Discussion:New Reg Sec 1.263(a) De Minimis Safe Harbor Election

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Discussion Forum Index --> Advanced Tax Questions --> New Reg Sec 1.263(a) De Minimis Safe Harbor Election


Discussion Forum Index --> Tax Questions --> New Reg Sec 1.263(a) De Minimis Safe Harbor Election

Jake (talk|edits) said:

11 April 2014
Client remodeled kitchen in residential rental. Acted as her own contractor. Two items were over $500, the cabinets ($1,500) and labor paid to installer ($1,400). All other items, electrical, flooring tile, etc. were individual expenditures under $500 each - total was about $1,500. My first thought was that this was a single project and the entire $4,400 cost had to be aggregated. Now I am wondering if she can expense all but the cabinets and that labor. help please.

Coddington (talk|edits) said:

11 April 2014
Let's back up a little first.

1. Did your taxpayer have a book de minimis expensing policy as of the beginning of the tax year?

2. Did your taxpayer expense these items for book purposes in accordance with this policy?

If your taxpayer does not have a book expensing policy at the beginning of the year, then you cannot use the de minimis safe harbor election. You may still be able to expense these items, but you'd have to prove clear reflection of income on audit.

3. If your taxpayer did have a book expensing policy and expensed the assets under that policy, the de minimis safe harbor election regs say that you can look at either the invoice or the individual invoice line item level to apply the $500 rule. How was the transaction structured? Did she buy $1500 cabinets and other materials and supplies costing less than $500 at Home Depot and then paid a third party separately to install the cabinets and installed everything else herself?

Coddington (talk|edits) said:

11 April 2014
I believe the OP is talking about the de minimis safe harbor election of Treas Reg. section 1.263(a)-1(f) Reg. 1.263(a)-1.

Spell Czech (talk|edits) said:

11 April 2014
Here's a copy of that section of the new regulations. I have removed an enormous block of examples - eleven of them - at subsection (f)(7).

(f) De minimis safe harbor election—(1) In general. Except as otherwise provided in paragraph (f)(2) of this section, a taxpayer electing to apply the de minimis safe harbor under this paragraph (f) may not capitalize under §1.263(a)-2(d)(1) or §1.263(a)-3(d) any amount paid in the taxable year for the acquisition or production of a unit of tangible property nor treat as a material or supply under §1.162-3(a) any amount paid in the taxable year for tangible property if the amount specified under this paragraph (f)(1) meets the requirements of paragraph (f)(1)(i) or (f)(1)(ii) of this section. But see section 263A and the regulations under section 263A, which require taxpayers to capitalize the direct and allocable indirect costs of property produced by the taxpayer (for example, property improved by the taxpayer) and property acquired for resale.

(i) Taxpayer with applicable financial statement. A taxpayer electing to apply the de minimis safe harbor may not capitalize under §1.263(a)-2(d)(1) or §1.263(a)-3(d) nor treat as a material or supply under §1.162-3(a) any amount paid in the taxable year for property described in paragraph (f)(1) of this section if—

(A) The taxpayer has an applicable financial statement (as defined in paragraph (f)(4) of this section);

(B) The taxpayer has at the beginning of the taxable year written accounting procedures treating as an expense for non-tax purposes—

(1) Amounts paid for property costing less than a specified dollar amount; or

(2) Amounts paid for property with an economic useful life (as defined in §1.162-3(c)(4)) of 12 months or less;

(C) The taxpayer treats the amount paid for the property as an expense on its applicable financial statement in accordance with its written accounting procedures; and

(D) The amount paid for the property does not exceed $5,000 per invoice (or per item as substantiated by the invoice) or other amount as identified in published guidance in the Federal Register or in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter).

(ii) Taxpayer without applicable financial statement. A taxpayer electing to apply the de minimis safe harbor may not capitalize under §1.263(a)-2(d)(1) or §1.263(a)-3(d) nor treat as a material or supply under §1.162-3(a) any amount paid in the taxable year for property described in paragraph (f)(1) of this section if—

(A) The taxpayer does not have an applicable financial statement (as defined in paragraph (f)(4) of this section);

(B) The taxpayer has at the beginning of the taxable year accounting procedures treating as an expense for non-tax purposes—

(1) Amounts paid for property costing less than a specified dollar amount; or

(2) Amounts paid for property with an economic useful life (as defined in §1.162-3(c)(4)) of 12 months or less;

(C) The taxpayer treats the amount paid for the property as an expense on its books and records in accordance with these accounting procedures; and

(D) The amount paid for the property does not exceed $500 per invoice (or per item as substantiated by the invoice) or other amount as identified in published guidance in the Federal Register or in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter).

