Capitalize or Deduct? IRS Offers Simpler Rules
The tax law allows businesses to deduct ordinary and necessary expenses, including the costs of repairs and maintenance. However, amounts paid to acquire and improve buildings, equipment, and other tangible property must be capitalized and generally are deducted over time through depreciation.
Reconciling the two rules has been difficult for many businesses. To help clarify how the rules apply, the IRS issued final regulations in 2013 for application beginning in the 2014 tax year.
De minimis Safe Harbor
The regulations include a safe harbor rule that allows eligible businesses to treat as “de minimis” (and therefore currently deductible) certain expenditures for low-cost items. Using the safe harbor rule can simplify tax recordkeeping and allow relatively inexpensive asset purchases to be written off more quickly.
Initially, businesses electing the safe harbor could deduct up to $5,000 or $500 per invoice (or per item as substantiated by the invoice), with the higher limit available to taxpayers with an applicable financial statement (AFS) — generally, a financial statement audited by a CPA. However, after numerous commentators argued that the lower $500 limit did little to ease the administrative burdens of small businesses that lack an AFS, the IRS recently announced it would increase that limit to $2,500.
Eligible taxpayers will still have to meet the other requirements of the safe harbor, including the need to have appropriate accounting procedures in place at the beginning of the tax year.
Example. ABC’s accounting procedures provide that ABC will treat purchases of assets costing $2,500 or less as an expense on its books and records. ABC buys four printers for $800 each and receives a final invoice for $3,200. The expenses satisfy the new safe harbor rule because the cost of each item is not more than $2,500 and within ABC’s accounting guidelines.
The new $2,500 limit will generally apply for tax years that begin on or after January 1, 2016.
Safe Harbor for Retail/Restaurant Remodeling Costs
The IRS also announced a new safe harbor formula for restaurant and retail businesses. To simplify the determination of whether the cost of “remodel-refresh” projects are for repairs/maintenance or for improvements, the new rule allows eligible businesses to simply treat 75% of the year’s qualified costs as the deduction portion and the other 25% of the costs as the capital expenditure portion.
To be eligible for the new method, a taxpayer must have an AFS and be in the trade or business of (1) selling merchandise to customers at retail or (2) preparing and selling meals, snacks, or beverages to customer order for immediate on-premises and/or off-premises consumption. (Certain types of businesses won’t qualify.) A taxpayer that leases or sublets a building to a retailer or restaurant that incurs remodel-refresh costs may also qualify.
This new rule is effective for tax years beginning on or after January 1, 2014.
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