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Safe Harbors Provide Relief in Final Capitalization Regulations

The Final Capitalization Regulations included several safe harbors that provide some much needed relief from the originally proposed regulations.  Three of the safe harbors are outlined below:

The “de minimis safe harbor election” was expanded to allows:

  1. qualifying businesses to currently deduct lower-costing assets, materials and supplies;
  2. a safe harbor amount per building for qualifying small property owners to deduct improvements made to an eligible building; and
  3. building owners receive a safe harbor to currently deduct routine maintenance.

The first safe harbor allows a $500-per-asset deduction.  The taxpayer makes an annual election at the beginning of each tax year by placing a written accounting procedure in their records stating that “de minimis safe harbor” will be used. All property costs that fall under the election are currently expensed and may not be capitalized. Note that the property loses any future opportunity for capital gain treatment if and when it is later sold for a gain.

The “routine maintenance safe harbor” is automatic and allows the taxpayer to currently expense the expected recurring maintenance costs on a “unit of property” as determined over a 10 year period. Routine maintenance expenses are what is necessary to keep the property operating efficiently for its originally intended purpose. Costs not included are betterments, replacements, or restorations, or adaptations of a property to a new and different use. A “unit of property” is a grouping of assets that are functionally interdependent. Examples include a tractor and it’s tires or a building and it’s structural components.

The “safe harbor for small taxpayers with buildings” is a separate election made for each building owned or leased by the taxpayer. Qualifying small property owners would have an average of $10 million or less in annual gross receipts in the 3 preceding years.  The deduction is the lesser of 2% of the unadjusted basis of the building or $10,000.  Amounts deducted under the “de minimis safe harbor” or the “safe harbor for routine maintenance are counted toward the $10,000 limit.

The specific safe harbor rules are, of course, long and complex.  Please be sure to consult your tax advisor.