Revisiting the de minimis safe harbor tangible property regulations

The de minimis safe harbor election allows businesses to expense items which are usually depreciated.

By: Brittany Benson  /  November 27, 2018

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Now that the Tangible Property Regulations (TPR) have been in place for several years, business owners are wise to revisit them to determine whether they can immediately deduct their business expenses for tangible property.

Business owners should know about the de minimis safe harbor from the TPR, before they decide to capitalize or deduct their business expenses. The de minimis safe harbor, if followed and documented, protects taxpayers from negative IRS action when they deduct on the current year return certain expenses that are usually required to be capitalized and depreciated.

De minimis safe harbor for less expensive property

The de minimis safe harbor simplifies many expensing and tax questions for business owners. It does away entirely with the question of whether qualifying purchases must be capitalized or expensed.

Two possible thresholds depending on the taxpayer’s applicable financial statement

To use the de minimis safe harbor, the company must have in place at the beginning of the year accounting policies treating the cost as an expense. If such policies are in place, items eligible for the election are property:

  • Costing $2,500 or less per item (2016 and later years), or
  • With a useful life of 12 months or less.

Taxpayers who have an applicable financial statement (AFS) benefit from a higher dollar threshold. Under the higher dollar threshold, taxpayers can deduct immediately up to $5,000 per invoice or item used to acquire or produce certain tangible property. There is no limit to the number of items or invoices which may qualify for the de minimis safe harbor, but the taxpayer does need to have a written accounting policy in place at the beginning of the year treating the cost as an expense.

Traditionally, capital improvements must be depreciated, while repairs are deductible (i.e., expensed). The de minimis safe harbor does not apply to inventory, land, or amounts required to be capitalized under the uniform capitalization (UNICAP) rules. Instead, these items are generally classified as “capital expenditures” which taxpayers must depreciate.

Unit of property determination is important

It is important to note that the regulations require the amounts paid to improve a unit of property (UOP) must be capitalized. This is often applicable in cases involving work to repair or improve buildings, for example, when taxpayers own rental property. Taxpayers must first identify the UOP, then determine whether the work constitutes an “improvement” and whether that improvement could be its own UOP. This can be a complex determination and the rules for determining what constitutes a UOP should be consulted before deducting or capitalizing expenses under the TPR.

For the definitions of UOP, see Chapter 3 of the IRS resource, Capitalization of Tangible Property, Treas. Reg. § 1.263(a) and related regulations.

Applying the safe harbor to various situations

For the safe harbor examples below, assume each item purchased by the taxpayer is a UOP.

De minimis safe harbor for taxpayers without an AFS

Example: Mr. and Mrs. Otis, rental property owners, could use the de minimis safe harbor to expense the purchase of small appliances and other home goods for their units:

  • Air conditioner ($1,800),
  • Refrigerator ($1,500),
  • Dishwashers ($500 each),
  • Carpets ($2,000), and
  • Draperies ($500).

Under the de minimis safe harbor, the Otises can deduct immediately the cost of these items, each of which costs less than $2,500.

De minimis safe harbor for items with 12-month or less economic useful life

Example: The Randolph Law Firm maintains a law library in its office. In Year 1, Randolph purchases subscriptions to law journals and research information services. Assume that these subscriptions have an economic useful life of less than 12 months. Each journal subscription costs $400 annually and the subscription to the firm’s legal research service is $1,000 annually. Randolph does not have an AFS but does have accounting procedures in place at the beginning of Year 1 to expense amounts paid for property costing $500 or less and those with an economic useful life of 12-months or less. The amounts paid for the journals and the research service meet the requirements for the de minimis safe harbor and Randolph can expense the cost of the journal subscriptions and research service in the year the amounts are paid.

Non-invoice additional costs

Example: Assume ABC is a corporation providing consulting services. ABC doesn’t have an AFS but does have accounting policies in place at the start of Year 1 to expense property costing less than $2,500. In Year 1, ABC pays $600 to an interior designer to shop for, evaluate, and recommend furniture ABC should purchase for its conference room. Based on these recommendations, ABC acquires a conference table and 10 chair set for $2,400. ABC received an invoice in Year 1 from the interior designer for her services for $600. ABV also received invoice from the furniture supplier for the table and chairs. Together, they exceed the $2,500 safe harbor threshold. However, ABC is not required to include in the furniture’s cost a pro rata amount for the interior designer’s work because the cost of acquiring the property is not included on the same invoice as the furniture. Accordingly, amounts paid by ABC for the conference room table set qualify for the safe harbor and ABC is not required to capitalize the amount paid for the conference room furniture set. ABC can also deduct the cost of acquiring the furniture in the year the amounts are paid.

