SECTION 2. BACKGROUND

.01 Taxpayers operating in the retail and restaurant industries regularly incur expenditures to remodel or refresh buildings used in the trade or business of selling tangible personal property or services to the general public. A project to remodel or refresh a retail establishment or a restaurant is generally referred to as a “remodel” or a “refresh,” depending on the extent of work performed (collectively referred to as a “remodel-refresh project” as defined in section 4.03). Generally, a retail or restaurant taxpayer undertakes a remodel-refresh project to remain competitive and to improve the customer experience. These projects typically involve a planned undertaking to alter the physical appearance and layout of the building to maintain a contemporary and attractive environment, to more efficiently locate different functions and products, to conform to current industry standards and practices, to standardize the customer experience, to offer the most relevant goods, food, or beverages, and to address changes in demographics by changing offerings and their presentation. Typically, taxpayers also perform routine repairs and

maintenance during a remodel-refresh project.

.02 Section 162 generally allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including the costs of repairs and maintenance. Section 263(a) generally requires the capitalization of amounts paid to acquire, produce, or improve tangible property.

.03 Section 1.162–4 allows taxpayers to deduct amounts paid for repairs and maintenance of tangible property if the amounts are not otherwise required to be capitalized. Section 1.263(a)–3 generally requires taxpayers to capitalize amounts paid to improve a unit of property. Section 1.263(a)–3(d) defines improvements as amounts paid that are for a betterment to a unit of property, that restore a unit of property, or that adapt a unit of property to a new or different use. Sections 1.263(a)– 3(j), (k), and (l) provide detailed criteria for determining whether amounts fall into any of these categories. Section 1.263(a)– 3(e)(2) provides for the application of these criteria to the building unit of property by applying the criteria separately to the building structure and specifically designated building systems.

.04 Although § 1.263(a)–3 provides several examples that apply the improvement criteria and the unit of property rules to remodel or refresh costs, many remodel-refresh projects are more complicated and diverse than the scenarios included in the examples. Because remodelrefresh projects frequently involve work performed on building structures and a variety of building systems, the final tangible property regulations generally require taxpayers performing remodelrefresh projects to apply separate legal analyses to many different components of the building. These analyses become especially difficult in situations where, as part of their remodel-refresh projects, taxpayers adapt portions of space to a new and different use. Moreover, the application of the improvement rules to particular buildings can be complex because remodel-refresh projects vary so much in frequency, quality, and degree. Consequently, taxpayers and the IRS frequently encounter questions regarding whether the costs for a particular remodel-refresh proj

ect should be characterized as repairs, maintenance, or an improvement of the taxpayers’ property, causing taxpayers and the IRS to expend significant resources on this factually intensive issue.

.05 In addition, § 263A requires the capitalization of the direct and allocable indirect costs of real or tangible property produced by a taxpayer for use in its trade or business or acquired for resale. See also § 1.263A–1(a)(3)(ii). Section 263A and its regulations apply to a retail or restaurant taxpayer’s self-constructed property and, therefore, require the capitalization of the direct and allocable indirect costs of property constructed, built, installed, or improved during a remodel-refresh project. See § 1.263A–2(a)(1). Thus, the rules under § 263A require taxpayers to apply an additional analysis to their remodelrefresh projects to determine which costs must be capitalized as the direct or allocable indirect costs of producing property used in their trade or business.

.06 To reduce disputes regarding the deductibility or capitalization of remodelrefresh costs (as defined in section 4.04), this revenue procedure provides a safe harbor approach under which qualified taxpayers (as defined in section 4.01(1)– (3)) may determine the portions of their remodel-refresh costs that may be deducted or must be capitalized for purposes of §§ 162(a), 263(a), and 263A(b)(1). This safe harbor method minimizes the need to perform a detailed factual analysis to determine whether each remodel-refresh cost incurred during a remodel-refresh project is for repair and maintenance under § 1.162–4 or for an improvement under § 1.263(a)–3. In addition, because this safe harbor method is applied to the entire building unit of property, the safe harbor method also eliminates the need to apply these rules separately to each building structure and each building system designated under § 1.263(a)–3(e). Moreover, the safe harbor eases the factual inquiry into whether costs incurred during a remodel-refresh project adapt property to a new or different use, requiring qualified taxpayers to exclude from the safe harbor only amounts that adapt more than 20 percent of the total square footage of the building to a new or different use. Finally, the safe harbor removes the qualified taxpayer’s requirement to complete a sepa

Bulletin No. 2015–49 827 December 7, 2015

rate analysis under § 263A and the corresponding regulations to determine whether any remodel-refresh costs, including interest, must be capitalized as direct and allocable indirect costs of producing property used in its trade or business.

.07 Section 4 provides definitions for purposes of applying the remodel-refresh safe harbor. This section defines qualified taxpayers, qualified projects, and remodel or refresh costs that are eligible for treatment under the safe harbor. Section 4 also defines excluded remodel-refresh costs for purposes of determining which costs incurred during a qualified project must be excluded in determining the total qualified costs (as defined in section 4.07) subject to the safe harbor. Excluded remodelrefresh costs generally consist of amounts that are clearly characterized as capital expenditures, amounts that are paid for properties that are not part of a qualified building, and amounts that are properly analyzed under Code and regulation provisions outside the context of this revenue procedure. To summarize, the remodelrefresh costs eligible for the safe harbor are the costs incurred in a typical remodelrefresh project for § 1250 property that are often subject to controversy regarding the proper treatment for federal income tax purposes.

