Listen up for your 2016 taxes: The Internal Revenue Service (IRS) has changed the rule governing the assets businesses must capitalize and depreciate. Starting in the 2016 tax year, assets worth as much as $2,500 can avoid capitalization and depreciation, rather than $500 previously. This is called the “safe harbor de minimis limit.”
It’s been two years since implementation of the “final” tangible property regulations issued by the IRS and Treasury Department. As a refresher, the regulations were issued to clarify and simplify tangible-property regulations. Simplification included the intent to ease taxpayers’ administrative burden of capitalization and depreciation for small-business assets.
Initially, the IRS issued regulations including a small-item exception for assets costing less than $500. This was actually quite a leap forward; prior to 2014, there was technically no dollar value exception as to whether an asset was considered too small to be capitalized. The original criteria was whether the asset had a useful life greater than one year, which required it to be capitalized.
Obviously, farmers and businesses alike developed their own standards for what was considered de minimis, or too small to merit consideration.
After the IRS and Treasury Department issued the above regulations, they formally requested comments on whether it’s appropriate to increase the de minimis safe harbor limit provided in subsection 1.263 of the Internal Revenue Code. In response to the comments they received, the IRS issued Notice 2015-82 in late November, increasing the lower tier $500 safe harbor limit to $2,500. This increased limit is effective for costs incurred during taxable years beginning on or after Jan. 1, 2016.
The IRS also offered audit protection in the notice, if a taxpayer were to use the de minimis safe harbor for $2,500 or less per invoice (or per item as substantiated by invoice) if the taxpayer otherwise satisfies the requirements of Subsection 1.263(a)-1(f)(1)(ii). To satisfy the requirements, the taxpayer should have accounting procedures at the beginning of the year that treat these smaller-asset acquisitions or improvements as an expense in their financial statements of the farm or business.
It’s important to note a farm or business with an Applicable Financial Statement (as defined in the regulations) has a much higher de minimis limit of $5,000. Additionally, if a farm or business established a higher limit for consideration, as a result of substantive consideration, the safe harbor limit doesn’t restrict or limit a taxpayer from establishing such procedures. The de minimis safe harbor does not limit a taxpayer’s ability to deduct otherwise deductible repair or maintenance costs that exceed the amount subject to the safe harbor.
If you wish to apply the provisions of the safe harbor election, have your tax preparer include an election statement with your tax return for the year you’re filing, for example:
“Under IRC Regulations 1.263(a)-1(f), the taxpayer hereby elects to apply the de minimis safe harbor election to all qualifying property placed in service during the tax year.”
This election is effective on a year-by-year basis. You might elect application each year by including a statement in your tax return.
Regarding the treatment in your books and records, simply indicate you’re following the de minimis safe harbor, and record the disbursement as an expense at the time of purchase and also as materials and supplies on your year-end ledgers or statements. Tax rules can be tricky; make sure your adviser is up on the latest changes.
Note: This article is published on my Farm Journal Tax Column. View my column post here.