Additional invoice costs

Example: Bolt, Inc. has a written account policy at the beginning of Year 1 to expense amounts paid for property costing less than $2,500. In Year 1, Bolt pays $4,500 for the purchase and installation of routers in 10 of its office locations. Assume each router is its own unit of property. Bolt receives an invoice including the total amount of $4,500, of which, $2,500 is for the 10 routers and $2,000 is for their installation. Bolt allocates the additional invoice costs to the materials on a pro rata basis, bringing the cost of each router to $450 ($250 materials + $200 labor and overhead). The amounts paid for the routers meets the de minimis safe harbor rules and can be deducted in the year they are paid.

Materials and supplies

Example: Harris Corporation provides consulting services to its customers and has a written accounting policy in the beginning of Year 1 to expense amounts paid for property costing $500 or less. In Year 1, Harris purchases 1,000 computers for $500 each. Assume that each computer is a unit of property and is not a material or supply. Harris also purchases 200 office chairs for $100 each for a total cost of $20,000 and 250 customized briefcases at $80 each for a total cost of $20,000. Assume the chairs and briefcases are materials or supplies. Harris treats the amounts paid for the computers, office chairs, and briefcases as expenses on its books. These amounts meet the requirements for the de minimis safe harbor. If Harris elects to apply the de minimis safe harbor in Year 1, Harris doesn’t capitalize the amounts paid for the computers, chairs, and briefcases and, instead, may deduct the amounts paid in the year they are paid. If the taxpayer uses the de minimis safe harbor for acquisition, production, and improvement costs, the taxpayer must also use the de minimis safe harbor for materials and supplies that meet the de minimis safe harbor rules.

Materials and supplies include tangible, non-inventory property used and consumed in the taxpayer’s operations and include:

  • Acquired components,
  • Consumables,
  • 12-month property, and
  • $200 property.

Coordination with Section 263A UNICAP rules

Example: Jay Corporation has a written accounting policy at the beginning of Year 1 to expense amounts paid for property costing less than $1,000 or that has an economic useful life of 12-months or less. In Year 1, Jay Corporation acquires jigs, molds, and patterns for manufacturing of Jay’s products; each of these items costs less than $1,000 each. Assume these items are materials and supplies and that Jay elects to apply the de minimis amounts in Year 1. Note that the amounts paid for the jigs, molds, and patterns could be subject to the UNICAP rules of §263A if the amounts are comprised of the direct or allocable indirect costs of property produced by Jay Corp. or property acquired for resale so Jay Corporation should consult the UNICAP rules.

File an attachment to federal return to claim safe harbor from traditional expense rules

Taxpayers who would like to take advantage of the de minimis safe harbor must attach a statement to their timely filed federal tax return describing the items subject to the safe harbor. In the case of an S Corporation or partnership, the election is made at the entity level, not at the shareholder or partner level. The de minimis safe harbor is available to corporations, S corporations, partnerships, LLCs, and individuals filing a Form 1040 with Schedule C, E, or F.

The de minimis safe harbor was unaffected by the Tax Cuts and Jobs Act (TCJA) of 2017.

Form 3115 may be required when changing accounting methods

An annual election is not a change in method of accounting. For example, taxpayers do not have to file a Form 3115 to use the de minimis safe harbor for a particular tax year or to stop using the de minimis safe harbor for a subsequent year.

 

The security of knowing that small amounts can be expensed provides security for small business owners. All it takes is ensuring that their business’ policy for small purchases mirrors the de minimis safe harbor and annually filing a statement with the IRS. It’s a good idea to keep good records of purchases throughout the year and whether those purchases were expensed pursuant to the de minimis safe harbor.

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Brittany Benson

Brittany Benson, JD, is a tax research analyst at The Tax Institute. Brittany specializes in the issues that affect Native American, international, and ministerial taxpayers.

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