Repair v Capitalization RegulationsRevisited
The Repair v Capitalization regulations released in September 2013 have continued to be read and reread with different questions and interpretations. Here are the interpretations and rules as we read them. First a quickie explanation, then more details.
There are four safe harbor amounts: $200, $500, $5,000, and $10,000. Taxpayers can choose to use amounts smaller than these and still have safe harbor protection. But if a taxpayer chooses to use larger amounts, the taxpayer will not have safe harbor protection and must be ready to justify why the larger amount is reasonable.
** $200 – The definition of “materials and supplies” includes property that has an acquisition or production cost of $200 or less. This $200 is per item. If the per item breakout is not available, then the $200 test is applied per invoice. This is an all or nothing provision. If the item, including all adjustments such as sales tax, cost $201, then the item does NOT fit this provision.
** $500– The $200 amount above is increases to $500IF:
1) The taxpayer does not have an “applicable financial statement”,
2) The taxpayer has at the beginning of the taxable year accounting procedures treating as an expense for non-tax purposes amounts paid for property costing $500 or less,
3) The taxpayer treats the amount paid for the property as an expense on its books and records in according with these accounting procedures, and
4) The amount paid for the property does not exceed $500 per invoice (or per item as substantiated by the invoice).
** $5,000– The $500 amount is increased to $5,000:
1) The taxpayer HAS an “applicable financial statement”,
2) The taxpayer has at the beginning of the taxable year WRITTEN accounting procedures treating as an expense for non-tax purposes amounts paid for property costing $5,000 or less,
3) The taxpayer treats the amount paid for the property as an expense on its books and records in according with its written accounting procedures, and
4) The amount paid for the property does not exceed $5,000 per invoice (or per item as substantiated by the invoice).
An “applicable financial statement” for this purpose is:
1) A financial statement required to be filed with the Securities and Exchange Commission (SEC) (the 10-K or the Annual Statement to Shareholders),
2) A certified audited financial statement that is accompanied by the report of an independent CPA (or in the case of a foreign entity, by the report of a similarly qualified independent professionals) that is used for:
-- a) Credit purposes;
-- b) Reporting to shareholders, partners, or similar persons; or
-- c) Any other substantial non-tax purpose; or
3) A financial statement (other than a tax return) required to be provided to the federal or a statement government or any federal or state agency (other than the SEC or IRS).
** $10,000 – This one is unrelated to the other provisions. A “qualifying taxpayer” can treat improvements to a building as a repair and maintenance if three tests are met.
Test #1 – A “qualifying taxpayer” is one who has average gross receipts over the past three years (or annuitized amount if in existence less than three years), of $10,000,000 or less. “Gross receipts” does not include sales taxes or other similar state and local taxes if the taxes are imposed on the purchaser of the goods/services and the taxpayer merely collects them and remits them to the taxing authority.
Test #2 – An “eligible building property” is one which has an unadjusted basis of $1,000,000 or less. In the case of a taxpayer renting a building (as opposed to owning the building), this $1,000,000 test is determined by adding the total rents paid under the lease plus expected renewals. This test is a “per building” test.
Test #3 – The total of amounts paid during the year for repairs, maintenance, improvements, and similar activities performed on the eligible building property does not exceed the LESSER of:
1) 2 percent of the unadjusted basis of the eligible building property, or
2) $10,000.
If all three of these tests are met, the taxpayer can elect to treat the improvements as repairs and maintenance.
ELECTION PROCEDURES
A taxpayer who wants to use the $500 or $5,000 safe harbor amounts must attach a statement to a timely filed return (due date plus extensions). The statement must be titled “Section 1.263(a)-1(f) de minimis safe harbor election” and include the taxpayer's name, address, taxpayer identification number, and a statement that the taxpayer is making the de minimis safe harbor election under §1.263(a)-1(f). (We do not see a statement required for the $200 safe harbor amount.) This election is an ANNUAL election.
A taxpayer who wants to use the $10,000 safe harbor amount must attach a statement to a timely filed return (due date plus extensions). The statement must be titled “Section 1.263(a)-3(h)Safe Harbor Election for Small Taxpayers” and include the taxpayer's name, address, taxpayer identification number, and a statement that the taxpayer is making the de minimis safe harbor election under §1.263(a)-3(h). This election is an ANNUAL election.
SIDE NOTE – Just because an item falls into the “materials and supplies” expense category does NOT mean it is currently deductible. It still must meet the incidental v nonincidental tests. If a cash basis taxpayer pays for an expense that is incidental, such as a book of 20 postage stamps, it is deductible when paid. If a cash basis taxpayer pays for an expense that is nonincidental, it is deductible when used or consumed in the same manner as Prepaid Supplies.
For example, Taxpayer bought a book of 20 postage stamps in December for $9.80. Taxpayer used 5 stamps in December and 15 stamps in January. This is an incidental expense and the entire $9.80 is deductible in December.
For example, Taxpayer bought 5,000 Forever postage stamps in December to avoid any price increase. Taxpayer typically uses 500 postage stamps in a year. This is a nonincidental expense (prepaid expense) and Taxpayer can deduct in December only the stamps that were used in December. The remaining stamps are not deductible until they are used at some time in the future.
This text has been shared with you courtesy of: David & Mary Mellem, EAs & Ashwaubenon Tax Professionals, 920-496-1065 (920-496-9111).
©2015 Ashwaubenon Tax Professionals. No reproduction of this article is permitted without the express written consent of Ashwaubenon Tax Professionals, 2140 Holmgren Way, Suite 1040, Green Bay, WI 54304.
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