by: Barry Ward, Leader, Production Business Management & Director, OSU Income Tax Schools – Ohio State University Extension
Edited material from the “National Income Tax Workbook 2016”, Land Grant University Tax Education Foundation Inc.
The final tangible property (property that can be felt or touched) regulations affect all taxpayers who acquire, produce, or improve tangible property. The regulations clarify whether costs are currently deductible or whether the taxpayer must capitalize and depreciate the costs. The final regulations are generally effective for tax years beginning on or after January 1, 2014.
The final repair regulations include a de minimis (the law/IRS does not concern itself with anything under this amount) safe harbor that allows taxpayers to elect to deduct the cost of tangible property, rather than recovering the cost through depreciation expense. The de minimis safe harbor increases a farm client’s ability to expense the purchase cost of livestock and small equipment.
Under the Treas. Reg. § 1.263(a)-1(f)(1) de minimis safe harbor, a taxpayer can take a current-year deduction (when the cost is paid or incurred) for the acquisition or production of units of tangible property that cost less than a specified amount, even if the taxpayer would normally have to capitalize the cost, or deduct the amount paid when the property is first used or consumed in the business. Thus, a farm client may be able to deduct otherwise capitalizable expenditures under the safe harbor. However, for a farmer who intends to later sell the property at a gain, electing the de minimis safe harbor may increase the tax owed on the later sale.
Although the taxpayer’s accounting procedures can set any dollar limit for expensing amounts, the per-item tax deduction is limited to $2,500 for taxpayers without an applicable financial statement (AFS) and $5,000 for taxpayers with an AFS. Therefore, if the accounting procedure sets a threshold that exceeds $2,500 ($5,000 for taxpayers with an AFS), only the items that cost $2,500 ($5,000) or less qualify for the safe harbor. This activity will likely trigger extra IRS scrutiny. For farmers, the safe harbor is particularly useful to expense small equipment and livestock held for productive use, such as animals held for dairy or breeding.
When a taxpayer properly applies the de minimis safe harbor, the amount paid is not treated as a capital expenditure or as materials and supplies. Instead, the taxpayer deducts the amount under Treas. Reg. § 1.162-1, provided the expense otherwise constitutes an ordinary and necessary business expense. If the items to be deducted don’t have an applicable expense line on Schedule F, they can be listed as “Other expenses”.
Any subsequent gain on disposition of the property is ordinary income, so in some situations, it may be preferable to not elect to expense the property under the de minimis safe harbor.
Property expensed under the de minimis safe harbor is not I.R.C.§ 1231 property, and the taxpayer must report the sale on Form 4797, Sales of Business Property, Part II, as ordinary income. The income from the sale does not meet the test for self-employment income and, even though it is ordinary income, the taxpayer does not report the income on Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship), or Schedule F (Form 1040), Profit of Loss From Farming, where it would be subject to self-employment (SE) tax.