In November of this year, the IRS raised the safe harbor threshold for deducting certain capital items from $500 to $2,500. Small businesses that do not have audited financial statements and other “applicable financial statements” may use this safe harbor amount. For businesses that do have audited financial statements, the safe harbor threshold remains at $5,000 for tangible property expensing.
So what does all of this mean for you?
It means a change from the final regulations issued on September 17, 2013 wherein the $500 rule first came into being. These safe harbor rules were to be implemented on or after January 1, 2014. Even though the new $2,500 rule goes into effect January 1, 2016, the IRS will, in effect, turn a blind eye to its usage in 2015, upon any audit. Bottom line, as of this writing, is that you can use the new rule for tax years beginning in 2012.
What exactly is this $2,500 or $5,000 safe harbor amount?
If you have an expenditure that is $2,500 or less per invoice or per item of the invoice that normally would be capitalized you may make a safe harbor election to deduct the expense currently.
As an example: If you purchased 10 computers from Dell for a total of $23,000, and each computer was listed on the invoice at its cost of $2,300 each, then the entire $23,000 can be expensed under this safe harbor rule. There is no need to capitalize and depreciate these items, if you so elect.
If you are eligible for the $5,000 threshold, because you have audited financial statements, written accounting procedures supporting this policy, are needed.
Where does this leave regular repair and maintenance expenses?
The de minimis safe harbor provided under § 1.263(a)-1(f) was intended as an administrative convenience whereby a taxpayer was permitted to deduct small dollar expenditures for the acquisition or production of new property or for the improvement of existing property, which otherwise must be capitalized under § 263(a).
The de minimis safe harbor does not limit a taxpayer's ability to deduct otherwise deductible repair or maintenance costs that exceed the amount subject to the safe harbor. The safe harbor merely establishes a minimum threshold below which all qualifying amounts are considered deductible. Consistent with longstanding federal income tax rules, a taxpayer may continue to deduct all otherwise deductible repair or maintenance costs, regardless of amount.
Repair and maintenance vs. capitalization - Where is the line between the two?
That question has produced a lot of written material, resulting mostly from court cases where this issue has been litigated. In general, § 263(a) provides that the costs incurred to improve a unit of property must be capitalized. Expenses that result in betterment, restoration or adaptation to the unit of property are considered to have improved the unit of property. Section 162 provides a deduction for all ordinary and necessary business expenses paid or incurred during the taxable year in carrying on a trade or business.
The Supreme Court has recognized that the decisive distinctions between current expenses and capital expenditures are those of degree and not of kind. This means that careful examination of the particular facts and circumstances is required to determine whether a current deduction or capitalization is the appropriate tax treatment.
The regulations state that the cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient condition, may be deducted as an expense. Repairs in the nature of replacements however, to the extent that they arrest deterioration and appreciably prolong the life of the property, shall be capitalized.
The courts have distinguished between deductible repairs and non-deductible capital improvements based on whether the expenditure puts or keeps the property in an ordinary efficient operating condition. If improvements are made that 'put' the particular capital asset in efficient operating condition, then they are capital in nature. If, however, they are made to 'keep' the asset in efficient operating condition, they constitute repairs and are deductible.
How does the Section 179 deduction intersect with this new de minimis rule?
Once you have made your classifications as to capital items versus repair and maintenance items, then the following steps would occur:
- Determination of the use of the de minimis safe harbor threshold of $2,500 ($5,000)
- Designation of the capital assets purchased during the year to be expensed via § 179 availability
- Leaving assets left to list and depreciate according to § 167.
What if you still can't tell if something should be capitalized or expensed?
Contact your professional tax advisors. They can help you make the right decisions in your particular case, and make helpful suggestions as to what to do in the future. For instance, a suggestion may be for you to create the documents necessary to support your decisions for capitalizing or for expensing, and for you to use consistency to guide you in your decision making from year to year.
