The good news is…the enhanced capitalization regulations that were enacted last year have changed. On November 24, 2015, the IRS announced that they were simplifying the paperwork and recordkeeping requirements for small businesses by raising from $500 to $2,500 the safe harbor threshold for deducting certain capital items.
As you may remember, new regulations were finalized in 2013 that explained when you could deduct amounts paid to acquire, produce, or improve tangible property and when those amounts must be capitalized. Compliance with those regulations became mandatory starting with tax years beginning after Dec. 31, 2013, or in other words, with your 2014 tax return.
The regulations set forth the general rule that amounts paid to improve a unit of property must be capitalized. An improvement is defined as an expenditure that betters a unit of property, restores it, or adapts it to a new and different use. On the other hand, the regulations allow a current deduction for repairs and maintenance to property or for amounts paid to produce and acquire materials and supplies that are consumed during the year. Units of property with an economic useful life of no more than 12 months qualify as materials and supplies under this rule.
The regulations also allow a taxpayer to deduct certain limited amounts paid for tangible property that are expensed for financial accounting purposes. The amount of this safe harbor depends on whether the taxpayer has an applicable financial statement (AFS). An AFS can be a certified audited financial statement that is used for credit purposes, for reporting to partners, or for other non-tax purposes. A taxpayer with an AFS may rely on this de minimis safe harbor if no more than $5,000 per invoice, or per item as substantiated by the invoice, was paid for the property.
For businesses without an AFS, the regulations set the de minimis safe harbor at an amount not to exceed $500 or other amount as identified in published IRS guidance. The IRS has now published guidance raising this threshold from $500 to $2,500. This change is effective for years beginning in 2016 and after. However, the IRS has stated that they will not challenge the use of the new $2,500 threshold prior to 2016—as long as the taxpayer satisfies the safe harbor requirements stipulated in the regulations.
To take advantage of the safe harbor amounts, the regulations state that the business must have accounting procedures in place at the beginning of the tax year that treat as an expense amounts paid for property that either 1) costs less than a specified dollar amount or 2) has an economic useful life of 12 months or less. The taxpayer must also use these accounting procedures for all non-tax reporting as well, such as in its books and records or in other financial reporting.
The increase in this threshold creates an opportunity for many small businesses to simplify their accounting and possibly increase current tax deductions. We recommend that you either amend your current accounting procedures or adopt new procedures before the end of this year. We also suggest that you put it in writing. A sample policy has been blogged as well.