TD 9636 The New Rules

The Final Regulation released on 9/19/2013 made some substantial changes to the Repairs vs Capitalization rules. Surprisingly, most of them are in the small business taxpayers favor.

De Minimis Safe Harbor is a election made up to a specific dollar amount allowed to be expensed when it would normally be required to be capitalized. For the purpose of this discussion the election must be made on the timely filed original return(including extension), the election must be in a written internal policy for a non-tax reason and the policy must be made prior to the beginning of the tax year. The election (or failure to make one) for the tax year is irrevocable.

One big drawback to the new de minimis safe harbor rules is the requirement that the internal policy be in writing, for a non-tax reason and be made prior to the beginning of the tax year. A statement must be attached to the return with “Section 1.263(a)-1(f) de minimis safe harbor election has been made”. The regulation does not require a listing of the items the election has been made for to be attached, simply an election statement.

So, if you have a client that didn’t know about the regulations before 1/1/2014 they may not now legally opt into the election until tax year 2015. TD 9636 has specifically stated that the IRS will not allow retroactive elections.

As with most changes to the tax code there are pros and cons to this election.

Pros include an immediate deduction when paid instead of when consumed, no depreciation or recapture issues, the IRS does not generally question safe harbors (but they are still subject to normal substantiation requirements), and no Form 3115 (Change of Accounting Method) is required.

The cons include the fact the election is irrevocable, must be made (or not) on the original timely filed return, and is an “all or nothing” proposition.

If the election is made, all items fitting the criteria and placed in service must be either placed in the safe harbor or none of them may be used for that election.

The criteria for the de minimis safe harbor election are as follows:

1. There must be a written policy in place at the beginning of the tax year.
2. The written policy must stipulate a non-tax reason for the policy (ie. Easier accounting or record keeping, etc)
3. Items can have a useful economic life of 12 months or less.
4. Expenses must be below below a certain dollar amount
5. The amount can not exceed $500 per invoice or per separately numerated item on the invoice ;
or
The dollar limit goes to $5,000 if the taxpayer or entity has a requirement for an Annual Financial Statement (AFS)(A financial statement filed with the SEC and audited by a credentialed auditor. Not applicable for most small businesses)
6. The item may not be inventory
7. The election may not be used for land
8. The election may not be used for any items elected to be capitalized

The total cost of the items for the purpose of this safe harbor are determined based on the price plus transactions costs (tax, shipping, installation, etc) per item. If there are multiple items on the invoice transaction costs are allocated by any reasonable method.

Example: You purchase items for your rental house including a microwave oven for $300, a washer for $350, a dryer for $300, and a fridge/freezer for $800. These items are listed out separately on the invoice. The invoice also included sales taxes of 9.25% and a delivery and installation charge of $300. The total invoice is $2212. You take the microwave oven with you and install it yourself.

You could reasonably break this out in several ways. Seemingly, the most logical way would be to simply divide the invoice total by the four items. However, that would allow you to use the safe harbor on none of them since that would make each item over the $500 maximum. If you were to break out each item and apply the tax and delivery charges individually you would be able to use the safe harbor method on everything except the fridge/freezer.

Our segment for tomorrow will cover Improvements vs Repairs.

In accordance with Circular 230 Disclosure