Balance in business... in life!

Equipment & Property Purchases: Expense or Capitalize?

Computer_PurchaseYou just purchased computer equipment. Can you expense the purchase this year? Or must you capitalize the purchase?

T.D. 9636 came out in September 2013 and was published in Internal Revenue Bulletin 2013-43 on October 21, 2013. It “contains final regulations that provide guidance on the application of sections 162(a) and 263(a) of the Internal Revenue Code (Code) to amounts paid to acquire, produce, or improve tangible property. The final regulations clarify and expand the standards in the current regulations under sections 162(a) and 263(a).”

Simply stated, the regulations provide specific rules for determining when you can expense an equipment or property purchase, or when you must capitalize the purchase.

When you purchase property or equipment, you utilize these assets over a period of several years (their “useful life”). Rather than expensing them in the year of purchase, you would “capitalize” the cost and deduct this cost by depreciating it over the useful life of the asset.

But capitalizing every purchase doesn’t makes sense.  There is a time and monetary investment associated with the on-going record keeping to depreciate and subsequently dispose of a capitalized asset. It doesn’t make sense to capitalize asset purchases with lower costs. That is why you have a “Capitalization Policy”.

Capitalization Policy. Your business may have an established practice of expensing the cost equipment or property as long as the cost is under a certain dollar amount rather than capitalizing and depreciating it. This would be an example of a “capitalization threshold policy”, also sometimes called a “de minimis expensing rule”. It may be a written formalized policy, or just an informal practice. The dollar amount would vary from business to business based upon factors such as the size of the company, type of equipment, etc. This policy would impact reporting for both financial statements and income taxes.

New Regulation. New Capitalization Rules. The new regulations in TD 9636 issued in September, 2013 brings specific guidance to what would be acceptable capitalization policies for tax reporting purposes, specifying rules to determine whether purchases of equipment and property should be capitalized or expensed. The IRS wants businesses to establish capital thresholds limited by this new regulation. The threshold amount depends on whether a business has an “applicable financial statement.”

$5,000 De Minimis threshold. The Regulation defines “Applicable financial statement” as those that are audited (or are filed with the federal or state government or any federal or state agency). This is mostly larger businesses. If your business files applicable financial statements, then you can make an annual election to expense property and equipment purchases costing $5,000 or less per invoice (or per item on the invoice).

$500 De Minimis threshold. The Regulation states that if your business does not file applicable financial statements, you would still need to make an annual election to expense property and equipment purchases, but the threshold amount would be $500 or less per invoice (or per item as shown on the invoice).

Applying the Capitalization Policy: Each of the above threshold provisions require three basic steps:

  1. Adopting a formal, written policy by the beginning of the tax year that the policy is to apply.
  2. Expensing under the policy must apply to both your financial statement reporting and income tax reporting.
  3. An annual election regarding the policy must be included with the filing of your tax return.

Sample Capitalization Policies: I have seen several policy statements as well as may samples.

EXAMPLE 1

ABC CompanyCAPITALIZATION POLICYAdoption Date: December 31, 2013By: John Doe, CFO

Purpose:  This accounting policy establishes the minimum cost (capitalization amount) and de minimis expensing policy, that shall be used to determine the capital assets that are to be recorded in ABC Company’s annual financial statements (or books) and income tax reporting.

Capital Asset definition:  A “Capital Asset” is defined as a unit of property that: (1) has an economic useful life that extends beyond 12 months; and (2) was acquired or produced for a cost of $5,000 or more.  Capital Assets must be capitalized and depreciated.

Capitalization Thresholds:  ABC Company establishes $5,000 as the threshold amount for minimum capitalization.  Any items costing below this amount should be expensed.

Capitalization Method and Procedure:  All Capital Assets are recorded at historical cost as of the date acquired.

Asset Expensing Procedure:  Tangible assets costing below the aforementioned threshold amount are recorded as an expense for ABC Company’s annual financial statements.  Alternatively, assets with an economic useful life of 12 months or less are required to be expensed for financial statement purposes, regardless of the acquisition or production cost.

EXAMPLE 2 (SHORT)

ABC CompanyCAPITALIZATION POLICYAdoption Date: December 31, 2013By: John Doe, CFO

ABC Company hereby adopts a capitalization and de minimis expensing policy in which only those items exceeding $5,000 per invoice or per item will be capitalized. All items with a cost below $5,000 will be expensed. This policy is intended to be used for the company’s tax and financial reporting.

This post is meant to present an overview of the issue, but there are many additional considerations that may impact your business. Please contact your accounting and tax professional to determine how this regulation may impact your business.

 Rick

Circular 230 Disclosure: This is to advise you that, unless expressly stated, nothing in this communication (including any attachment or other accompanying materials) was intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding any federal tax penalties, or for promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to anyone.

Leave a Comment