Safe harbor expensing options for real estate owners
The recent Tangible Property Regulations have caused quite a stir in the world of commercial real estate, providing a myriad of new strategies for use in maximizing tax savings on your most significant fixed assets. In addition to clarifying the expense vs. capitalization decision process, the TPRs also provide the ability to dispose of the remaining cost basis of “ghost” assets through Partial Asset Disposition. In addition, the regulations have established three powerful expensing options that every commercial property owner should be familiar with.
The de minimus safe harbor (§1.263(a)-1(f)(1)(i), & (ii)) allows for the deduction of certain amounts paid to acquire tangible property at two different levels. Taxpayers with applicable financial statements (AFS) can deduct up to $5,000 per item or invoice. Candidates 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 has to be in place the first day of the tax year in which it is to apply. This is an election, not a change in accounting method, and as such does not require the filing of a Form 3115.
If you don’t have an AFS, you can still benefit from the de minimus election. In fact, as of November 24th 2015, the IRS has significantly increased the de minimus safe harbor limit for taxpayers without an applicable financial statement (AFS). While the final Tangible Property Regulations initially capped such deductions at $500, this revision raises the threshold to $2,500 per item substantiated by an invoice. This will allow for the immediate deduction of many tangible property items that would otherwise remain left to slowly depreciate.
The safe harbor for small taxpayers (§1.263(a)-3(h)) 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. Taxpayers may deduct either $10,000 or 2% of the unadjusted basis of the building, whichever is less. This is also considered an election, with no Form 3115 required.
There is one caveat however, and it is noteworthy. The maximum deduction allowed under the safe harbor for small taxpayers includes all repair-related deductions in that tax year. The deductions are cumulative, and in that sense the small taxpayers’ safe harbor is potentially limiting. However, the right advisors can help you choose the best way to mix your expenses and maximize your benefit.
The routine maintenance safe harbor (§1.263(a)-3(i)) is a special favorite in the industry, as it can be used by any landlord, regardless of income, property size, or AFS-status. Under this safe harbor, taxpayers can deduct amounts spent on routine maintenance with no cap. To be considered “routine,” the activity has to be one that you expect to repeat at least once every 10 years. Inspecting, cleaning, testing, and replacing worn assets with comparable ones are all eligible activities. Any replacement that improves the property, however, is ineligible.
Each safe harbor has its own boundaries, and there is an interplay between them as well. They are best employed strategically by a tax professional well-versed in maximizing their utility.
Terri S. Johnson, CRE, is a co-founder and managing partner at Capstan Tax Strategies.