To Capitalize or Expense…That is the Question
Businesses buy supplies, materials and equipment constantly. Repairs and maintenance on existing assets also recur frequently. How does your accounting department handle these outlays?
The Internal Revenue Service (IRS) finalized regulations in September 2013 regarding whether expenditures were considered immediate tax deductions or should be capitalized. The regulations are applicable to tax years beginning after 2013; so calendar year businesses are now on task with applying these new rules on their 2014 income tax returns.
The regulations are vast as you would expect with a complicated set of questions. Additionally, the rules are fluid; new Revenue Procedures continue to be issued in order to clarify certain aspects of the regulations. The key takeaway for closely held businesses is that with this guidance, businesses should be reviewing not only their current capitalization policy but also looking at their depreciation schedules to see if there is an opportunity to write-off old assets under the regulations.
SMALL BUSINESS RELIEF – Before recent relief was provided, every business wishing to make an accounting method change was required to formally request the change with the IRS. The form to request the change (Form 3115) is complex and time-consuming for the preparer. Under new guidance, qualifying small taxpayers are no longer required to complete Form 3115 in order to request certain accounting method changes. Small taxpayers are defined as businesses having (for each separate trade or business) assets totaling less than $10,000,000 or average annual gross receipts of $10,000,000 or less.
MATERIALS AND SUPPLIES – The regulations establish that purchases falling into this category include item purchases costing $200 or less and have an economic useful life of less than 12 months. The cost of materials and supplies can be expensed in the year they are first used or consumed.
DE MINIMIS SAFE HARBOR – An annual election is available to taxpayers that do not have an “Applicable Financial Statement” to immediately expense a unit of property that costs less than $500 per invoice (or $500 per item if substantiated on the invoice) if such a policy exists at the beginning of the tax year. For taxpayers with an “Applicable Financial Statement” (generally an Audited Financial Statement), the threshold is $5,000 per invoice (or $5,000 per item if substantiated on the invoice). The capitalization policy must be in writing for those taxpayers with an “Applicable Financial Statement”. The De Minimis Safe Harbor is available without an accounting method change.
REPAIRS – The regulations are helpful in describing what a repair is not. Any amount that is a restoration, adaptation or improvement must be capitalized.
ROUTINE MAINTENANCE SAFE HARBOR – The regulations provide that amounts paid for routine and recurring amounts paid to keep a unit of property in working condition may be treated as repair costs. Under the routine maintenance safe harbor, the business needs to segregate amounts paid for real estate and other property. If the amount is paid to maintain real estate, the amount can be expensed if the business expects to perform the repair more than once during a ten-year period. If the amount is paid to maintain other property, the amount can be expensed if the expense is expected to recur more than once during the property’s class life.
REAL ESTATE SMALL TAXPAYER SAFE HARBOR – For those real estate businesses with average annual gross receipts of less than $10,000,000 and real estate with an undepreciated cost basis of less than $1,000,000, a small taxpayer safe harbor is available. Under this safe harbor, an annual election can be used to immediately expense the total amount paid for repairs, maintenance and improvements up to the lesser of $10,000 or 2% of the basis of the real estate.
The regulations provide for additional guidance on acquisition and facilitative costs, complete or partial dispositions of property, spare parts, and defining units of property.
We hope this information is helpful. If you are interested in speaking with us about how the above regulations affect you and your business, we’d be happy to discuss. Please contact Karen Snodgrass or Deanna Salo from Cray, Kaiser Ltd. (630-953-4900), a strategic partner with the Chicago Family Business Council.
Karen Snodgrass CPA Deanna L. Salo CPA
Cray, Kaiser Ltd. Cray, Kaiser Ltd.
1901 S. Meyers Road 1901 S. Meyers Road
Suite 230 Suite 230
Oakbrook Terrace, IL 60181 Oakbrook Terrace, IL 60181
Phone: (630) 953-4900 x248 Phone: (630) 953-4900 x210
Fax: (630) 953-4905 Fax: (630) 953-4905 Email: firstname.lastname@example.org Email: email@example.com