The IRS Enhances a Tax Break for Real Estate Operators
Recently, the Internal Revenue Service (“IRS”) released Notice 2015-82 which raised the repair regulations de minimis safe-harbor threshold for taxpayers without applicable financials statements to $2,500. For many taxpayers, this is a welcome change from the $500 limit that was originally provided in the final repair regulations and will allow taxpayers to have more flexibility with their capitalization policy.
This change was the result of public commentary that the IRS requested after the final repair regulations were issued. The main consensus in the commentary was that the original threshold in the regulations was too low to effectively relieve small business taxpayers of the administrative burden that is involved in determining capital expenditures.
HOW THIS AFFECTS YOU
This change opens up an even greater tax savings opportunity for taxpayers within the real estate industry by allowing them to expense amounts paid for the acquisition or production of a unit of property that would otherwise normally be capitalized and depreciated.
Take an example where an apartment owner purchases 20 new air conditioner units with a total invoice price of $50,000. The invoice specifically identifies that each unit has a price of $2,500 including installation. The taxpayer has a written accounting procedure in place at the beginning of the year to expense expenditures of $2,500 or less and this policy is applied by their accounting personnel on the taxpayer’s books and records. If the de minimis safe-harbor election is made on the timely filed tax return, the result would be a $50,000 deduction for expenditures that would otherwise have been capitalized and depreciated over 27.5 years.
However, even though the safe-harbor applies to the acquisition or production of a unit of property like stoves, refrigerators, and air conditioners, it does not apply to expenditures related to new building construction which generally still require capitalization under the uniform capitalization rules.
WHAT ARE THE REQUIREMENTS
In order to take advantage of this opportunity, the taxpayer must make an election on their timely filed tax return. In addition, the taxpayer must have accounting procedures in place at the beginning of the year to expense amounts up to the $2,500 threshold amount and must treat amounts paid or incurred for book purposes consistent with these accounting procedures. For taxpayers without applicable financial statements, the accounting procedures do not need to be written. However, it is advisable that taxpayers still have a written accounting procedure to establish that a policy was in effect at the beginning of the year. Moreover, the application of the $2,500 threshold is based on a per item invoice or per item (as substantiated by the invoice) basis. Because of this flexibility, the tax benefit of the safe-harbor can be maximized by mandating that vendor invoices have a per item cost segregation on them.
WHEN IS THE CHANGE EFFECTIVE
This increase to the safe-harbor threshold amount is effective for tax years beginning on or after January 1, 2016. However, for taxpayers using the increased threshold in taxable years beginning before January 1, 2016, the IRS will provide audit protection allowing them to use the increased threshold if they otherwise satisfy the safe-harbor requirements.
Please feel free to contact our firm at (949) 260-1430 to determine how the de minimis safe-harbor election may be applied to your business.
Written by David Souza
SKINNER FOUCH & OLSON LLP