De Minimis Safe Harbor: Expense or Capitalize Small Purchases

Should I expense or capitalize a laptop, phone or tool?

A laptop, phone or tool whose usefulness extends substantially beyond a year is generally capitalized: listed as an asset and deducted through depreciation (Publication 334; Schedule C instructions). Three rules can still put the cost on this year's return, depending on the price of each item.

The election is annual and covers every qualifying item paid that year, so you cannot pick one laptop and skip another.

A case is not simple when purchases run to tens of thousands in a year or include items over the limit, the books carry the item as an asset or treat it differently from the return, no small-purchase policy existed on the first day of the year, an earlier year's statement was never filed, or the item is partly personal.

Gather itemized invoices, the books' policy for small purchases and the accounts it posts to, prior returns with any election statements, and the fixed-asset list.

What is the $2,500 de minimis safe harbor, and what is the limit?

The de minimis safe harbor is an annual election that lets a business deduct small purchases of tangible property when paid, instead of capitalizing them, if the books also expense them (IRS). "Paid" follows the accounting method: under an accrual method it means the liability was incurred, which can fall in an earlier year than the payment (regulation). The limit depends on whether the business has an applicable financial statement.

An applicable financial statement is an SEC filing, a certified audit with an independent CPA's report used for credit, owner reporting or another substantial non-tax purpose, or a statement a government agency other than the IRS or SEC requires (regulation).

The regulation text still states $500 for businesses without an applicable financial statement, or another amount set in published guidance. Notice 2015-82 raised it to $2,500 for tax years beginning on or after January 1, 2016.

How the limit is counted:

• The test is per invoice, or per item when the invoice shows each item's cost. The regulation's example treats ten printers on one invoice as ten items.
• Delivery or installation billed on the same invoice counts toward the item's cost. If one invoice covers several items and shared delivery or installation, spread that cost across the items by a reasonable method, such as pro rata to price, and test each item with its share. Costs billed on a separate invoice, such as a designer's fee for choosing the furniture, need not be added.
• Invoices created to split property normally bought as one unit into pieces under the limit can trigger the regulation's anti-abuse rule.

What must my books show to qualify for the safe harbor?

Three things must hold: a policy that existed on the first day of the tax year, the books expensing the item in line with it, and a cost within the limit (regulation).

• A policy at the start of the year, often called a capitalization threshold. It expenses purchases below a dollar amount, or items with a useful life of 12 months or less. Without an applicable financial statement it need not be written; with one it must be (IRS).
• The item is expensed in the books. A laptop carried in an asset account with depreciation booked against it generally fails this test.
• The cost is within the IRS limit, and the item fits the policy. Under a dollar-amount policy the item must also cost less than that amount: a policy that expenses only items below a low amount leaves a pricier laptop outside the safe harbor, even if the IRS limit would cover it, and a policy that expenses items "less than" the IRS limit does not reach an item that costs exactly the limit. A policy for items with a useful life of 12 months or less is a second route, still capped by the IRS limit; a business with both policies applies the safe harbor to what qualifies under either.

A policy adopted partway through the year, or in a business's first year, is a question for a CPA: the regulation requires the policy at the beginning of the tax year. A business without an applicable financial statement may have a policy that expenses more than the IRS limit, and the IRS says items above the limit may still be deducted if the policy clearly reflects income.

How do I make the de minimis safe harbor election?

The election is a statement attached to the timely filed original return, extensions included, for each year the purchases are made. It is not a change in accounting method, so Form 3115 is not used (IRS).

1. Confirm the books expensed each qualifying item under a policy in place on the first day of the year.
2. Title a statement "Section 1.263(a)-1(f) de minimis safe harbor election."
3. Give the taxpayer's name, address and taxpayer identification number, and state that the taxpayer is making the de minimis safe harbor election under section 1.263(a)-1(f).
4. Attach it to the original return for the year the amounts were paid.
5. Repeat it every year; one year's statement does not cover the next.

The election covers every qualifying item paid that year, a partnership or S corporation makes it for itself rather than its owners, and it cannot be revoked for that year (regulation). A sole proprietor reports the amounts as other expenses in Part V of Schedule C and on no other line (Schedule C instructions).

What does the safe harbor leave out, and what if an item costs more than the limit?

The safe harbor leaves out inventory, land and certain spare parts, and it covers tangible property only, so software licenses and other intangibles follow other rules (regulation). Section 263A can also still require capitalizing tools and equipment whose cost belongs to property the business produces or buys for resale; certain businesses with gross receipts under the section 448(c) thresholds are exempt from section 263A (IRS).

The limit is a test for the safe harbor, not a cap on deductions. An item over it is not automatically capitalized (IRS): it is deductible if it is a repair or supply, and otherwise is depreciated, or deducted in year one through section 179 or bonus depreciation. Writing off equipment in the first year covers that choice; for a building repair, see rental repair or improvement.

Can I deduct the entire cost of a work computer I also use for personal things?

A computer used only for the business may be deducted in full if it meets the safe harbor tests; if it is also used personally, only the business share is deductible. The safe harbor decides when a purchase is deducted, not how much: the amount must still be an ordinary and necessary business expense (regulation), and the personal part of a partly personal expense is generally not deductible (Publication 334).

