IRS Updates Tangible Property Regulations for Small Taxpayers for 2016 Tax Year
Tanya Gierut, CPA
A few years ago, the IRS provided clarification on the proper tax treatment of expenditures relating to tangible property, known as the “new repair regs.” These regulations presented taxpayers with clarification on whether the expenses could be immediately deducted or whether they were required to be capitalized on your balance sheet and taken as a deduction over time through depreciation.
The rules provided taxpayers with a de minimis safe harbor rule that allowed taxpayers to immediately expense the cost if below a certain threshold. For the 2016 tax year, the IRS updated the de minimis threshold for small businesses and taxpayers.
Under the old regulations, a taxpayer with an applicable financial statement (generally an audited financial statement) was allowed a $5,000 deduction per item or invoice. Many small taxpayers do not need or require a certified audited financial statement, so they were left with a safe harbor deduction of only $500 per item or invoice. In addition, this deduction of $500 could only be taken if there was a written policy in place that defined their property expenditure procedures for property with an economic useful life of 12 months or less.
If the small taxpayer did not comply with having a written policy and procedure in place, then the expenditures would have to be capitalized or deducted through Section 179 expense. By capitalizing the expenditure, your expense would be limited to the annual depreciation for that year and would therefore cause additional taxable income. If you elect to take Section 179, there are additional rules that first need to be met, in addition to Section 179 expense having their own limits and thresholds.
Updated Rules for 2016
Effective for the 2016 tax year, the IRS increased the threshold for taxpayers without an applicable financial statement to $2,500. (The limit for taxpayers with applicable financial statements remains at $5,000.) To take advantage of the safe harbor rule, you still must have the accounting policy and procedures described above in place at the beginning of the tax year for which you are making the election and communicated to all employees; however it is not required to be in writing but is highly recommended.
The IRS has also pledged to provide “audit protection” on the issue. That means the agency will not challenge your use of the higher threshold in tax years beginning in 2012, 2013, 2014 or 2015 if you otherwise satisfied the requirements. If you did not have the required policy, for example, you are stuck with the $500 threshold for those years.
One of the stipulations in the repair regulations is that you must consistently comply with your own policy. For example, if your policy requires the expensing of amounts paid for invoices or items below $2,500, you need to expense every such invoice or item. You cannot pick and choose which items to expense or capitalize.
Moreover, the safe harbor rules apply only to amounts that do not exceed the $2,500 threshold, regardless of where you set the threshold in your accounting policy. The policy might require the expensing of amounts paid for invoices or items below a higher threshold — but the safe harbor will still apply only to invoices or items that don’t exceed $2,500.
To take advantage of these new updated rules and regulations, you must make an annual irrevocable election and attach it to your timely filed tax return, including extensions.
The tax rules regarding property expenditures can be very complex. If you have any questions or think you can take advantage of these updated rules, please give us a call to discuss further.
New Tax Law Offers PATH to Savings
Justin Sylvan, CPA
In late December 2015, former President Barack Obama signed H.R. 2029, which includes provisions that created the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act). The wide-ranging tax law makes permanent or extends three breaks that have proven popular with many taxpayers in the real estate industry. These provisions can make it easier for taxpayers to expense or recover the costs of certain types of property related to their businesses, rather than depreciating them over lengthy recovery periods.
Sec. 179 Deduction
Under Section 179 of the Internal Revenue Code (IRC), business taxpayers can immediately deduct — or “expense”— the cost of certain tangible personal property that is purchased for business use in the year of purchase (for example, computers, office furniture and office equipment) rather than recovering the costs more slowly through depreciation deductions. For 2014, businesses were allowed to deduct up to $500,000 in qualified new or used assets, subject to a dollar-for-dollar phase-out trigger when the cost of all qualifying property placed in service during the taxable year exceeded $2 million.
Before the PATH Act, the deduction and phase-out amounts for 2015 had fallen to $25,000 and $200,000, respectively. The uncertainty created by Congress’s annual late-year extensions of Sec. 179 left some small businesses reluctant to invest in new equipment. However, the act makes the 2014 limits permanent (with the limits indexed for inflation beginning in 2016). The provision further modifies the expensing limitation for qualified real property, such as qualified leasehold-improvement property, qualified restaurant property and qualified retail-improvement property. The act eliminates the $250,000 cap beginning in 2016.
If your business is eligible for full Sec. 179 expensing, you could obtain a greater benefit from expensing rather than from bonus depreciation because the expensing provision might let you deduct an asset’s entire acquisition cost. Plus, you can use Sec. 179 expensing for both new and used property, and bonus depreciation might be subject to recapture on disposition of the asset. On the other hand, taxpayers must have net income to take advantage of Sec. 179 expensing.
IRC Sec. 168(k) was also extended but not permanently. The provision, which allows businesses to recover the costs of depreciable property more quickly by claiming bonus first-year depreciation for qualified assets, will run through 2019, with declining benefits each year. For property placed in service during 2015, 2016 and 2017, the bonus depreciation percentage is 50%. It will fall to 40% in 2018 and 30% in 2019.
Businesses can still use Sec. 168(k) to claim unused AMT credits instead of bonus depreciation, and the amount of unused AMT credits that may be claimed increases beginning in 2016. Qualified assets include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software, water utility property and qualified leasehold-improvement property.
As noted above, the Sec. 179 deduction might provide a greater tax benefit than bonus depreciation if you qualify for it. However, bonus depreciation may help more taxpayers than Sec. 179 expensing because it does not include a limit on the amount of assets purchased, require net income or phase out at any point. Of course, you must also consider any applicable state tax consequences when purchasing equipment.
15-Year Straight-Line Depreciation Cost Recovery Period
The PATH Act makes permanent the 15-year straight-line cost recovery period for qualified leasehold improvements (alterations in a nonresidential building to suit the needs of a particular tenant), qualified restaurant property and qualified retail-improvement property. Such expenditures would otherwise be subject to the 39-year depreciation period.
Finding the Best Path Forward
The PATH Act includes numerous other significant provisions that could affect the taxes of both businesses and individuals. Make sure you contact your tax advisor regarding these changes. He or she can help minimize your tax burden.
Sidebar: Incentive for Charitable Real Estate Donations Made Permanent
The PATH Act made permanent several tax benefits related to charitable giving, including the deduction for contributions of real property for conservation purposes. To be eligible for the deduction, you must contribute a qualified real property interest, to be used only for conservation purposes, to a qualified organization. The organization must have a commitment to protect the donation’s conservation purposes and the resources to enforce the restrictions.
Qualified real property interests include your entire interest in real estate (other than a mineral interest), a remainder interest or a restriction (granted in perpetuity) on the use that may be made of real property. Your deduction is generally limited to 50% of your adjusted gross income less your deduction for all other charitable contributions. The PATH Act allows you to carry forward any contributions you cannot deduct because of this limit for 15 years, up from the previous limit of five years.