Big Change: IRS Increases Capitalization Safe Harbor by 500 Percent
by John M. Lohman, CPA
On November 24th, 2015, the Internal Revenue Service announced a significant change in the threshold for what is considered a capital item. Notice 2015-82 raised the capital item safe harbor threshold from $500 to $2,500, effective for the 2016 tax year. Capital items are acquisitions of furniture or equipment that must be “capitalized” with the cost of the asset being recovered through depreciation deductions taken over a number of years, depending on the nature of the item.
For years 2012 – 2015 the IRS had recently generated new regulations, called “The Repair Regs”, that established $500 as the capitalization threshold for small businesses that did not have “applicable financial statements” (financial statements audited by an independent accountant). Under the originally published “Repair Regs” safe harbor, items costing less than $500 were to be deducted as supplies; items costing $500 or more were required to be capitalized and depreciated.
The new capitalization threshold is $2,500 and is applicable for the 2016 tax year. Consequently, beginning January 1st (for calendar year taxpayers), any item costing less than $2,500 may be deducted as an expense in the year acquired. Although the Notice specifies that the change is effective beginning with the 2016 tax year, the Notice also states that if an entity otherwise qualifies for the deminimis safe harbor limit in the years covered by the “Repair Regs” prior to 2016, the IRS will not challenge the use of $2,500 as the safe harbor limit. Consequently, the $2,500 limit can be used by taxpayers in 2015 without fear of it ever being an audit issue.
To qualify for the deminimis safe harbor, a statement that the taxpayer is making the deminimis safe harbor election under Regulation section 1.263(a)-(1)(F) must be attached to that year’s tax return. We recommend that business entities have a written capitalization policy in place that dovetails with the IRS safe harbor.
This change in the safe harbor was due to more than 150 letters the IRS received on this issue from businesses and their representatives and the AICPA. The letters noted that $500 was too low to relieve the administrative burden on taxpayers. IRS Commissioner John Koskinen commented: “This important step simplifies taxes for small businesses, easing the recordkeeping and paperwork burden on small businesses and their tax preparers.”
Businesses with “applicable financial statements” may continue to use the $5,000 capitalization threshold previously established under the aforementioned “Repair Regs”.
If you have questions about the new deminimis safe harbor or other provisions of the “Repair Regs”, please consult your tax advisor or contact us at DGN, LLC.