September 8, 2023
Effective January 1st, 2014, the Tangible Property Regulations (TPRs) might feel like yesterday’s news.
- The TPRs guide taxpayers through an important real estate decision making process – can the cost of an asset be expensed? Or must it be capitalized?
- The TPRs also permit Partial Asset Disposition, or the immediate write-off of the remaining depreciable basis of a disposed asset.
This was front page news back in 2014.
However, a veritable alphabet soup of legislation has passed since then – TCJA, CARES, CCA, and more – and it might be easy to simply forget about the TPRs.
The Regulations remain very much in play, working beautifully in combination with newer legislation to comprise a comprehensive tax strategy.
We’re introducing a 4-Part series of blogs on the TPRs, to remind readers of their multifaceted utility. Subsequent blogs will be released in every other issue of the Capstan newsletter. (If you’d like to get our monthly newsletter, just let us know.)
Let’s start at the beginning, with the TPRs’ three Safe Harbor elections:
- De Minimus Safe Harbor
- Routine Maintenance Safe Harbor
- Safe Harbor for Small Taxpayers
These are elections, not a change in accounting method, and as such do not require the filing of a Form 3115.
De Minimus Safe Harbor §1.263(a)-1(f)(1)(i), & (ii)
The De Minimus Safe Harbor allows for the deduction of certain amounts paid to acquire tangible property. There are two versions of the election, one for taxpayers with an AFS, and one for taxpayers without an AFS.
WITH Applicable Financial Statements (AFS)
Taxpayers with AFS can deduct up to $5,000 per item or invoice. A detailed invoice is crucial to successfully making this election.
To take advantage of this level of the De Minimus Safe Harbor election, taxpayers also need to have a written policy in place that treats said amounts as expense for non-tax below a certain dollar amount or treats assets with a life of 12 months or less as an expense. This policy must be in place the first day of the tax year in which it is to apply. Accounting treatment needs to be consistent for both book and tax purposes.
Consider a taxpayer that purchased 10 new PTAC units for his apartment building. The PTAC units cost $1,000 each, for a total of $10,000, and were all itemized on a single invoice. As long as the taxpayer has an AFS, a written policy in place, and that all-important itemized invoice, he may be able to deduct the full $10,000 price of the PTAC units.
Taxpayers without AFS can deduct up to $2500 per item or invoice. The non-AFS taxpayer also needs to have a procedure in place at the beginning of the tax year with content comparable to that described above. However, this policy doesn’t have to be in writing.
Routine Maintenance Safe Harbor §1.263(a)-3(i)
This is a Safe Harbor for all taxpayers — it can be used by any property owner regardless of income, property size, or AFS-status. Under this Safe Harbor, taxpayers can deduct amounts spent on routine maintenance with no cap.
Routine maintenance is a “preventative or cyclic maintenance that is an essential part of the ongoing care and upkeep of a building and its systems.” Things like inspecting, cleaning, testing, and replacing worn assets with comparable ones fall under this heading. Any replacement that improves the property, however, is not eligible. (Improvements, betterments, etc. certainly have their own place under the TPRs and will be discussed in a future blog.)
To be considered “routine,” the activity has to be one that you expect to repeat at least once every 10 years. Sealcoating your parking lot every four years? Sure. Replacing a worn-out roof every two decades? Nope. Even If the activity doesn’t end up being required every 10 years, the IRS will still be on board if it was reasonable to expect that it would have been required based on previous experience.
Safe Harbor for Small Taxpayers §1.263(a)-3(h)
This election is only available to taxpayers with gross receipts below $10 million for the last three years, and only applies to buildings with an unadjusted basis of less than $1 million.
Eligible candidates can deduct the cost of work performed on owned or leased buildings in the amount of $10,000 or 2% of the unadjusted basis of the building, whichever is less.
Consider an example – Taxpayer A owns a small rental property with an unadjusted basis of $300K. 2% of that basis is $6,000, which is less than $10.000, so $6,000 represents the maximum deduction possible for all three Safe Harbors. Property repair and maintenance generally costs about $2,000 annually. This year though, all the washer/dryers needed to be replaced at an additional cost of $3000. Therefore, the total maintenance amount this year is $5,000, which is less than 2% of the building’s unadjusted basis, and can therefore be deducted in full under the Safe Harbor for Small Taxpayers.
There’s one important caveat. If a taxpayer elects the Safe Harbor for Small Taxpayers, the maximum deduction allowed must include all repair-related deductions taken in a given year.
You can’t take $10K through Small Taxpayers, and another $5K through De Minimus, and another $3K through Routine Maintenance. Once you elect Safe Harbor for Small Taxpayers, the total of all three elections must not exceed $10K or 2% of the unadjusted building basis, whichever is less.
Let’s return to Taxpayer A and his small rental property. Imagine that he had an unusual year, a year in which $8,000 worth of property maintenance was required. This exceeds 2% of the building’s unadjusted basis ($6,000). If he takes the Small Business Safe Harbor, his total deduction will be capped at that $6,000, and will only cover 75% of his maintenance costs. In this case, the Routine Maintenance Safe Harbor is the way to go, as he will be able to deduct his maintenance costs in full.
The three TPR Safe Harbors are just the beginning of what the TPRs have to offer the thoughtful taxpayer. Next time we’ll discuss the BAR Test, but if you have questions about TPR applications, no need to wait till then – please reach out at your convenience. As always, we’re here to help.
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