Recently, the Internal Revenue Service issued final tangible property capitalization regulations. These regulations provide clarity to a complex area of tax law for business taxpayers who acquire tangible property or who own tangible property which they improve, maintain or repair. The final regulations address the proper characterization and tax treatment of expenditures related to these acquisitions, improvement, maintenance and repair activities.
Generally, under IRC Section 263(a), amounts paid to acquire, produce or improve tangible property must be capitalized. However, taxpayers are permitted to deduct ordinary and necessary business expenses, including the costs of certain supplies, repairs and maintenance under IRC § 162(a). It is often difficult to distinguish (1) between assets that must be capitalized and property that is a material or supply, and (2) between improvement costs and repair or maintenance costs. The finalized regulations attempt to clarify when such payments may be deducted and when they must be capitalized.
De Minimis Safe Harbor Election
A key provision in the final regulations is a revised safe harbor election that permits a deduction for de minimis amounts paid for tangible property. Under the safe harbor election, a taxpayer may elect to not capitalize (in other words, to currently deduct) specified amounts paid in the tax year to acquire or produce tangible property, provided the amounts don’t exceed applicable thresholds. The amount of the threshold depends on whether the taxpayer has written accounting procedures in place and, if so, whether the taxpayer has certain type of financial statement, normally one only done by larger enterprises and not normally prepared by small businesses.
Small businesses with written accounting policies
A small business with a written accounting policy in place calling for (1) expensing amounts paid for property less than a specified amount and/or (2) expensing payments for property with an economic life of 12 months or less, may rely on the de minimis safe harbor as long as the costs do not exceed $500 per item.
Taxpayers without either a certain Financial Statement or Written Accounting Procedures
The final regulations increase the ceiling for characterizing tangible property as materials or supplies to $200 (formerly $100). Thus, taxpayers who do not have an applicable financial statement or written accounting procedures in place as of the beginning of the tax year may still deduct expenditures for tangible property costing $200 or less. Most small businesses fall into this category.
Making the Election
In order to use the safe harbor, businesses must have accounting procedures in place on the first day of the tax year. The accounting procedures must treat as an expense amounts paid for property that cost less than a specified dollar amount or have an economic useful life of 12 months or less. Failure to timely establish written accounting procedures may result in having to capitalize amounts that might otherwise have been expensed. In addition, the taxpayer’s timely filed original tax return must include an annual election to expense items addressed by the safe harbor provision. The annual election is irrevocable and generally applies to all tangible property including materials and supplies purchased during the tax year. We will prepare the election on the tax return for you but need you to take action to adopt an accounting policy as of 12/31/2013.
We’ve included a downloadable copy on this web site: http://tinyurl.com/tshb2013 . Sign the included document and place the information in your permanent firm information. For more information and clarification of the new rules, please contact us at 559-252-8585.