On Sept. 13, 2013, IRS issued the final regs that provide guidance on whether businesses can deduct or must capitalize amounts that they pay to acquire, produce, or improve tangible property.
Effective date. The final regs took effect on January 1, 2014. The regs generally apply to tax years beginning on or after January 1, 2014. However, taxpayers can choose to apply the final regs to tax years beginning on or after January 1, 2012, or apply the 2011 temporary regs to tax years beginning on or after January 1, 2012 and before January 1, 2014.
Overview of regs. The regs provide guidance in areas formerly covered by court decisions. In some cases, they simply codify the existing rules, while in other cases they break new ground.
The regs are lengthy and complex. The summary below is intended to give an overview of how the regs treat issues of deduction and capitalization. We would be happy to sit down with you to discuss the regs at length and see how they will affect your specific business situation.
De minimis safe harbor. As part of the final regs there is a new de minimis expensing rule that allows taxpayers to deduct amounts used to purchase and improve tangible property. If the taxpayer has an Applicable Financial Statement (AFS) (this is typically an audited financial statement), written accounting procedures for expensing amounts paid or incurred for such property under certain dollar amounts, and treats such amounts as expenses on its AFS in accordance with its written accounting procedures, the regs allow up to $5,000 to be deducted per invoice.
To take advantage of this $5,000 de minimis rule, taxpayers must have written accounting procedures in place that specify a per-item dollar amount (up to $5,000) that will be expensed for financial accounting purposes and must take an election on their current year tax return. Therefore, to take advantage of the 2014 de minimis rule, taxpayers should have a policy in place effective for January 1, 2014.
For smaller businesses that do not have an AFS, the final regs added a safe harbor de minimis amount. The per-item or invoice threshold amount in this case is $500, if you have a capitalization policy in place that is effective as of January 1, 2014. Otherwise the limit will be $200 per item.
Capitalization or deduction. Amounts paid to improve a unit of property must be capitalized. The regs create all-encompassing guidelines on what constitutes an improvement, namely an expenditure that betters or restores a unit of property or adapts it to a new and different use.
Incidental repairs are deductible, provided the property’s cost or basis is not increased by the expenditure. These costs do not materially add to the value of property or appreciably prolong its life. Rather they keep the property in an ordinarily efficient operating conditon.
A current deduction is also allowed for certain tangible property defined as materials and supplies (that are not inventory) that are used or consumed in the business’ operations during the year. The property must be used to maintain, repair or improve a unit of tangible property owned, leased, or serviced by the taxpayer and that is not acquired as part of any single unit of tangible property. The property must also have an economic useful life of no more than 12 months and cost $200 or less to acquire or produce.