The limit is tested on the amount paid per invoice or per item (regulation), so a second computer is measured on its own, at what was paid for it, and only its business share is deductible (Publication 334). Photographic and video recording equipment is listed property when it is of a type generally used for entertainment, recreation or amusement, unless it is used exclusively at the business's regular establishment or in connection with its principal trade or business (regulation). Listed property needs records of its cost and business use even when the safe harbor deducts it (regulation), and a business-use test for section 179 and depreciation (Publication 946). Mixed-use expenses covers working out the percentage.

How do I change an asset account to an expense account in the books?

Move the cost from the asset account to an expense account with a journal entry, then reverse any depreciation already booked. Do it only when the item was bought in the year the election is made for and qualifies under the policy. An item bought in an earlier year was tested in that year, because the election covers the amounts paid during the year it is made for.

1. Check the item: within the IRS limit and qualifying under the policy (its dollar amount or its 12-month useful-life rule), with the policy in place on the first day of the year.
2. Debit the expense account and credit the asset account for the item's cost.
3. If depreciation was booked, reverse it: debit accumulated depreciation and credit depreciation expense for the same amount, in the same year. If it was booked in an earlier, closed year, the entry and its effect on prior years need a CPA's review.
4. Remove the item from the fixed-asset list.
5. Write down the policy and its dollar amount for next year's return.

Make the correction before the return is filed so the two agree. If the year is closed or filed, the regulation does not say how late a books correction can be made for the safe harbor test, and changing a filed year's books can mean an amended return; see uncategorized expenses before tax time.

An item expensed against the book policy goes the other way: to an asset account, with depreciation starting when it is placed in service. Books and return can still differ for good reason, such as section 179 or bonus depreciation on an item the books capitalize; a corporation's Schedule M-1 reconciles income per books with income per return (Form 1120 instructions). Keep a tax column and a book column on the fixed-asset list; see rebuilding a missing depreciation schedule.

I forgot the election this year: what are my options?

The regulation requires the statement with the timely filed original return. It says the election cannot be made by an accounting-method change, and cannot be made by an amended return before the Commissioner consents to a late election (regulation). The IRS's tangible-property page describes only the timely statement and gives no later fix.

Late-election relief comes from two regulations the election rule points to:

• Automatic six months. Section 301.9100-2(b) gives six months from the return's original due date, not counting extensions, to make a regulatory election due with the return, if the return was filed on time. The de minimis election is that kind of election, and its rule points to sections 301.9100-1 through 301.9100-3 for extensions of time. The filing is an amended return with the statement, marked "FILED PURSUANT TO § 301.9100-2" at the top and sent where a timely filing would have gone. No ruling request or user fee is needed, but the return for every affected year must be consistent with the election. The election rule itself bars an amended return before the Commissioner consents to a late election, and no source says whether this automatic extension counts as that consent, so a CPA should confirm before anyone relies on it.
• A request for consent. Section 301.9100-3 covers other cases. It is a letter ruling request with a user fee, granted when the taxpayer acted reasonably and in good faith and the Government's interests are not prejudiced.

Without the election, items $200 or less are generally supplies and the rest are generally capitalized and depreciated. Section 179 can be elected on an amended return filed within the time allowed by law (Form 4562 instructions), and bonus depreciation applies unless the business opts out; see writing off equipment in the first year.

Example

These examples are illustrative; all amounts are in US dollars, and none of the businesses has an applicable financial statement.

A laptop and a monitor on separate invoices

A self-employed designer buys a $1,800 laptop and a $900 monitor on separate invoices. The books have had a policy since the first day of the year to expense purchases under $2,500, both are posted to an expense account, and the designer attaches the election statement to the timely return. Each item is under the limit, so both may be deducted as other expenses on Schedule C if they are ordinary and necessary business costs.

The next year the designer buys a $2,000 tablet and leaves the statement off the return. The first year's election does not carry over, so the tablet is outside the safe harbor for that year.

A saw over the limit

A contractor buys a $3,800 saw. It is over the limit, so the safe harbor does not apply and the normal rules decide. A saw that lasts for years is generally capitalized and depreciated, which spreads the cost; section 179 or bonus depreciation may deduct it in year one if the saw qualifies.

A tablet booked as an asset

A consultant pays $2,000 for a tablet, books it to an equipment account and depreciates it, while the return deducts it. The books and the return disagree. If the return's deduction rests on section 179 or bonus depreciation, the difference can stand. If it rests on the safe harbor, the books must expense the tablet: with a policy to expense items under $2,500 in place on the first day of the year and the return not yet filed, the consultant moves the $2,000 to an expense account, reverses the depreciation, and attaches the election statement; the two then match. Without that policy, the tablet is outside the safe harbor, and the return may still deduct it in year one if section 179 or bonus depreciation applies; see the equipment guide.

Different for you?

• Purchases run to tens of thousands in a year, or items are over the limit: section 179, bonus or regular depreciation decides each year. Read writing off equipment in the first year and buying equipment before year-end, and sort each item into expense or asset with bookkeeping help.
• The books and the return treat the same items differently: reconcile the fixed-asset list and expense accounts to the return with bookkeeping help and rebuilding a missing depreciation schedule.
• A prior preparer never made the election, or you missed a year: whether a late election is available depends on the facts, so have each year's books and filed return reviewed together with bookkeeping help.
• A year-end purchase mixes personal and business use: test the invoice or item against the limit at what was paid, then deduct only the business share, worked out with mixed-use expenses; have the books and the return agree on each item with bookkeeping help.
• The purchase is a repair or improvement to a rental building: use rental repair or improvement.
• The money was spent before the business opened: see startup costs for an LLC or sole proprietor.