Tangible Property Regulations: The Safe Harbors
Adam Aucoin, Tax Senior Manager
As mentioned in a previous BNN Newsletter article, 2014 tax returns will be accompanied by numerous changes to the methods involved in classifying fixed assets and repairs. These regulations cover, among other things, how to determine whether to expense or capitalize repairs, asset dispositions (including partial dispositions), treatment of materials and supplies, and capitalization rules related to expenditures to buy or produce tangible property.
Due to the voluminous nature of these new regulations, this article will not attempt to cover all aspects of the new rules, but instead will focus on three of the new safe harbors created by the regulations:
- De minimus Safe Harbor
- Routine Maintenance Safe Harbor
- Small Taxpayer Safe Harbor
De minimus Safe Harbor
The de minimus safe harbor allows a taxpayer to immediately expense tangible property, under a certain dollar threshold, that is otherwise required to be capitalized. This safe harbor can be used in two different scenarios. The first scenario is for taxpayers with an applicable financial statement (AFS) and the second scenario is for those without an AFS. For either scenario the accounting procedure, including the dollar threshold, must be:
- in place at the beginning of the tax year,
- supported by an invoice showing cost and quantity,
- used for all items that qualify, and
- treated in the same manner for both tax and book.
Scenario #1: Taxpayer with an AFS
For taxpayers with an AFS, the taxpayer can expense, if in agreement with their accounting policy on the matter, an amount equal to or less than $5,000 per item. An AFS is defined as a set of financial statements required to be filed with the SEC, a set of certified audited financial statements, or a set of financial statements that is required to be provided to a federal or state government and/or agency. In addition, the accounting capitalization policy must be both documented and communicated.
Scenario #2: Taxpayer without an AFS
Taxpayers without an AFS, but with a capitalization policy that meets the rules above, can expense amounts up to and including $500 per item.
- Example A:
Details: Bruins, LLC purchases ten new television sets for its training facility. The televisions cost $2,400 each, as indicated by an invoice. Bruins, LLC has certified audited financial statements and has a written policy in place to expense items that are $5,000 or less.
Result: All ten televisions can be expensed under the safe harbor rules because each item costs less than the $5,000 limit established by the accounting policy. However, to receive this favorable tax treatment, the expenditure also must be deducted for purposes of the financial statements. If not deducted for book purposes, the criteria for deduction under the safe harbor rules is failed and the costs must be capitalized for tax purposes.
Details: Flyers, LLC purchases a treadmill for $1,500, a weight bench for $405, and a laptop for $500. Flyers, LLC’s capitalization policy is to expense any item that is $450 or less and they do not have an AFS.
Result: Flyers, LLC can expense the weight bench but needs to capitalize the treadmill and the laptop because those two items are greater than $450. Even though the laptop is $500 or less, which is the limit for taxpayers without an AFS, their accounting policy only allows for items up to $450.
Taxpayers without a written accounting capitalization policy will be allowed to expense all items less than $200 as materials and supplies.
Routine Maintenance Safe Harbor
Pursuant to this safe harbor, routine maintenance costs are deductible when incurred, rather than capitalized. In this context, routine maintenance for most assets is defined as any activity that a taxpayer can reasonably expect to perform more than once during the useful life of an asset. For buildings, routine maintenance is any cost expected to be made more than once every ten years.
It should be noted that the repair does not actually have to be performed more than once. It just needs to be substantiated that at the time of the repair the expectation was that the repair would occur more than once during the life of the asset (or ten years in the case of a building repair).
- Example C:
Details: Bruins, LLC repaints a building for $45,000. It is expected that this repainting will be needed every 5 to 8 years.
Result: Because repainting will be a recurring activity (at least once every ten years) this item can be expensed for tax purposes.
Small Taxpayer Safe Harbor
A small taxpayer is defined as a taxpayer whose average annual gross receipts for the three preceding years is $10,000,000 or less. For these taxpayers there is an additional safe harbor designed to simplify compliance with the regulations related to capitalization of building improvements.
The safe harbor applies to improvements to a building with an unadjusted cost basis of $1,000,000 or less. For repairs, maintenance, and improvements to such buildings, taxpayers can elect to not capitalize any costs associated with the building if the total amount of repairs, maintenance, and improvements for the year does not exceed the lesser of:
- 2% of the unadjusted cost basis of the building
- Example D:
Details: Bruins, LLC has a building, Building A, with an unadjusted cost basis of $650,000. Total repairs and maintenance for the year totaled $2,000 for Building A. Bruins also made capital improvements to the building totaling $6,000. Bruins, LLC has a second building, Building B, with an unadjusted cost basis of $400,000. Total repairs and maintenance for the year totaled $5,000 for Building B. Bruins also made capital improvements to Building B totaling $4,000.
Result: Bruins may expense all items for Building A because in total they do not exceed $10,000 or 2% of the unadjusted cost basis ($13,000). For Building B, Bruins may deduct the $5,000 of repairs but must capitalize the $4,000 of improvements because the costs in total exceed 2% of the unadjusted cost basis ($8,000).
The new regulations for tangible property are quite extensive but embedded in the new regulations are some safe harbors that are intended to simplify capitalization standards in some instances. Certain conditions must be met to qualify for the safe harbors, so you should discuss with your tax advisor to determine their applicability to your business!
If you would like to discuss these matters further, please contact Andy Smith or your BNN professional.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.