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the Restaurateur

IRS Releases Safe Harbor for Restaurant Repairs

December 18, 2015

Have you repaired or remodeled your restaurant recently? The IRS has released its long awaited safe harbor rules for building repairs.

On November 19th, the IRS released guidance surrounding IRS Revenue Procedure 2015-56 which provides certain qualified taxpayers with a safe harbor accounting method for costs incurred related to remodeling their “qualified buildings”. The IRS has imposed certain terms and rules regarding this update, and restaurateurs and retailers are encouraged to read up on the change.

Are only restaurants subject to the update?

The qualified taxpayers must be in the business of running a retail establishment or a restaurant (and must also have “applicable financial statements”). An Applicable Financial Statement is defined in Regulation § 1.263(a)-1(f)(4) – generally audited financial statements.

History of the tangible property regulations

The concepts of “building systems” and “unit of property” were established by the tangible property regulations.

  • “Building systems” refers to several systems within a building—the plumbing, electrical, HVAC, fire protection and alarm, security, elevator, escalator, and the gas distribution systems.
  • The unit of property (UOP), on the other hand, typically refers to a collection of components that are functionally interdependent. For example, a building structure would be the foundation, shell, roof, windows and doors combined as one UOP.

Under the tangible property regulations, retailers and restaurateurs were required to analyze capital expenditures connected to the improvement, adaptation or renovation of the “building system” or in the “unit of property” context to determine if a capitalization was required.

Why the need for the safe harbor?

There are a few issues surrounding the previous rules, including:

  • “Refreshing” a building, according to business owners, requires work to be done on the building systems outlined within the tangible property regulations. Hence, the requirement to apply an individual legal analysis to each different component of a building was especially tough given their situation.
  • Restaurant owners and retailers have been frustrated by the cumbersome process to determine which refresh/remodeling costs should be expensed and deducted right away, and which must be capitalized and depreciated over time.
  • With the old system, restaurant owners and retailers had to do thorough factual assessments as a way of knowing whether refresh-remodel expenses should be treated as repairs, maintenance or replacements.
  • The previous system was not only complicated, but very expensive for both taxpayers and the IRS.

What are the new rules?

Tax filings for 2014 and beyond are eligible for the new rules, which include:

  • Business owners no longer have to determine whether costs are deductible repairs and maintenance expenses under IRC Sec. 162(a) or if they must be capitalized under IRC Sec. 263(a).
  • Retailers and restaurant owners are able to deduct 75% of qualified costs as repairs and maintenance expenditures and the resulting amount will be considered deductible instantly (These items are ordinarily depreciated over 39 years). The remaining 25% will be capitalized and depreciated over time.

Keep in mind that in addition to “applicable financial statements”, restaurants must also have a new Form 3115 filed with the IRS. This has been a long time coming, and retailers and restaurateurs are pleased to finally see the safe harbor rules become law.

Refer to IRS Rev. Proc. 2015-56 for more details.

If you own a restaurant or retail business and want to understand how these rules may affect you, contact any member of our Hospitality Services Team.

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