(iii) Taxpayer with both an applicable financial statement and a non-qualifying financial statement. For purposes of this paragraph (f)(1), if a taxpayer has an applicable financial statement defined in paragraph (f)(4) of this section in addition to a financial statement that does not meet requirements of paragraph (f)(4) of this section, the taxpayer must meet the requirements of paragraph (f)(1)(i) of this section to qualify to elect the de minimis safe harbor under this paragraph (f).

(2) Exceptions to de minimis safe harbor. The de minimis safe harbor in paragraph (f)(1) of this section does not apply to the following:

(i) Amounts paid for property that is or is intended to be included in inventory property;

(ii) Amounts paid for land;

(iii) Amounts paid for rotable, temporary, and standby emergency spare parts that the taxpayer elects to capitalize and depreciate under §1.162-3(d); and

(iv) Amounts paid for rotable and temporary spare parts that the taxpayer accounts for under the optional method of accounting for rotable parts pursuant to §1.162-3(e).

(3) Additional rules—(i) Transaction and other additional costs. A taxpayer electing to apply the de minimis safe harbor under paragraph (f)(1) of this section is not required to include in the cost of the tangible property the additional costs of acquiring or producing such property if these costs are not included in the same invoice as the tangible property. However, the taxpayer electing to apply the de minimis safe harbor under paragraph (f)(1) of this section must include in the cost of such property all additional costs (for example, delivery fees, installation services, or similar costs) if these additional costs are included on the same invoice with the tangible property. For purposes of this paragraph, if the invoice includes amounts paid for multiple tangible properties and such invoice includes additional invoice costs related to these multiple properties, then the taxpayer must allocate the additional invoice costs to each property using a reasonable method, and each property, including allocable labor and overhead, must meet the requirements of paragraph (f)(1)(i) or paragraph (f)(1)(ii) of this section, whichever is applicable. Reasonable allocation methods include, but are not limited to specific identification, a pro rata allocation, or a weighted average method based on the property’s relative cost. For purposes of this paragraph (f)(3)(i), additional costs consist of the costs of facilitating the acquisition or production of such tangible property under §1.263(a)-2(f) and the costs for work performed prior to the date that the tangible property is placed in service under §1.263(a)-2(d).

(ii) Materials and supplies. If a taxpayer elects to apply the de minimis safe harbor provided under this paragraph (f), then the taxpayer must also apply the de minimis safe harbor to amounts paid for all materials and supplies (as defined under §1.162-3) that meet the requirements of §1.263(a)-1(f). See paragraph (f)(3)(iv) of this section for treatment of materials and supplies under the de minimis safe harbor.

(iii) Sale or disposition. Property to which a taxpayer applies the de minimis safe harbor contained in this paragraph (f) is not treated upon sale or other disposition as a capital asset under section 1221 or as property used in the trade or business under section 1231.

(iv) Treatment of de minimis amounts. An amount paid for property to which a taxpayer properly applies the de minimis safe harbor contained in this paragraph (f) is not treated as a capital expenditure under §1.263(a)-2(d)(1) or §1.263(a)-3(d) or as a material and supply under §1.162-3, and may be deducted under §1.162-1 in the taxable year the amount is paid provided the amount otherwise constitutes an ordinary and necessary expense incurred in carrying on a trade or business.

(v) Coordination with section 263A. Amounts paid for tangible property described in paragraph (f)(1) of this section may be subject to capitalization under section 263A if the amounts paid for tangible property comprise the direct or allocable indirect costs of other property produced by the taxpayer or property acquired for resale. See, for example, §1.263A-1(e)(3)(ii)(R) requiring taxpayers to capitalize the cost of tools and equipment allocable to property produced or property acquired for resale.

(vi) Written accounting procedures for groups of entities. If the taxpayer’s financial results are reported on the applicable financial statement (as defined in paragraph (f)(4) of this section) for a group of entities then, for purposes of paragraph (f)(1)(i)(A) of this section, the group’s applicable financial statement may be treated as the applicable financial statement of the taxpayer, and for purposes of paragraphs (f)(1)(i)(B) and (f)(1)(i)(C) of this section, the written accounting procedures provided for the group and utilized for the group’s applicable financial statement may be treated as the written accounting procedures of the taxpayer.

