Rev. Proc. 2016-29: Safe Harbor for Land Improvements

Revenue Procedure 2016-29 from the Internal Revenue Service offers a streamlined method for businesses to handle costs for specific land improvements. This procedure establishes an optional “safe harbor” framework that, if followed, ensures compliance with certain tax regulations without a detailed, case-by-case analysis of expenditures.

The primary function of this procedure is to clarify the accounting treatment of land improvement costs. It addresses whether these expenses must be capitalized, meaning they are added to the property’s basis and recovered over time. For certain taxpayers in a real property trade or business, this safe harbor provides a clear path for depreciating these assets over a predetermined period, removing uncertainty from the tax reporting process.

Qualifying for the Safe Harbor

Eligibility to use the safe harbor method depends on meeting criteria related to the taxpayer’s business operations. A taxpayer may qualify if their average annual gross receipts for the three preceding taxable years are $10 million or less. This threshold is designed to make the simplified method accessible to smaller businesses.

An alternative path to qualification exists for taxpayers engaged in a real property trade or business, irrespective of their gross receipts. This provision extends the safe harbor’s availability to enterprises whose core operations are centered on real estate.

Qualified Real Property Trade or Business

The tax code defines a “qualified real property trade or business” to include a wide range of real estate professions. Businesses involved in real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage meet this definition.

To be considered engaged in such a trade or business, a taxpayer must demonstrate material participation. More than one-half of the personal services performed by the taxpayer during the tax year must be in real property trades or businesses. The taxpayer must also perform more than 750 hours of services during the taxable year in these real property activities.

Eligible Land Improvements

The safe harbor applies only to specific enhancements made to land that is owned or leased by the eligible taxpayer. While the cost of raw land is not depreciable, the improvements placed upon it may be.

Qualifying improvements under this revenue procedure include:

• Landscaping, such as the installation of trees, shrubs, and lawns
• The construction of walkways and patios
• Fences, retaining walls, and non-building structures like swimming pools and tennis courts
• Parking areas, including paving, striping, and lighting
• Drainage systems and utility connections like water and sewer lines that are not part of a building

Applying the Safe Harbor Method

Applying the safe harbor method provides an exemption from the Uniform Capitalization (UNICAP) rules found in the Internal Revenue Code. These rules require producers and resellers of property to capitalize all direct costs and a portion of indirect costs that are allocable to that property, which can be a complex calculation.

By using the safe harbor, the costs of the eligible land improvements are carved out from the UNICAP requirements. This means the taxpayer does not need to undertake the detailed analysis required to allocate indirect costs to these specific improvements, which simplifies the accounting process.

Depreciation Treatment

The safe harbor provides a specific depreciation treatment for eligible land improvements. Under this method, the improvements are classified as 15-year property for the General Depreciation System (GDS). This allows the taxpayer to recover the cost of the improvements through annual depreciation deductions over a 15-year period.

Without the safe harbor, some land improvements might be considered non-depreciable land costs or be assigned a longer recovery period. A 15-year life accelerates the rate at which a business can deduct the expense of the improvements. This can improve cash flow by reducing taxable income in the earlier years of the property’s life.

Making the Safe Harbor Election

Adopting the safe harbor is a change in accounting method, which normally requires IRS consent. However, Revenue Procedure 2016-29 provides for automatic consent for this specific change, so a taxpayer does not need to file a request and wait for approval. This automatic consent streamlines the adoption process, and the change is effective for the taxable year in which it is made and applies to all subsequent tax years.

Required Documentation (Form 3115)

The document for making this accounting method change is Form 3115, Application for Change in Accounting Method. This form must be completed and filed to formally notify the IRS of the election. It requires information about the taxpayer, the old and new accounting methods, and the nature of the change.

For this safe harbor, taxpayers must identify the change using the appropriate Designated Change Number (DCN) as specified in the form’s instructions. The taxpayer will need to describe their business activities on the form to confirm eligibility. They must also detail the types of land improvements being subjected to the new method.

The Submission Process

A completed copy of Form 3115 must be attached to the taxpayer’s timely filed federal income tax return for the year the change is implemented. This attachment serves as the official election of the safe harbor method.

In addition to attaching the form to the tax return, a signed copy of Form 3115 must also be filed with the IRS national office. The mailing address for this filing is located in the instructions for Form 3115.

Post-Submission Expectations

After filing Form 3115, the change in accounting method is effective for the year of the change. The taxpayer will begin applying the safe harbor method to all eligible land improvement costs incurred in that year and for all future years.

The taxpayer must also calculate a Section 481(a) adjustment. This adjustment accounts for the cumulative difference between the old and new accounting methods for improvements made in prior years. This calculation prevents the duplication or omission of deductions and is reported on Form 3115, with the adjustment taken into account over one or four years, depending on whether it increases or decreases taxable income.