.08 Section 5 provides a remodelrefresh safe harbor method. Section 5.02(1) provides the allocation ratio for determining the portion of qualified costs that may be deducted under § 162(a) and the portion that must be capitalized as improvements under § 263(a) or as property produced by the qualified taxpayer for use in its trade or business under § 263A(b)(1). The allocation ratio takes into account non-inventory § 263A costs, amounts that adapt a portion of a qualified building to a new or different use, and losses on the dispositions of relevant building assets (or portions thereof). The allocation ratio is based on an analysis of data compiled from taxpayers, IRS Examination, and IRS Appeals.

.09 Section 5.02(3) provides rules under the remodel-refresh safe harbor for the capitalization, depreciation, and disposition of a qualified building (or a portion thereof) to which the qualified taxpayer

has applied the remodel-refresh safe harbor.

.10 Sections 5.02(4), 5.02(5), and 5.02(6) provide limitations on how the disposition rules may be applied by a qualified taxpayer using the remodelrefresh safe harbor. Because the allocation ratio takes into account losses on the dispositions of relevant building assets (or portions thereof), these limitations exist to ensure that a taxpayer using the remodelrefresh safe harbor does not use the allocation ratio to determine its deductible costs for a remodel-refresh project while also claiming a disposition loss on the related assets disposed of.

.11 Section 1.168(i)–1 provides rules for general asset accounts. Section 1.168(i)–8 provides rules for dispositions of property depreciated under § 168. Sections 1.168(i)–1(e)(2)(viii)(B)( 1 ) and 1.168(i)–8(c)(4)(ii)(A) provide that each building, including its structural components, is the asset for tax disposition purposes, except as otherwise provided in the final disposition regulations. Where a taxpayer places in service an improvement or addition to the building after the original building is placed in service, the improvement or addition is the asset for depreciation and disposition purposes in accordance with §§ 168(i)(6), 1.168(i)– 1(e)(2)(viii)(B)( 1 ), and 1.168(i)– 8(c)(4)(ii)(D). .12 Section 1.168(i)–8(d)(2) permits a taxpayer to elect in most cases to treat the disposed portion of an asset as a disposition (for example, the disposition of a roof (or a portion of the roof)) in the taxable year in which the portion is disposed of. If an asset is not included in a general asset account, a taxpayer generally must recognize gain or loss and cease depreciation on the disposition of (1) the asset (for example, the original building, including its structural components, or the building addition or improvement) or (2) a portion thereof for which the taxpayer makes the partial disposition election. See § 1.168(i)–8(e). If an asset is included in a general asset account, a taxpayer generally does not realize a loss upon disposition of the asset or a portion thereof, and continues to depreciate the disposed asset or disposed portion of an asset. See § 1.168(i)–1(e)(2)(i).

.13 Because the safe harbor allocation ratio takes into account losses on the dispositions of relevant building assets (or portions thereof), section 5.02(4) provides that a qualified taxpayer using the remodel-refresh safe harbor method provided in this revenue procedure may not make the partial disposition election under § 1.168(i)–8(d)(2), Prop. Reg. § 1.168(i)– 8(d)(2), section 6.33 of the Appendix of Rev. Proc. 2011–14, 2011–4 I.R.B. 330, as modified by section 3.03(1) of Rev. Proc. 2014–17, 2014–12 I.R.B. 661, 677, and section 3.02(4) of Rev. Proc. 2014– 54, 2014–41 I.R.B. 675, 679, or section 6.33 of Rev. Proc. 2015–14, 2015–5 I.R.B. 450, 483, to dispose of a portion of a qualified building, including an asset placed in service and disposed of in a taxable year prior to the year that the safe harbor was utilized by the taxpayer. Section 5.02(4)(b) provides the time and manner of revoking a partial disposition election that is related to a qualified building and made in a prior taxable year. If the taxpayer does not make this revocation, section 5.02(4)(c) provides that the change in method of accounting to utilize the safe harbor is made on a cut-off basis for the qualified building to which the unrevoked partial disposition election pertains.

.14 In addition, if a qualified taxpayer recognized a gain or loss on the disposition of a component of a qualified building under § 1.168(i)–1T or § 1.168(i)–8T, as applicable, or in a taxable year beginning before January 1, 2012, section 5.02(5) provides that the taxpayer must change its method of accounting to be in accord with § 1.168(i)–1(e)(2)(viii) or § 1.168(i)–8(c)(4) (determination of asset disposed of), as applicable, and must take into account the entire amount of the § 481(a) adjustment in computing taxable income for the year of change. If the taxpayer does not make this change in method of accounting, the remodelrefresh safe harbor provided in this revenue procedure does not apply to any qualified building for which the taxpayer recognized a gain or loss on the disposition of a component under § 1.168(i)–1T or § 1.168(i)–8T, or in a taxable year beginning before January 1, 2012.

.15 Section 5.02(6) provides that a qualified taxpayer using the remodel

December 7, 2015 828 Bulletin No. 2015–49

refresh safe harbor method must include in general asset accounts the assets comprised of the capitalized portion of the qualified costs and assets previously placed in service and subject to the remodel-refresh safe harbor method. Section 5.02(6)(d) permits qualified taxpayers utilizing the remodel-refresh safe harbor to make a late general asset account election under § 168(i)(4) and § 1.168(i)–1 for assets previously placed in service and subject to the safe harbor method.

.16 A taxpayer’s method for determining whether an amount is deducted or is capitalized is a method of accounting under § 446. Except as otherwise expressly provided in the Code or in Treasury regulations, § 446(e) and § 1.446–1(e)(2) require a taxpayer to secure the consent of the Commissioner of Internal Revenue (Commissioner) before changing a method of accounting for federal income tax purposes. Section 1.446–1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions necessary to permit a taxpayer to obtain consent to change a method of accounting. Section 7 provides the procedures for a qualified taxpayer to obtain automatic consent for a change in method of accounting to use the safe harbor method provided by this revenue procedure.