Every client with a fixed asset register has a threshold, written down or not. A purchase below it is expensed and a purchase above it is capitalized. The tangible property regulations give taxpayers a safe harbor so the line is not a matter of argument with an examiner, but only if the election is made correctly and the client's own accounting policy supports it. This article covers the safe harbor, the election and the policy that goes with it.
The safe harbor
The IRS describes the de minimis safe harbor election in the tangible property regulations. A taxpayer that has an applicable financial statement (AFS) may deduct amounts paid for tangible property up to $5,000 per invoice or item, as substantiated by invoice. A taxpayer without an AFS may deduct amounts up to $2,500 per invoice or item. Notice 2015-82 raised the non-AFS limit from $500 for tax years beginning on or after January 1, 2016.
An applicable financial statement is, in general, a financial statement filed with the SEC, a certified audited statement with a CPA report, such as one prepared for a loan, for shareholders or for other non-tax purposes, or a statement required by a federal or state government agency other than the IRS or SEC. A reviewed or compiled statement does not fit that description. A client that moves from a review to an audit can therefore become eligible for the higher limit, which belongs in the conversation about engagement level.
Treasury Regulation 1.263(a)-1(f)(2) excludes property that is or is intended to be inventory, land, and rotable, temporary and standby emergency spare parts that the taxpayer capitalizes or accounts for under the optional rotable method. Section 263A still requires capitalization of costs allocable to property the taxpayer produces or acquires for resale. Amounts above the limit are not automatically capitalized. They follow the ordinary rules and may still be deductible as materials and supplies or as repairs.
The election
- Annual. The election is made each year.
- Statement. The taxpayer attaches a statement titled "Section 1.263(a)-1(f) de minimis safe harbor election" to the timely filed original federal return for the year, including extensions.
- All or nothing. Once made, it applies to all qualifying amounts for the year, including materials and supplies, and it cannot be revoked. For a partnership or S corporation, the entity makes the election, not the owners.
- No Form 3115. The election is not made by filing Form 3115, so it cannot be made late through an accounting method change.
Build the election into the return checklist. The regulation does not allow the election through an amended return unless the Commissioner first consents to a late election under sections 301.9100-1 through 301.9100-3. Without that relief, a missed statement means the safe harbor is not available for that year, and the capitalization decision reverts to the regulations. See Form 3115 change in accounting method for what the method change process does and does not fix.
The book policy
The safe harbor depends on the taxpayer's own accounting procedures, which must treat as an expense for non-tax purposes either amounts below a stated dollar amount or amounts with an economic useful life of 12 months or less. A taxpayer with an AFS must have those procedures in writing at the beginning of the year and must expense the item on the AFS. A taxpayer without an AFS does not need written procedures under the regulation, but must have accounting procedures in place at the beginning of the year and must expense the amounts on its books and records under them. Even where a firm's engagement is only tax, the client should have a written capitalization policy in its books, because it is the best evidence of a consistent procedure. The policy should state:
- The threshold per item or per invoice, and which one applies.
- What is capitalized above the threshold. Under the regulation, delivery and installation costs on the same invoice count toward the per-invoice or per-item limit, and costs billed on a separate invoice do not.
- Treatment of groups of similar items bought together, such as furniture for a new office.
- Treatment of software, website costs and leasehold improvements.
- The approval for exceptions.
- The date the policy took effect and who approved it.
The regulation also has an anti-abuse rule that applies where invoices are created to componentize property normally acquired as a single unit. Keep the book threshold and the tax election consistent. A client that capitalizes everything over a low book threshold and elects the safe harbor on the tax return can run into a policy mismatch that has to be explained.
Interaction with bonus depreciation and section 179
The safe harbor expenses small items outright. Items above the line are capitalized and then recovered through MACRS, where section 179 and bonus depreciation can accelerate the deduction. The safe harbor has no income limit, which section 179 does. For a client with limited taxable income, the safe harbor helps without raising limit questions. See section 179 and bonus depreciation and MACRS conventions.
Audit and review impact
Auditors evaluate the capitalization threshold against materiality. A threshold that is low relative to materiality adds clerical work without changing the statements. A threshold that is high relative to materiality can leave unrecorded assets and understated depreciation. Where the threshold is a policy choice, document the analysis. See property, plant and equipment capitalization and depreciation and the glossary entries on de minimis safe harbor and capitalization vs expensing.
Procedure for the annual review
- Pull the additions and the repairs and maintenance accounts.
- Sort the items above and below the threshold by invoice.
- Confirm the book policy threshold is applied consistently.
- Attach the election statement to the return.
- Reconcile the fixed asset register to the general ledger and to the tax depreciation schedule.
- Record items grouped under one invoice for analysis. A single invoice with many small units is measured per item only where each item is separately substantiated.
FAQ
Is the election made on Form 3115?
No. It is made by attaching a statement to a timely filed original return.
Does the safe harbor apply to inventory?
No. Inventory and land are excluded.
Does a reviewed financial statement count as an AFS?
No. An AFS is in general an audited statement of a listed type.
CORAA prepares ready-to-review audit files for US CPA firms; see /us.
Sources
- IRS, Tangible property final regulations: https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations
- IRS, Notice 2015-82, Increase in De Minimis Safe Harbor Limit: https://www.irs.gov/pub/irs-drop/n-15-82.pdf
- eCFR, 26 CFR 1.263(a)-1, Capital expenditures, general rule: https://www.ecfr.gov/current/title-26/section-1.263(a)-1
- IRS, Capitalization of Tangible Property Audit Technique Guide: https://www.irs.gov/pub/irs-pdf/p5712.pdf
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