For tax professionals who has ever had to review a client ’ s expenses for repair , acquisition or production of tangible property , the question of whether to capitalize or expense continues to stump even the most experienced CPAs due to the subjectivity involved and heavy reliance on facts and circumstances .
Thousands of dollars of expenses may need to be capitalized in one situation , while the same amount may be deducted in another . This article addresses this issue along with some key points CPAs and taxpayers should consider . It briefly explains the benefits of expensing , limitations on capitalizing , and the application of two useful safe harbors : the de minimis safe harbor and the safe harbor for routine maintenance .
The benefit of expensing an item versus capitalizing it is readily apparent , but there are other factors to consider . If the amounts are below the de minimis threshold , the taxpayer will need to have documentation only to substantiate the amount paid . The taxpayer ’ s adviser and preparer will not need to spend time analyzing the support for , or nature of , the expenses , and there will never be an issue of recapture .
With bonus depreciation phasing out and scheduled to be eliminated by the end of 2026 , the impact of capitalizing an expense becomes greater . Even with bonus depreciation , taxpayers run the risk of dealing with depreciation recapture ( where they must report previously taken depreciation as ordinary income ) if an asset is disposed of before the end of its useful life .
The Sec . 179 deduction is also available in many instances but has its own complexities and limitations : which assets qualify ; the maximum threshold to deduct ; and most important , the inability of the Sec . 179 deduction to reduce the bottomline income to a loss position . Granted , an excess Sec . 179 deduction carries over to future years , but it is not an immediate deduction in the year the expense is incurred .
Another pitfall of the Sec . 179 deduction that many CPAs may not be aware of is that trusts and estates cannot claim it . Therefore , a client with a pass-through entity with a trust or estate as a partner should be aware that any Sec . 179 deduction allocated to such a partner will be a nondeductible expense for that partner .
The De Minimis Safe Harbor Selection Regs . Sec . 1.162-4 provides that a taxpayer may deduct amounts paid to acquire or produce tangible property if the amounts paid are not otherwise required to be capitalized . One of the easiest ways to answer the oft-vexing question of whether to capitalize an expense is the de minimis safe harbor election under Regs . Sec . 1.263 ( a ) -1 ( f ).
This election allows taxpayers to expense an item immediately , with no need to substantiate why it is not being capitalized .
It is important to note that the dollar threshold is applied per invoice ( or per item as substantiated by the invoice ). Therefore , even though taxpayers are not required to keep detailed documentation for items expensed under this election , taxpayers who purchase multiple items on one invoice should retain a copy of the itemized invoice . The election applies to the acquisition or production of a unit of tangible property ( Regs . Sec . 1.263 ( a ) -2 ), materials or supplies ( Regs . Sec . 1.162-3 ) and additional categories discussed in this article .
If the de minimis safe harbor is elected under Regs . Sec . 1.263 ( a ) -1 ( f ), it must be applied to all materials and supplies that meet the requirements of de minimis , except for those the taxpayer elects to capitalize and depreciate or uses the optional method of accounting for rotable and temporary spare parts , under Regs . Secs . 1.162-3 ( d ) and ( e ), respectively . This election does not apply to amounts paid for land ; property that is intended to be included as inventory ; or any rotable , temporary , or standby emergency spare parts that the taxpayer has elected to capitalize under Regs . Sec . 1.162-3 ( d ).
The de minimis election is made annually by attaching a statement to the taxpayer ’ s timely filed original federal tax return ( including extensions ) for the tax year in which the amounts were paid . Most , if not all , tax software programs can produce this election statement . The taxpayer is also required to have an accounting procedure ( in written form if the taxpayer has an applicable financial statement ( AFS )) indicating that it will expense any item below the threshold and treat the amount paid as an expense on its financial statements and books . See the sidebar , “ Sample De Minimis Expensing Policy ,” for an example of a written accounting policy for purposes of qualifying for the de minimis election .
De Minimis Threshold There are two de minimis threshold amounts depending on whether the taxpayer has an AFS . An AFS includes any of the following :
• A financial statement required to be filed with the SEC ;
• A certified audited financial statement that is accompanied by the report of an independent CPA ; or
• A financial statement ( other than a tax return ) that is required to be submitted to a federal or state government / agency ( not including the SEC or IRS ) ( Regs . Sec . 1.263 ( a ) -1 ( f )( 4 ). If the taxpayer has an AFS , the de minimis threshold is $ 5,000 . If the taxpayer does not have an AFS , the threshold is $ 2,500 ( Regs . Sec . 1.263 ( a ) -1 ( f )( 1 )( ii )( D ), as amended by Notice 2015-82 ). Regs . Sec . 1.263 ( a ) -1 ( f )( 7 ) also provides several helpful examples addressing different scenarios . Example 3 is a good illustration of the threshold being used for individual items in an invoice where the de minimis safe harbor applies and a taxpayer has an AFS . Following is a summary of that example :
Example : Company C has a written accounting policy at the beginning of year 1 , which C follows , to expense amounts paid for property costing $ 5,000 or less . In year 1 , C pays $ 6,250,000 to purchase 1,250 computers at $ 5,000 each . C receives an invoice from its supplier indicating the total amount due ($ 6,250,000 ) and the price per item ($ 5,000 ). Assume that each computer is a unit of property under Regs . Sec . 1.263 ( a ) -3 ( e ). The amounts paid for the computers meet the requirements for the de minimis safe harbor ; C must expense the purchases pursuant to C ’ s accounting policy ; and C may make a de minimis safe-harbor election for year 1 and deduct the entire amount in year 1 for tax purposes .
Safe Harbor for Routine Maintenance Another safe harbor that can help taxpayers avoid the uncertainty of expensing versus capitalizing an item is the safe harbor for routine maintenance under Regs . Sec . 1.263 ( a ) - 3 ( i ). This is more complex and has more criteria for eligibility www . calcpa . org OCTOBER 2024 CALIFORNIA CPA 13