A common question we deal with is when to capitalize and depreciate assets rather than expensing them. It is often advantageous for a client to be able to expense smaller purchases rather than setting them up in depreciation schedules and either dealing with Section 179 rules or delaying the full deduction. The IRS has provided a capitalization de minimis safe harbor rule to help businesses determine when to capitalize and when to expense new assets. In the past many companies have used a rule of thumb limit to determine when to set up and depreciate a new asset purchase. The IRS is making this easier by providing a safe harbor rule that companies can rely on.
The safe harbor rule is based on an annual, irrevocable election made by the taxpayer on their tax return. It is mostly simple, but the safe harbor amount is different depending on whether the taxpayer provides audited financial statements or not. In the case where audited financial statements are provided, the safe harbor amount is $5,000. Where no audited financial statements are produced, the limit drops to $2,500. Originally the lower safe harbor amount was $500, but the IRS increased it to $2,500 in response to public comment.
In addition to the annual election, companies must document the safe harbor in their accounting procedures. In other words, the company should note in their accounting procedures that items below the safe harbor are automatically expensed. The higher safe harbor level of $5,000 can be used by companies who do not have audited financials, but do provide financials to state or federal agencies.
Once the election has been made and the accounting procedure is in place, it must be applied to all purchases under the safe harbor with the exception of inventory, land, and temporary, rotable, or spare parts that the taxpayer elects to depreciate. If a company has a written accounting procedure that uses an amount less than the safe harbor, the accounting procedure must be followed until it is modified.
This safe harbor provides a simple and reliable way to account for these costs, however it does not cover all situations. Even if a purchase exceeds the safe harbor, there may be a reasonable basis for expensing it rather than capitalizing. For questions on specific situation, please don’t hesitate to contact us.