On November 25, 2015 IRS provided small businesses and landlords with repair and capitalization relief. Please see Notice 2015-82 (PDF). The 2013 regulations provided guidance on what is a repair and what had to be capitalized. Bullet point four of this post mentions the 2013 changes. The regulations allowed businesses to treat amounts up to $500 as supplies. Previously, taxpayers would have had to justify deducting new property costing under $500. The new notice changes the amount from $500 to $2,500.
Looks like this car requires more than $500 in work!
Tangible property is just what it sounds like. It is property you can touch. Intangible property – such as a patent – cannot be touched. The copyright document can be touched but not the actual idea. For a long time, taxpayers and IRS have argued about whether or not a piece of tangible property is a repair or subject to capitalization. The distinction matters because businesses can immediately deduct repair and maintenance costs, with some exceptions. On the other hand, something that has to be capitalized is typically depreciated over anywhere from a few years to 40 years.
Depreciation is a method of claiming part of the cost of the capitalized asset each year for several years.
- Repair = 100% deducted in year one (there are some exceptions which are beyond the scope of this post)
- Capitalized = deduct as little as 2.5% of the cost each year for 40 years, sometimes even less per year.
Taxpayers that have an applicable financial statement got a $5,000 safe harbor in the 2013 regulations. Taxpayers without an applicable financial statement (AFS) only received the $500 safe harbor. An AFS is one that is audited or required to be filed with a regulatory agency. If the only reason for audited AFS was to get the $5,000 safe harbor then the taxpayer was still stuck with the $500 safe harbor.
XYZ Company built a $2,500 storage shed. Prior to the 2013 regulations, IRS would have wanted the taxpayer to deduct an average of $65 a year for the next 39 years. Assume XYZ Company has an AFS. If the shed was constructed in 2014 or after, then XYZ could claim the entire $2,500 as a supply deduction in the year built.
Assume ABC Company does not have an applicable financial statement and it builds the $2,500 shed in 2014. Under the 2013 regulations, ABC was stuck with claiming an average of $65 a year for 39 years. Notice 2015-82 changes this for 2016 (and for many also for 2015). If ABC builds a new shed in 2016 for $2,500, it can claim a supply deduction in 2016 of $2,500. A much better deduction than $65 a year for 39 years.
Repair and capitalization relief for 2015?
The notice states it “is effective for costs incurred during taxable years beginning on or after January 1, 2016.” This seems to say no businesses qualify for the $2,500 safe harbor under the notice until 2016. However, the notice goes on to say
For taxable years beginning before January 1, 2016, the IRS will not raise upon examination the issue of whether a taxpayer without an [applicable financial statement] can utilize the de minimis safe harbor … for an amount not to exceed $2,500 per invoice (or per item as substantiated by invoice) if the taxpayer otherwise satisfies the requirements ….
IRS is saying that if a taxpayer uses the $2,500 safe harbor in 2015, then IRS will not deny the supply deduction as long as it is less than or equal to $2,500. The taxpayer still has to meet all the other requirements that existed when the amount was $500.
How is this for some repair and capitalization relief? Audit protection, nice.