(vii) Combined expensing accounting procedures. For purposes of paragraphs (f)(1)(i) and (f)(1)(ii) of this section, if the taxpayer has, at the beginning of the taxable year accounting procedures treating as an expense for non-tax purposes (1) amounts paid for property costing less than a specified dollar amount; and (2) amounts paid for property with an economic useful life (as defined in §1.162-3(c)(4)) of 12 months or less, then a taxpayer electing to apply the de minimis safe harbor under this paragraph (f) must apply the provisions of this paragraph (f) to amounts qualifying under either accounting procedure.

(4) Definition of applicable financial statement. For purposes of this paragraph (f), the taxpayer’s applicable financial statement (AFS) is the taxpayer’s financial statement listed in paragraphs (f)(4)(i) through (iii) of this section that has the highest priority (including within paragraph (f)(4)(ii) of this section). The financial statements are, in descending priority—

(i) A financial statement required to be filed with the Securities and Exchange Commission (SEC) (the 10-K or the Annual Statement to Shareholders);

(ii) A certified audited financial statement that is accompanied by the report of an independent certified public accountant (or in the case of a foreign entity, by the report of a similarly qualified independent professional) that is used for—

(A) Credit purposes;

(B) Reporting to shareholders, partners, or similar persons; or

(C) Any other substantial non-tax purpose; or

(iii) A financial statement (other than a tax return) required to be provided to the federal or a state government or any federal or state agency (other than the SEC or the Internal Revenue Service).

(5) Time and manner of election. A taxpayer that makes the election under this paragraph (f) must make the election for all amounts paid during the taxable year for property described in paragraph (f)(1) of this section and meeting the requirements of paragraph (f)(1)(i) or paragraph (f)(1)(ii) of this section, as applicable. A taxpayer makes the election by attaching a statement to the taxpayer’s timely filed original Federal tax return (including extensions) for the taxable year in which these amounts are paid. See §§301.9100-1 through 301.9100-3 of this chapter for the provisions governing extensions of time to make regulatory elections. 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). In the case of a consolidated group filing a consolidated income tax return, the election is made for each member of the consolidated group by the common parent, and the statement must also include the names and taxpayer identification numbers of each member for which the election is made. In the case of an S corporation or a partnership, the election is made by the S corporation or the partnership and not by the shareholders or partners. An election may not be made through the filing of an application for change in accounting method or, before obtaining the Commissioner’s consent to make a late election, by filing an amended Federal tax return. A taxpayer may not revoke an election made under this paragraph (f). The manner of electing the de minimis safe harbor under this paragraph (f) may be modified through guidance of general applicability (see §§601.601(d)(2) and 601.602 of this chapter).

(6) Anti-abuse rule. If a taxpayer acts to manipulate transactions with the intent to achieve a tax benefit or to avoid the application of the limitations provided under paragraphs (f)(1)(i)(B)(1), (f)(1)(i)(D), (f)(1)(ii)(B)(1), and (f)(1)(ii)(D) of this section, appropriate adjustments will be made to carry out the purposes of this section. For example, a taxpayer is deemed to act to manipulate transactions with an intent to avoid the purposes and requirements of this section if—

(i) The taxpayer applies the de minimis safe harbor to amounts substantiated with invoices created to componentize property that is generally acquired or produced by the taxpayer (or other taxpayers in the same or similar trade or business) as a single unit of tangible property; and

(ii) This property, if treated as a single unit, would exceed any of the limitations provided under paragraphs (f)(1)(i)(B)(1), (f)(1)(i)(D), (f)(1)(ii)(B)(1), and (f)(1)(ii)(D) of this section, as applicable.

Horrendous amount of examples were removed from here...

(g) Accounting method changes. Except for paragraph (f) of this section (the de minimis safe harbor election), a change to comply with this section is a change in method of accounting to which the provisions of sections 446 and 481 and the accompanying regulations apply. A taxpayer seeking to change to a method of accounting permitted in this section must secure the consent of the Commissioner in accordance with §1.446-1(e) and follow the administrative procedures issued under §1.446-1(e)(3)(ii) for obtaining the Commissioner’s consent to change its accounting method.

