A few years ago, the IRS provided clarification on the proper tax treatment of expenditures relating to tangible property, known as the "new repair regs." These regulations presented taxpayers with clarification on whether the expenses could be immediately deducted or whether they were required to be capitalized on your balance sheet and taken as a deduction over time through depreciation.

The rules provided taxpayers with a de minimis safe harbor rule that allowed taxpayers to immediately expense the cost if below a certain threshold. For the 2016 tax year, the IRS updated the de minimis threshold for small businesses and taxpayers.

Old Rules...

Under the old regulations, a taxpayer with an applicable financial statement (generally an audited financial statement) was allowed a $5,000 deduction per item or invoice. Many small taxpayers do not need or require a certified audited financial statement, so they were left with a safe harbor deduction of only $500 per item or invoice. In addition, this deduction of $500 could only be taken if there was a written policy in place that defined their property expenditure procedures for property with an economic useful life of 12 months or less.

If the small taxpayer did not comply with having a written policy and procedure in place, then the expenditures would have to be capitalized or deducted through Section 179 expense. By capitalizing the expenditure, your expense would be limited to the annual depreciation for that year and would therefore cause additional taxable income. If you elect to take Section 179, there are additional rules that first need to be met, in addition to Section 179 expense having their own limits and thresholds.

Updated Rules for 2016

Effective for the 2016 tax year, the IRS increased the threshold for taxpayers without an applicable financial statement to $2,500. (The limit for taxpayers with applicable financial statements remains at $5,000.) To take advantage of the safe harbor rule, you still must have the accounting policy and procedures described above in place at the beginning of the tax year for which you are making the election and communicated to all employees; however it is not required to be in writing but is highly recommended.

The IRS has also pledged to provide "audit protection" on the issue. That means the agency will not challenge your use of the higher threshold in tax years beginning in 2012, 2013, 2014 or 2015 if you otherwise satisfied the requirements. If you did not have the required policy, for example, you are stuck with the $500 threshold for those years.

One of the stipulations in the repair regulations is that you must consistently comply with your own policy. For example, if your policy requires the expensing of amounts paid for invoices or items below $2,500, you need to expense every such invoice or item. You cannot pick and choose which items to expense or capitalize.

Moreover, the safe harbor rules apply only to amounts that do not exceed the $2,500 threshold, regardless of where you set the threshold in your accounting policy. The policy might require the expensing of amounts paid for invoices or items below a higher threshold — but the safe harbor will still apply only to invoices or items that don't exceed $2,500.

To take advantage of these new updated rules and regulations, you must make an annual irrevocable election and attach it to your timely filed tax return, including extensions.

Questions

The tax rules regarding property expenditures can be very complex. If you have any questions or think you can take advantage of these updated rules, please give us a call to discuss further.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.