Property improvement plans for flagged hotels

PIPs help brands provide a consistent guest experience across all properties. Many brands have been increasingly demanding in their PIP requirements in recent years. The plans often will require significant cost outlay for interior and exterior renovations, updates to or additions of amenities, branding changes like color schemes and modernizations.

Benefits to hotel owners include increased profitability from newer, more appealing and cleaner facilities, as well as from improvements to layout, brand consistency, operational efficiency and technology updates.

Hotel owners may overlook the potential tax savings that can be realized through performing repair and maintenance (R&M) and cost segregation studies on new improvements, called PIP Reviews. Companies sometimes struggle distinguishing between a repair and a capital improvement. In 2013, the IRS issued the final tangible property regulations, aka the “repair regs,” which sought to clarify the existing rules in order to determine whether certain costs are currently deductible or must be capitalized.

Rules remain complicated

Even though these regulations were supposed to clarify the definitions, the rules remain very complicated. Further complicating matters is the revised definition of qualified improvement property, which now applies to hotels. 

With good record keeping and thoughtful analysis, owners can start to immediately realize tax savings. The repair regs include a De Minimis Safe Harbor rule, whereby a taxpayer can classify amounts up to $5,000 per unit as expenses, provided the taxpayer has an audited financial statement ($2,500 without) and written accounting procedures thereon.

The De Minimis rule is particularly beneficial when a taxpayer purchases large quantities of fixtures, such as lamps or toilets, which is the case for many hoteliers executing their PIPs. The total invoice may be well over $5,000, but each unit cost, with all indirect costs included, can be well under and therefore written off as a currently deductible repair.

After carving out costs that meet the Safe Harbor rule, the next step is to determine if the remaining expenditures are a betterment, an adaption or a restoration, aka the “BAR test”; if so, they must be capitalized. These tests must be applied to the unit of property (UOP) to which these expenditures relate.

Generally speaking, a betterment will correct a material defect that existed prior to placing the UOP in service; an adaptation will adapt the UOP to a new or different use; and a restoration will rebuild the UOP to a like-new state or replace a part that comprises a major component or a substantial structural part of the UOP. 

Given the nature of most PIPs, they likely aren’t going to be considered betterments or adaptions. Furthermore, PIPs will be considered restorations only  if they replace a significant portion of a component’s UOP or physical structure.

Considering PIPs typically only replace a small percentage of the building and/or systems (e.g., toilets in 25 out of 250 rooms), it’s likely these improvements don’t meet the restoration test. The exception would be for all other tangible property and any manufacturing equipment.

Classifying furniture, fixtures and equipment

Furniture, fixtures and equipment are considered other tangible personal property; if a taxpayer is replacing these items, unless they meet the Safe Harbor rules, they’ll need to be capitalized. The good news is these items typically will qualify for a shorter class life and bonus depreciation. Although the bonus depreciation in 2023 is no longer 100%; it’s still significant at 80% (it phases out by 20% annually until expiring in 2027).

For any other costs that will be required to be capitalized, a cost seg study will identify any costs that can be reclassed to a shorter class life, such as QIP or land improvements (which also will qualify for bonus depreciation).

If hoteliers can navigate these complexities, they’ll be rewarded with smaller tax bills. And hoteliers that might have missed such benefits on past projects still can collect the benefits from a PIP review as a look-back study.

Here is a case study that describes the potential benefit.

Questions? Contact your Mazars team today for a consultation.