Deducting Capital Expenditures as Current Expenses
IRC §162 allows a business to deduct all ordinary and necessary expenses in carrying out the trade or business. However, IRC §263(a) requires that the cost of acquiring, producing, or improving tangible property be capitalized regardless of the cost. So, to deduct business property, either depreciation or 1st year expensing was used, which requires additional recordkeeping. This additional information may be needed for future tax returns, especially if depreciation is chosen. For many businesses, depreciation or 1st year expensing for low-cost items is often more trouble than it's worth. Business property that is expected to last more than 1 year must, according to IRS rules, be depreciated or expensed as a §179 deduction. Additional information must be provided for each item, including the date the property was placed in service, the name of the item, business use percentage, and so on.
It was a common belief that if the item was low enough in cost, such as paperclips, then the item could be written as a current expense, even though the property was expected to last more than 1 year. However, the IRS has never designated at what price level that property with an expected lifetime exceeding 1 year can be written as an expense or must be depreciated, so most businesses decided on their own threshold. There have been many rulings and court cases that attempted to define a threshold. The IRS has decided to aggregate the many rulings and court cases affecting the deduction of tangible property, codified in what the IRS calls the final tangibles regulations. These regulations provide a safe harbor in the form of a de minimis rule that allows the acquisition or improvement of property to be deducted as a current business expense if the cost does not exceed the de minimis limit, which for most businesses, is $2500, or, for businesses with an applicable financial statement, $5000.
The safe harbor election negates the need to determine whether small dollar expenditures for the acquisition or production of property is deductible or capitalizable. However, the de minimis rule does not apply to direct or allocable indirect costs for property produced or acquired for resale.
This new safe harbor is available to all taxpayers since January 1, 2014. The safe harbor applies to each item and it does not decrease the amount that can be expensed under IRC §179. The de minimis safe harbor is most often used to deduct the cost of tangible personal property used in business, including components to maintain or repair such property. However, the safe harbor cannot be used to deduct the cost of land or inventory.
De Minimis Rule Requirements
The de minimis rule must be elected annually by attaching a statement titled "Section 1.263(a)-1(f) de minimis safe harbor election" to the timely filed original federal tax return including extensions for the taxable year in which the de minimis amounts are paid. The statement should include the taxpayer's name, address, and the Taxpayer Identification Number, as well as a statement that the de minimis safe harbor election is being chosen. Under this election, the de minimis safe harbor must be applied to all expenditures meeting the de minimis criteria in the taxable year: the business cannot choose to deduct 1 property under the de minimis rule and then another as a IRC §179 deduction, for instance, if both properties would qualify under the de minimis rule. However, any property that does not qualify for the de minimis rule should be deducted according to regular rules, such as using depreciation or claiming a §179 deduction. But, any items with an economic life not exceeding 1 year must be deducted under the de minimis safe harbor if the cost is within the limit.
To qualify for the safe harbor, the taxpayer must establish an accounting procedure requiring that expense items paid for property that costs less than a certain dollar amount or with the economic useful life of 12 months or less must be deducted as an expense and must be treated as currently deductible expenses in its accounting system. For small businesses using the $2500 de minimis limit, the accounting treatment of the property does not have to be written, but for those businesses that qualify for the $5000 de minimis limit, the accounting procedure must be in writing and signed before January 1 of the tax year.
Maximum De Minimis Amount
The maximum amount that businesses can deduct under the de minimis rule is $2500 per item. Originally, the amount was $500, but the IRS increased this to $2500 effective for 2016, and stated that it would accept the $2500 limit for the previous 2 years. If the business has what the IRS calls an applicable financial statement (AFS) for the year, which is a certified financial statement prepared by CPA, including financial statements filed with the SEC or other state or federal agencies, such as a Form 10K or an Annual Statement to Shareholders, then the de minimis amount is $5000. Usually, only publicly traded businesses or corporations file such statements. Note that any additional costs associated with an item must be included in the cost, such as fees for installing and setting up the equipment.
An AFS can include, besides financial statements required to be filed with this SEC, other types of certified audited financial statements accompanied by a CPA report, including statements provided to obtain a loan, reports to shareholders, other financial statements required to be provided to a state or federal government or agency other than the SEC or the IRS, or for other nontax purposes.
De Minimis Rule Requirements for Improvements to Property or Routine Maintenance
The safe harbor can be applied to improvements to owned or leased buildings or for routine maintenance, but there are specific requirements for each. The safe harbor election for small taxpayers allows a taxpayer to deduct improvements to owned or leased buildings rather than capitalize the costs, if:
- average annual gross receipts do not exceed $10 million
- the building has an unadjusted basis not exceeding $1 million
- the total amount paid for repairs, maintenance, or improvements during the tax year does not exceed the lesser of
- 2% of the unadjusted basis of the building or
The safe harbor for routine maintenance allows maintenance costs to be deducted rather than capitalized as an improvement if all the following are satisfied:
- for buildings and building systems, the maintenance will be performed more than once within 10 years after it is placed in service
- for property other than buildings, more than once during the property's class life.
However, the safe harbor for routine maintenance does not apply to betterments or to certain restorations. A betterment is defined as the amounts paid for:
- a material defect that existed before the acquisition or during the production of the unit or property
- a material addition, such as a physical enlargement
- the addition of the major component, to increase the capacity of the property or material, or
- increasing productivity, efficiency, strength, quality, or output of the property
However, the final tangibles regulations allow a business can elect to capitalize repair and maintenance costs, if they are treated as capital expenditures for accounting purposes. This election must be chosen for each year that the business incurs such costs, and the election must apply to all repair and maintenance costs that are capitalized under the accounting system.
For some taxpayers, who were capitalizing certain improvements but would like to currently deduct the amounts as repairs or maintenance, then a change of accounting method may be required.