Here is a common question, “when do I have to capitalize an expenditure and when can I deduct it as a repair or maintenance item?”
The difference between expensing and capitalizing can mean the difference between an immediate deduction at full value versus a deduction spread out over the useful life of the asset.
In September 2013, the IRS released final regulations governing when taxpayers must capitalize and when they can deduct their expenses for acquiring, maintaining, repairing, and replacing tangible property. The new “repair regs” are lengthy and complex. Every business with fixed assets must comply with these new rules for its first tax year beginning on or after January 1, 2014.
The IRS’s stated goal is to reduce controversies with taxpayers by moving away from a facts and circumstances determination whenever possible, as well as from the subjective nature of the existing standards in general. All well intentioned; however, with the low threshold safe harbor amounts not particularly favorable for the taxpayer.
Code Sec 263 requires the capitalization of amounts paid to acquire, produce, or improve intangible property. Code Sec 162 allows the deduction of all ordinary and necessary business expenses, including the costs of certain supplies, repairs, and maintenance.
In the regs, five main areas were addressed:
Materials and supplies are defined as a unit of property that has an economic useful life of 12 months or less with an acquisition or production costs of less than $200. Materials and supplies are generally deducted in the tax year first used or consumed.
The regs provide guidelines as to when amounts relating to acquisitions or improvements should be capitalized or deducted. These are tied to whether a taxpayer has an applicable financial statement generally defined as an audited financial statement.
A taxpayer with an applicable financial statement may deduct up to $5,000 of the cost of an item of property per invoice. The required written accounting procedures in effect as of the beginning of the tax year may specify a per item amount of less than $5,000. Taxpayers without an applicable financial statement may elect the de minimis safe harbor and expense up to $500 per invoice/item. Big difference. With an audited financial statement, the amount is $5,000. Without, $500.
These limits are safe harbor amounts. When accounting procedures expense items that exceed the $5,000 limit, it may still make the case with the IRS that a greater amount is reasonable under its facts and circumstances.
To take advantage of the $5,000 de minimis rule, taxpayers must have written book policies in place at the start of the tax year that specify a dollar amount (up to $5,000) that will be expensed for financial accounting purposes.
The de minimis rule is a safe harbor that is elected annually by including a statement with the taxpayer’s tax return for the year elected.
Consult with your CPA. Make sure you have a written capitalization policy in place before the end of 2013. For 2014 and beyond, make sure you are making the proper annual elections.