(h) Effective/applicability date—(1) In general. Except for paragraph (f) of this section, this section generally applies to taxable years beginning on or after January 1, 2014. Paragraph (f) of this section applies to amounts paid in taxable years beginning on or after January 1, 2014. Except as provided in paragraph (h)(1) and paragraph (h)(2) of this section, §1.263(a)-1 as contained in 26 CFR part 1 edition revised as of April 1, 2011, applies to taxable years beginning before January 1, 2014.

(2) Early application of this section—(i) In general. Except for paragraph (f) of this section, a taxpayer may choose to apply this section to taxable years beginning on or after January 1, 2012. A taxpayer may choose to apply paragraph (f) of this section to amounts paid in taxable years beginning on or after January 1, 2012.

(ii) Transition rule for de minimis safe harbor election on 2012 or 2013 returns. If under paragraph (h)(2)(i) of this section, a taxpayer chooses to make the election to apply the de minimis safe harbor under paragraph (f) of this section for amounts paid in its taxable year beginning on or after January 1, 2012, and ending on or before September 19, 2013 (applicable taxable year), and the taxpayer did not make the election specified in paragraph (f)(5) of this section on its timely filed original Federal tax return for the applicable taxable year, the taxpayer must make the election specified in paragraph (f)(5) of this section for the applicable taxable year by filing an amended Federal tax return for the applicable taxable year on or before 180 days from the due date including extensions of the taxpayer’s Federal tax return for the applicable taxable year, notwithstanding that the taxpayer may not have extended the due date.

(3) Optional application of TD 9564. A taxpayer may choose to apply §1.263(a)-1T as contained in TD 9564 (76 FR 81060) December 27, 2011, to taxable years beginning on or after January 1, 2012, and before January 1, 2014.

Jake (talk|edits) said:

12 April 2014
This is an individual who owns one rental double. Her "book" involves keeping very good records and receipts for all her expenses related to this rental - and then giving that info to me to prepare her personal tax return. There was no specific de minimis expensing "policy" at the beginning of the year beyond common sense of not capitalizing small items, e.g., under $100. I sent her the election document that she signed in late 2013 after the IRS published that de minimis Treas Reg. section 1.263(a)-1(f). She bought the $1,500 cabinets as well as other materials and supplies costing less than $500 at Home Depot etc. and then paid third parties separately to install the cabinets and everything else. Only the cabinet tear out and install person was over $500. The plumber was less than $500; the electrician less than $500; etc. In the old days my understanding was that even items that might normally be expensed such as painting supplies, you would include as a capital expense if part of a significant renovation. Maybe with that election she even has to expense those items under $500 - cannot capitalize.

Ckenefick (talk|edits) said:

12 April 2014
http://www.aicpa.org/InterestAreas/Tax/Resources/TaxMethodsPeriods/ToolsandAids/DownloadableDocuments/Quick%20Summary%20Chart%20of%20Final%20Tangible%20Property%20Regulations.pdf

Wouldn't we be looking at the $500 de minimis test or the $10,000 small taxpayer/entire building test?

Actionbsns (talk|edits) said:

12 April 2014
I was doing some reading on this topic for one of my clients last week and what I read stated something to the effect that making the election, when the client doesn't have an "applicable financial statement," could be handled without the formal election, by simply expensing the items in question. If the taxpayer elected to expense without a formal election, then depreciable items are treated as 1245 items and depreciation has to be ADS not MACRS, it further stated that a Sec 179 election would be allowed. I haven't read Chris's citation and maybe it includes this. I'm not at my office, but when I get there I can find the paperwork and provide a reference.

It just feels that for so many of our smaller clients, and my client is a VERY tiny orchard growing cacaoa plants, this is just plain overkill. These guys wake up in the morning and have a cup of coffee and hope they don't get a letter from their renter saying they are moving in 30 days, or that the cacaoa plants didn't get eaten overnight by some insect. They aren't thinking in terms of applicable financial statements or having written rules for accounting procedures. They buy QuickBooks or some other accounting program and they're off to the races, or at least they think they are. I posted a discussion a few years ago asking when does accounting become overkill, that's what this feels like.

Coddington (talk|edits) said:

12 April 2014
If you expensed items under $100, that would appear to be her book policy as of 1/1/2013. So...if everything cost more than $100, she can't use the increased $500 cap even if she makes the election in 2013. This kicks her out to the more general parts of the new regs, if she chooses to apply them in 2013. For brevity, I'll skip some steps.

