Often, small business owners are unsure about whether to record an expenditure as a repairs and maintenance expense or as a capital improvement. Numerous court cases have addressed amounts paid to improve and restore property and whether to classify them as capital expenditures or as ordinary repairs and maintenance.
Use the following guidelines to decipher how to allocate the expenditures between the two different classifications.
Record an expenditure as repairs and maintenance expense if the repair/improvement:
- Repairs property to restore the regular operating condition
- Restores property to its previous condition
- Preserves property through routine maintenance, or is an incidental repair
Record an expenditure as a capital improvement (this in accordance with the Internal Revenue Service [IRS] regulations) if the repair/improvement constitutes one of the following:
- Adds value to the property
- Adapts property to a new and different use
- Improves efficiency, capacity or productivity
- Fixes a defect or design flaw
- Restores property to a “like new” condition
- Prolongs the useful life of the property
In addition to following these rules, the company has the option to elect the De Minimis Safe Harbor rule. This election eliminates the burden of determining whether every small transaction made for the improvement of property or equipment purchased is to be expensed or capitalized. As of January 1, 2016, the IRS increased the threshold for this election from $500 to $2,500 per invoice or item for taxpayers without Audited Financial Statements (AFS). If the company has AFS, they may use this safe harbor rule to deduct amounts paid for tangible property up to $5,000 per invoice or item. For example, if the company purchases a computer for $3,000, they are only able to automatically expense this computer if they have AFS; otherwise, it must be capitalized as an asset, as it is over the $2,500 threshold.
To use the De Minimis rules, the taxpayer must have a written policy in place at the beginning of the tax year and use those same capitalization procedures on their AFS.
If you have questions regarding whether to expense or capitalize, or about the De Minimis Safe Harbor election, contact one of Yeo & Yeo’s tax professionals.