The IRS has released its final regulations on the proper tax treatment of expenditures related to tangible property, including buildings. The regs explain how property owners can distinguish between expenses (which are immediately deductible against current income) and capital expenditures (which must be recovered over time through depreciation).
The final regs, which apply to tax years beginning on or after Jan. 1, 2014, replace the temporary regs released in December 2011. They retain many of the earlier regs’ provisions but modify several sections and create and expand some notable safe harbors.
De minimis safe harbor
The final regs make a number of changes to existing rules regarding the safe harbor that allows taxpayers to avoid capitalization of certain expenditures, thereby improving cash flow and reducing current-year taxes.
They include a de minimis rule for taxpayers with and without applicable financial statements. The final IRS tangible property regulations provide some relief for taxpayers that don’t have their financial statements audited — so long as they have written accounting procedures in place for expensing amounts paid for property costing less than a certain dollar amount, or for property with an economic useful life or 12 months or less.
Such taxpayers can apply the de minimis safe harbor if the amount paid doesn’t exceed $500 per invoice or item. (This amount is subject to change by the IRS.) If the cost exceeds that threshold, however, no portion of it falls within the safe harbor. According to the IRS, the reduced threshold is necessary because of the reduced assurance that such taxpayers’ accounting procedures clearly reflect income The previous safe harbor applied only to amounts costing less than a certain dollar amount, not to amounts paid for property with a useful life under a certain period. and yes, the safe harbor for useful life is for taxpayers with applicable financial statements.
A taxpayer with an applicable financial statement may now apply the de minimis rule to deduct all amounts properly expensed as long as the amount paid for property doesn’t exceed $5,000 per invoice or item. The new regs also expand the de minimis rule to cover amounts paid for property with a useful economic life of 12 months or less as long as the amount per invoice or item doesn’t exceed $5,000. (
The de minimis rule is an annual irrevocable elective safe harbor, rather than a mandatory one. If a taxpayer elects the safe harbor, it must apply the rule to all amounts paid in the taxable year for tangible property that meets the requirements.
Routine maintenance safe harbor
Tax regs mandate that a cost which results in an improvement to a building structure or to any of the enumerated building systems (for example, the plumbing system) be capitalized. An improvement occurs if there was a betterment, restoration or adaption of a unit of property.
Under the final regs’ routine maintenance safe harbor, an activity isn’t an improvement if the taxpayer expected to perform it to keep the property in its ordinarily efficient operating condition. . The activity counts as “routine” only if, at the time the property was placed in service, the taxpayer reasonably expected to perform it more than once during the property’s life.
Unlike the temporary regulations, the final regs extend the safe harbor to buildings. The taxpayer must reasonably expect to perform the activity more than once in 10 years.
The final regs modified the temporary regs to clarify that a taxpayer’s expectation won’t automatically be considered unreasonable simply because the taxpayer ultimately doesn’t perform maintenance a second time during the relevant period. But the taxpayer would then need to substantiate that its expectation was reasonable at the time the property was placed in service. Bear in mind that costs for activities falling outside the routine main itenance safe harbor may nonetheless qualify as a deductible expense under the general rules for improvements.
Small business safe harbor
The regs create a new safe harbor for qualified small businesses — generally those with gross receipts of $10 million or less. On buildings that initially cost $1 million or less, such taxpayers can elect to deduct the lesser of $10,000 or 2% of the adjusted basis of the property for repairs, maintenance, improvements and similar activities each year.
The final regs and you
The provisions discussed here are just a small part of the extensive final regulations. The regs include rules addressing a range of other matters, such as the tests for betterment and restoration, materials and supplies, and rotable and temporary spare parts. Work with your TBC tax advisor to determine how the new regs affect you.