Preface: Understanding how to make the IRS tax code work for your business, can result in lower taxable income. Here’s what you should understand on tangible property regulations.
Business Owners Should Understand IRS Tangible Asset Regulations
When the IRS first passed the tangible property final regulations, it placed a de minimis safe harbor ceiling of $500 on individual purchases that could be exempted from capitalization on the balance sheet of businesses, e.g. a $550 computer would need added to the fixed asset schedule and capitalized to a fixed assets account with a depreciation expense; or $550 vehicle repair would need capitalized with the same accounting methodology.
IRS Notice 2015-82, welcomed from all tax accountants, increased this $500 de minimis safe harbor threshold for expensing individual purchases to $2,500 per invoice, or invoice item. Therefore, purchases of assets, repairs, and improvements, with a cost up to $2,500, can now be expensed in the year the expense is incurred. The threshold increase now permits building repairs and vehicle repairs and asset purchases such as machines or office equipment to be expensed in the year incurred if the cost is $2,500 or less. The IRS notice also provides audit protection to eligible businesses by not challenging the use of the $2,500 threshold for tax years ending before January 1, 2016 if the taxpayer satisfies the appropriate requirements.
The safe harbor feature of the final tangible regulations does not limit expensing of items to $2,500, but provides a safe harbor if the $2,500 balance is not exceeded. The de minimis amounts do not include amounts paid for inventory and land. Therefore, if you purchase $1,500 of inventory items, you need capitalize that asset onto the balance sheet.
To quote Robert A. Green, CPA, a contributor to Forbes.com “ For example, if a professional trader, qualifying for trader tax status, purchases a new workstation in December 2015 for $7,500, try to break down the purchase into separate items with each invoice being under $2,500. With all items on separate invoices under $2,500, the entire $7,500 can be a 2015 business expense without any capitalization for fixed assets and related depreciation. That leads to faster expensing, tax benefits and less compliance work.”
The safe harbor election permitting this $2,500 threshold is an election that is filed with an attached statement on your business tax return each year. An annual election is not a change in accounting method and doesn’t require a 3115.
So what else is really helpful to know about this tangible asset regulation? Like Robert Greens quote above, when you make purchases, make sure your invoices are itemized. Itemized expenses are deductible for individual purchases if the purchase is less than $2,500 on the invoice, e.g. if you purchase 30 software licenses for instances that cost $750 each, make sure the invoice on your purchases lists each individual license. The costs are less than $2,500 per item and can be expensed. If the invoice states one line item for $22,500 for the software licenses, you are obligated to capitalize that purchase. Secondly, if you have a company vehicle repair, request an itemized invoice for each expense. Only the line items in excess of $2,500 need capitalized. So on a $3,200 repair you could possible expense the entire cost with appropriate itemized invoice details.
Other ways to apply this safe harbor rule? Talk with your accountant before upgrading say windows in your residential rental. An itemized invoice with each window listed separately, and labor per window listed per windows unit, may permit you to deduct the entire upgrade. A $5,500 window upgrade with an itemized invoice approach may reduce your taxable rental income in the year of residential rental improvement, instead of the common capitalization and depreciation of the expense. Or say, you could maybe purchase the windows individually, and pay a contractor for installation. You could apply this strategy to other improvements too.
Understanding how to make the IRS tax code work for your business, can result in lower taxable income. Discuss any strategies with your tax accountant before implementation.