De Minimis Safe Harbor: Expensing Small Purchases Up to $2,500 or $5,000 Per Item

Section 263(a) of the Internal Revenue Code requires you to capitalize the costs of acquiring, producing and improving tangible property, regardless of the size of the cost. Before the final tangible property regulations, that meant deciding, item by item, whether even a small purchase had to be capitalized. The de minimis safe harbor election is the IRS's simplifying option for these small-dollar purchases.

What the election does

You may elect to apply the safe harbor to amounts paid to acquire or produce tangible property, to the extent you expense those amounts for financial accounting purposes or in your books and records. The IRS describes it as an administrative convenience. If you elect it, you do not have to capitalize the cost of qualifying small purchases.

The two limits

• Without an applicable financial statement (AFS): up to $2,500 per invoice or item, as substantiated by invoice. This limit is $2,500 for taxable years beginning on or after Jan. 1, 2016. It was $500 before that; Notice 2015-82 raised it to $2,500.
• With an AFS: up to $5,000 per invoice or item, as substantiated by invoice.

These limits only decide whether an expense qualifies under the safe harbor. They are not a ceiling on what you can claim as business expenses under the Code.

Who is affected

The final tangible regulations apply to anyone who pays or incurs amounts to acquire, produce or improve tangible real or personal property. That includes corporations, S corporations, partnerships, LLCs, and individuals filing Form 1040 or 1040-SR with Schedule C, E or F. Most of your small-business and self-employed clients are covered.

What counts as an AFS

An AFS includes a financial statement required to be filed with the SEC. It also includes certified audited financial statements accompanied by a CPA report, such as one provided for a loan, for reporting to shareholders, or for other non-tax purposes. A financial statement required to be provided to a federal or state government or agency other than the IRS or the SEC also counts.

Books and records requirement

Without an AFS, you do not need written accounting procedures. You must, however, expense the amounts on your books and records for the year under a consistent accounting procedure or policy that existed at the beginning of that year. With an AFS, the accounting procedures must be in writing.

What the safe harbor does not cover

• Amounts paid for inventory and land.
• Rotable, temporary and standby emergency spare parts that the taxpayer elects to capitalize and depreciate under section 1.162-3(d).
• Rotable and temporary spare parts accounted for under the optional method in section 1.162-3(e).

Small amounts can also still be subject to capitalization under section 263A if they include direct or allocable indirect costs of other property produced or acquired for resale. Certain taxpayers with gross receipts under the section 448(c) thresholds are exempt from section 263A.

Items above the limit

Going over the limit does not mean the item must be capitalized. The safe harbor simply does not apply to it, and the normal rules govern. For example, incidental materials and supplies or repair and maintenance costs can still be currently deducted under the general rules.

If a client has no AFS and a book policy of expensing items above $2,500, those amounts may still be deducted for federal tax purposes if the client can show the policy clearly reflects income. Electing the safe harbor for items of $2,500 or less helps make sure the IRS does not question those items.

How to make the election

Attach a statement titled "Section 1.263(a)-1(f) de minimis safe harbor election" to the timely filed original federal tax return, including extensions, for the year the amounts are paid. Include the taxpayer's name, address and Taxpayer Identification Number, plus a statement that the election is being made.

Once elected, the safe harbor must be applied to all expenditures that meet the criteria that year. The election is annual, so the statement must be filed with each year's return. It is not a change in method of accounting, so do not file Form 3115 to use it, to change the amount in a book policy, or to stop using it in a later year.

Materials and supplies

When you elect the safe harbor, materials and supplies that also qualify for it are treated as de minimis costs, not as materials and supplies. They are expensed in the year paid or incurred. Materials and supplies that do not qualify keep their usual treatment. Inventory accounted for as non-incidental materials and supplies under the small-business cash method procedures is still inventory and is not covered by the safe harbor.

What to tell clients

• Check whether the client has an AFS, since that decides the $2,500 or $5,000 limit.
• Confirm the client's books and records already expense small items under a consistent policy that existed at the start of the year.
• Keep invoices, because the limit is measured per invoice or item.
• Remember the election must be made on a timely filed original return, with a statement, every year.

This article summarizes the IRS page on the tangible property final regulations. Check the IRS source and the regulations for your clients' specific facts.

Informational only, based on the IRS source linked above; not tax or legal advice for a specific situation.