In an attempt to alleviate past confusion, the IRS issued new regulations clarifying which costs are classified as repairs and maintenance and deductible in the current year. This is versus those fixed asset expenditures that have to be capitalized and depreciated over a number of years.
General Rule: Taxpayer must capitalize and depreciate all costs that facilitate the acquisition or production of property. Improvements to property that better a unit of property, restore it, or adopt it to a new and different use must also be capitalized.
The regulations provide circumstances for when certain items can be expensed, rather than capitalized.
- De Minimis Safe Harbor: Supplies and Materials that are $200 or less per item, per invoice OR have a useful life of 12 months or less can be expensed in the current year.
- Routine Maintenance Safe Harbor: Repairs and maintenance that keep business property in ordinarily efficient operating condition, such as inspection, cleaning, testing, and replacement of worn or damaged part can be expensed.
- Per Building Safe Harbor for Small Businesses: Taxpayers with average annual gross receipts of $10 million or less in the three preceding tax years can deduct improvements made to a building with an unadjusted basis of $1 million or less. The deduction is limited to $10,000 or 2% of the building’s unadjusted basis. This election is made annually on a timely filed return and is on a building-by-building basis.
Exceptions to the General Rule:
- A Capitalization Policy establishes the threshold (minimum cost) for capitalization and depreciation of fixed assets. Taxpayers that have a written policy for accounting procedures in place by the beginning of the tax year can deduct up to $500 per item, per invoice (instead of $200). The $500 de minimis safe harbor election can be made by attaching a statement to a timely filed federal income tax return. This election is not considered a Change in Accounting Method and therefore Form 3115, Application for Change in Accounting Method, is not required. For businesses that had a written Capitalization Policy in place at 1/1/2014, the $500 threshold can be applied on the 2014 Federal return. For businesses that did NOT have a policy in place can still make the election for 2015 by establishing accounting procedures for the 2015 tax year before January 1st.
- The IRS has hinted at flexibility in the dollar ceilings where the taxpayer has the burden of showing that such treatment clearly reflects income. If you think your business model can support a higher de minimis threshold, consider filing Form 3115, Application for Change in Accounting Method, with the tax return for the year the change is to be effective.
These regulations are lengthy and complex, so contact your local Padgett office for assistance, as these new provisions will affect every business, even yours!
For more information, contact Padgett Business Services in Bothell, Washington at (425) 408-1695. We handle your bookkeeping, accounting, tax (personal & business) and payroll needs – so you can focus on what makes you money. Serving Bothell, Lynnwood, Kenmore, Mill Creek and surrounding areas.