.R.B. 827. Revenue Procedure 2015-56 provides certain qualified taxpayers primarily engaged in the trade or business of operating a retail establishment or restaurant, as well as certain landlords, a safe harbor method of accounting for determining whether expenditures paid or incurred to remodel or refresh a qualified building: (1) are deductible under Section 162(a), (2) must be capitalized as improvements under Section 263(a), or (3) must be capitalized as the costs of property produced by the taxpayer for use in its trade or business under Section 263A. The safe harbor applies to all qualifying remodel-refresh projects undertaken by a qualified taxpayer on qualified buildings, and allows taxpayers to immediately deduct 75% and capitalize the remaining 25% of the qualifying remodel-refresh costs.

FAQs overview

The FAQs are intended to provide guidance to taxpayers during implementation of the remodel-refresh safe harbor and to provide direction to the IRS agents in the examination of taxpayers that change their method of accounting to apply the safe harbor methodology. The IRS issued the safe harbor in November 2015 as Industry Issue Resolution (IIR) guidance in consultation with the retail and restaurant industry pursuant to Revenue Procedure 2003-36. EY represented two of the three industry groups that developed this safe harbor with the IRS and Treasury.

The most noteworthy takeaways from the 14 FAQs include the following:

— Five-year scope limitation resulting in non-automatic change — A taxpayer that filed a Form 3115 for designated change number (DCN) 184 for all of its tangible property will trigger the prior five-year item scope limitation if the taxpayer files DCN 222 for the remodel-refresh safe harbor in its 2016 tax year. (see FAQ #3)

— Partial dispositions — The FAQs confirm that a taxpayer may still use the remodel-refresh safe harbor if it fails to reverse partial dispositions. They also provide that a taxpayer that recognizes any partial dispositions in either the 2014 or 2015 tax year will be treated as making a timely partial disposition election for those dispositions. This election can only be revoked by filing a DCN 221 prior to the 2016 tax year. Accordingly, a taxpayer with any partial dispositions in the 2014 or 2015 tax year may be required to file DCN 222 on a cut-off basis (without a Section 481(a) adjustment) for those specific store locations where partial dispositions were recognized. (see FAQ #1 and #10)

— Qualified taxpayers — For those taxpayers that have multiple activities and report within multiple NAICS codes, the FAQs confirm that the taxpayer may still qualify to use the remodel-refresh safe harbor. The determination of a taxpayer's primary activity requires a facts-and-circumstances analysis. The FAQs state that the factors considered in this analysis include, for example, the portion of the taxpayer's revenue generated by its qualified business activities compared to the portion of revenue generated by the taxpayer's excepted business activities, the portion of the taxpayer's employees that perform qualified, as opposed to excepted activities, the portion of the taxpayer's property or properties dedicated to qualified, versus excepted, activities and similar comparisons. (see FAQ #6)

— Capitalized Expenditure Portion (CEP) — The IRS confirmed that a taxpayer may classify the 25% CEP as 15-year recovery period property under Section 168(e) to the extent the taxpayer can substantiate that the portion of the CEP relates to qualified leasehold improvement property, qualified restaurant property or qualified retail improvement property. (see FAQ #12)

— Election to capitalize repair and maintenance costs — The IRS confirmed that, for a taxpayer that has elected to capitalize repairs and maintenance costs, the remodel-refresh safe harbor may only be applied to amounts incurred in tax years for which the taxpayer did not make the election. (see FAQ #13)

Implications

Taxpayers should evaluate the effect of the FAQs on their plan for implementing the remodel-refresh safe harbor. Taxpayers planning to file an accounting method change for their 2016 tax year to utilize the safe harbor method should recognize the potential effect of any previously or currently filed changes under the tangible property regulations (DCN 184) that include qualified building property, which may require making the change to use the safe harbor using the non-automatic procedures in Revenue Procedure 2015-13.

Importantly, taxpayers should also be aware of timing restrictions related to Revenue Procedure 2015-56, including the inability for tax years ending after December 31, 2016, to make the change to revoke partial dispositions. The unavailability of change #221 beyond a tax year beginning in 2015 may impair the ability to claim a full Section 481(a) adjustment on the change to use the safe harbor. Additionally, taxpayers should review the positions they have taken in implementing the remodel-refresh safe harbor.

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