Changes are happening everyday to our tax laws and we wanted to make sure our clients are aware of all the changes. Please check back often for new updates that may affect you and/or your business. See below for new legislation that was recently passed that may have an inpact on your taxes.
Deduction and Capitalization of Expenditures Related to Tangible Personal Property
On September 19, 2013 the Internal Revenue Service issued new final Regulations Regarding Deduction and Capitalization of Expenditures Related to Tangible Personal Property. These Regulations are in effect for tax years beginning on or after January 1, 2014. The Internal Revenue Service also followed up with two additional Revenue procedures on January 24, 2014 and February 28, 2014 providing further clarification of certain areas in these new rules. These incredibly complex Regulations require you to keep much better records for repairs, maintenance, materials and supplies, and require you to specifically analyze each of these items costing over $2,500.00, assuming you do not have audited financial statements and make the annual de minimis safe harbor election in filing your timely filed (including extension) income tax returns. If you don’t have procedures in place the items costing over $200.00 would require additional analysis and the deduction for these items might be limited.
These new regulations apply to all businesses including rental properties, farms, sole proprietorships, partnerships, corporations (regular and S) and non-profits. So no matter what business form you are required to file, 1040 (individual), fiduciary (1041), partnership (1065), corporations (1120 or 1120S) or Non-Profits (990), these rules affect your tax return.
We are writing this letter to help you understand that if you do not analyze these individual items and classify them appropriately we will be required to spend substantial additional professional time, with substantial additional fees to do so.
Below is a summary of the new rules in effect for 2014 and what you will need to do to comply with the new IRS requirements with the election of the de minimis safe harbor election made with a timely filed tax return (including extension).
Materials and Supplies
The new Regulations allow your business to expense any individual material or supplies costing $200.00 or less (per invoice, or per item), or which you expect to last less than 12 months, or fuel, lubricants or any similar items that will be used in 12 months or less.
Action: Please add a new expense account to your accounting system titled “De Minimis Materials and Supplies” and enter any expense meeting the above qualifications in this account. Materials and supplies costing more than $200.00 that will need to be individually analyzed under the rules below to determine if they are qualified expenses to be deducted in the current year, capitalized until used or treated as equipment that must be depreciated over several years. Special rules apply for extra parts (rotable parts).
Equipment, Repairs and Maintenance
You are now allowed to write off any individual equipment item or equipment repair or maintenance item costing $500 or less (per invoice or per item). For buildings a different rule applies as discussed below.
Action: Please add a new expense account to your accounting system titled “De Minimis Equipment, Repairs and Maintenance” and enter any expense meeting the above qualifications in this account but refrain from adding any items above that cost to this account. Equipment, repair and maintenance items costing more than this will generally be required to be individually analyzed under the rules below to determine if they are qualified expenses, capitalized as materials supplies (deductible when used or disposed) or treated as equipment that must be depreciated over several years.
Building Repairs & Maintenance
If your building has a cost basis of $1,000,000 or less a special rule applies. Any repairs that are expected to occur more than once in ten years, and costing less than $10,000 individually may be written off as repairs.
Items that are not expected to be replaced more once in ten years must also be examined individually under the rules below to determine if they may be treated as expenses or depreciable assets.
Expenses Above the Limits
The IRS now requires you to examine each individual item outside of the above limits to determine if it has results in a betterment, restoration or adaptation of the main unit of property. A unit of property is now defined as the inter-related parts composing one larger unit.
For example a unit of property is a car composed of inter-related parts, so any repairs to the car must be examined as to whether they are a betterment, restoration or adaptation of the car as a whole rather than its individual components.
For buildings the test must first be applied to the building as a whole and then applied to its sub components of HVAC, plumbing, electrical, structure, elevators, security, fire protection or gas distribution.
Any costs resulting in betterment, restoration or adaptation under these rules must capitalize and depreciated; otherwise it is expensed as repairs.
Betterment is defined as fixing a condition that existed at purchase, or an increase in the physical size or capacity of an asset. Betterments must be capitalized and depreciated so they should be added to your building account.
A restoration is generally defined as a cost to return a non-functional asset to use, the cost of rebuilding an asset after the end of its depreciable life or replacing a major component of the unit of property.
For example a transmission replacement would be the replacement of a major component of a unit of property of a truck and must be capitalized and depreciated.
Finally, an adaptation cost is incurred to change the function of a piece of equipment or property to a different use, and must also be capitalized and depreciated.
We are sending a sample accounting policy for the De Minimis safe harbor under these new rules which we recommend be adapted to your business for use in 2014 and after. You need to have a policy for each of your businesses. We will have a copy in a PDF and Word format available on our website, just complete the business or taxpayer’s name, print and sign it. Please send us a copy once completed for our files, and you need to keep the policy with your permanent records.
Also, we are enclosing a summary of the steps to analyze your expenses in applying these rules under the Repairs and Capitalization Guidelines of these new Regulations, which outlines the steps that need to be taken on each purchase. It is complicated but needs to be applied to each purchase.
These new Regulations require many additional steps and analysis and are generally unfriendly to small businesses. We would be happy to discuss them with you, please call us to schedule an appointment with you or your accounting staff to help you keep the costs of IRS compliance down.
David A. Reumont CPA, PC.