Tangible Property Regulations Guidance

By: Luci M. Roseman, CPA

To Expense or Capitalize? That is a question that continues to elude taxpayers. Historically, the general rule has always been that tangible property with a useful life of 1 year or more must be capitalized. However, that has changed and there are a number of rules I would like to review with you.

De Minimis Safe Harbor Election

Any taxpayer with an accounting procedure to expense tangible property costing up to $2,500 ($5,000 if they have an Applicable Financial Statement), can make an annual election on their tax return to expense property costing up to the same amount.

If this is elected, the taxpayer must apply it to all items that qualify and must treat each item the same on the return and financials. For example, if a desk is expensed on the financials, it will need to be expensed on the return

Also, this election is determined per unit of property regardless of how many items are on the invoice or how many invoices the item is broken into.  For example, you buy a desk for $2,000 and a printer for $2,400 and they are both on the same invoice. The desk and printer both qualify since they are each under $2,500. Alternatively, over the course of four months you completely renovate the outside of your office building and the contractor invoices you $2,500 for the work done each month. This does not qualify for the De Minimis Safe Harbor election, since it is a single renovation project that costs $10,000 total.

Safe Harbor for Small Taxpayers

The Safe Harbor for Small Taxpayers is also an annual election on the tax return but this one is made on a building by building basis. It allows taxpayers with less than $10 million in gross receipts to expense improvements to qualified buildings.

In order to qualify, the building must have an unadjusted basis of less than $1 million and the total repair, maintenance, and improvements costs related to the building must be less than 2% of the building’s unadjusted basis and less than $10,000.

It is important to note that even though the repair and maintenance costs will be expensed whether the building qualifies for the safe harbor or not, these costs are still included in the calculation to determine if the building qualifies. Further, taxpayers won’t know if a building qualifies until the end of the year when the total costs for the building are known.

Routine Maintenance Safe Harbor

This is a method of accounting, not an annual election that a lot of taxpayers chose to adopt in 2014 when the new tangible property regulations came out. This method allows the taxpayers to expense any amounts made for routine maintenance.

In order to be considered routine maintenance the expense must meet all three rules:

  1. It must be for a recurring activity performed to keep the property in its ordinarily efficient operating condition,
  2. It must be required due to the taxpayers normal use of the property, and
  3. It must be expected to be performed more than once within the assets class life for personal property or more than once within 10 years for buildings.

An example of routine maintenance that we commonly see is re-painting in an apartment that the taxpayer rents out.

­­­­­­­­­­­­­­­­­­­­­­­­­­If your expenditure is related to a piece of property you already own and does not qualify as an expense under any of the three rules above, the RABI rules will need to be considered. These rules are complex enough that we could do a full day course on them but, in general, if the expense falls into the definition of a Restoration, Adaptation or Betterment, it will need to be capitalized and the taxpayer will need to consider the Improvement rules to determine the amount that should be capitalized.

The rules are highly subjective and require analyzing the examples provided by the IRS for similarities. They also require the understanding of what components are considered the unit of property. And buildings have their own separate rules on what to consider as the unit of property.

If you get to the point of needing to consider the RABI Rules, please discuss it with your CPA so they can walk you through the decision making process.

RABI Rules

Here are some basic RABI definitions to consider:

RestorationReplaces a major component or structural part, returns property to a useable condition after a state of disrepair, or re-builds the property to a like-new condition after end of its class life
AdaptationAdapts the property to a new or different use not consistent to the use when the taxpayer originally placed it in service
BettermentFixes a material condition or defect, creates a material addition, or materially increases productivity, efficiency, strength, quality, or output of the property
ImprovementDetermines what portion of the expenditures need to be capitalized if the expenditure falls into one of the categories above.

As you can see by the use of words like “material” and “major” above, these rules are subjective so getting the opinion of your tax advisor is crucial.

Finally, even if you determine a cost needs to be capitalized, you may still be able to deduct the whole or the majority of the cost under section 179 or Bonus depreciation rules.

Check Out our Video to Learn More

For more information

Visit irs.gov to learn more about these regulations https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations

Luci Roseman, CPA

Luci M. Roseman is a Manager in the Tax department of Cover & Rossiter. Since joining the firm in 2011, she has used her keen attention to detail and problem solving ability to help clients navigate the ever-changing tax laws. Luci received her Bachelor’s degree in Accounting from the University of Delaware. She is a recent graduate of AICPA’s Leadership Academy.