1. Old cabinet removal costs generally will be expensed if cabinets are their own UOP and the remaining basis written off. If they are part of the building UOP, you could make the partial disposition election to expense the removal costs and the remaining allocable basis. Then you capitalize and depreciate the installation and acquisition costs of the new cabinets. If the cabinets are part of the building UoP, then their replacement very well could be a deductible repair. (YMMV if the cabinet replacement includes the countertop and they're an improvement.)

2. An important concept for the de minimis safe harbor is that transaction/installation costs do not have to be included if they're on a separate invoice.

3. The old plan of rehabilitation doctrine is dead if you've implemented the new regs. If you have not, it may still apply. But to give you an idea of the difference between UNICAP and plan of rehabilitation, in the old days, if you're painting during a major remodel, you capitalize that expense. If you just happen to be painting during a major remodel, you generally only capitalize it if it directly benefits or was incurred because of the improvement activity. For example, you have to repaint a section of the hallway where a contractor had to cut through the sheet rock to install an improvement. You have to capitalize that cost.

4. Given the dollar amounts you're talking about, you're probably talking about repairs. You'll need to check out the UoP rules, especially as they relate to building systems. You'll also want to check out the 162 material and supply rules.

Coddington (talk|edits) said:

12 April 2014
Action,

What you read may be wrong. If you don't have an AFS, you don't need a written accounting de minimis expensing policy, but you still need a policy. You also still need to expense those items for book purposes and make the election statement on each year's tax return to be able to expense them on your tax return under the election. If you don't include that statement, you have to argue that the de minimis policy clearly reflects income (or convince the agent that the amount is immaterial). Of course, you can use section 179 where applicable if you don't make the election, but you may not know a client has a book expensing policy and the client may not track what is expensed.

Every time I present the final regs or pitch ideas based on them, I am upfront with CPA firms and taxpayers that the new tangible regs are the single biggest accounting method compliance initiative since the Code of '54. If you combined full-absorption, UNICAP, INDOPCO, and economic performance into one project, you'd get the scope of the tangible regs. Treasury and the Service are very upfront about virtually every taxpayer who owns, produces, or acquires tangible property will need to file Forms 3115 in 2014.

Actionbsns (talk|edits) said:

12 April 2014
Brian, what is the language that a small sole proprietor, or a taxpayer with one rental unit, or my farmer with a half acre of cacao plants needs to use to establish a policy? This is so totally bazaar. It's hard enough to get single shareholder S Corps to stay on top of corporate documents, making everyone do this type of thing borders on the ridiculous. Think of all those DIY types out there, and according to the media there are more of them this year than ever before, they don't have a clue about this.

My information is specific to farms, from 26CFR 1.263A-4 Rules for property produced in a farming business, Section d paragraph 3 Automatic Election. "A taxpayer makes the election under this paragraph (d) by not applying the rules of section 263A to determine the capitalized costs of plants produced in a farming business and by applying the special rules in paragraph (d)(4) of this section on its original return for the first taxable year in which the taxpayer is otherwise required to capitalize section 263A costs." The special rules involve Section 1245 treatment and the required use of ADS. My client is still in the pre-production stage and not yet subject to 263A.

Coddington (talk|edits) said:

13 April 2014
Okay, I see. You're talking about the 1.263A-4 UNICAP rules for farmers. We're talking about the 1.263(a)-1(f) de minimis expensing election. Forget what I said as it relates to your client.

Ckenefick (talk|edits) said:

13 April 2014
This is so totally bazaar.

Now that's bizarre.

Jake (talk|edits) said:

14 April 2014
I am 99% sure Sec 179 does not apply to rental property.

Coddington (talk|edits) said:

14 April 2014
Section 179 can apply to residential rentals, just not normally. The section 50(b) exclusion, however, doesn't apply to energy property, so if you install energy property on a residential rental you could use section 179 on those assets. That's why de minimis expensing under 263(a) "little a" is great, because you don't have to worry about section 179 limitations.

Jake (talk|edits) said:

17 April 2014
So putting in a 90+% energy efficient furnace, or a high SEER a/c could be 179? Energy star windows?

Coddington (talk|edits) said:

17 April 2014
Section 48 energy credit, not 25C.

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