By now, many savvy real estate owners and investors are aware of cost segregation studies. These studies allow owners to accelerate depreciation and reduce taxable income in the early years of ownership.
It’s a tax strategy that, more often than not, benefits owners. Yet there is another important regulation called Tangible Property Regulations that is frequently overlooked.
What continues to surprise me is the lack of awareness around the Tangible Property Regulations (TPRs), also known as “repair regulations.” They became final and mandatory on January 1, 2014. This is not a strategy that is optional. These regulations are mandatory for every building owner and clarify what expenditures should be expensed or capitalized.
Congress’s goal was to simplify and clarify what gets capitalized and what gets expensed when improving or repairing our properties. The reality of what followed is a bit more complex as it relates to TPRs. With TPRs there are as much or more tax “savings” than with cost segregation studies. Further, cost segregation studies are the “certain method” for complying with the TPRs. Applying TPRs to the fullest extent can help reduce taxable income. Let’s explore further.
Tangible Property Regulations
Unit of Property
Unit of Property (UOP) is an important concept with this regulation. Each building without connection to another building or structure is defined as an individual Unit of Property. The definition of the UOP is critical to understand before any capital versus expense decisions can be made. If the UOP is defined incorrectly, the decision around if an expenditure should be capitalized or expensed, could be wrong.
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Once the unit of property is determined, buildings are broken down into building systems. Each building system must be accounted for within every building. A building, generally, has nine systems, which are:
- Fire Protection and Alarm
- Gas Distribution
- Any other components identified in published guidance
Not every building will have all nine systems. For instance, a small warehouse may not have an escalator or elevator, but most have fire protection and security systems.
There are three Safe Harbor expenditures that can be applied to help reduce taxable income. They allow for certain expenditures to be expensed without scrutiny. Safe harbors are an administrative convenience. The goal is to reduce the burden on taxpayers for small items. The law is not interested in trivial expenditures.
Below are the three types of Safe Harbors and a description of what applies.
1. De Minimis Safe Harbor (DMSH)
- Latin for “minimal things.”
- For expenditures under $2,500
- This is an annual election and can only be used in the current year for which your taxes are submitted.
- The taxpayer must be able to provide an invoice to take advantage of the DMSH. The invoice must show that each component submitted is less than $2,500.
- For example, a door unit that costs $2,400 would qualify for the DMSH. However, if the invoice includes shipping and installation and the total comes to $2,700, it will not be allowed under the DMSH.
- Taxpayers should ask the vendor to split out the installation and training on a separate invoice so the DMSH will apply.
- This rule generally applies to all building components. But if the components are part of a larger renovation project, then the DMSH is not allowed.
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2. Small Taxpayer Safe Harbor (STSH)
- Elected annually.
- Allows small taxpayers, with average gross receipts under $10 million, to expense the lesser of 2% of the buildings on an adjusted basis or $10,000 on an annual basis.
- The safe harbor total dollar amount includes all expenditures from the DMSH. However, any expenditures done to the land improvement do not count towards the 2% or $10,000 limit.
3. Routine Maintenance Safe Harbor (RMSH)
- This is an often-overlooked safe harbor.
- Allows for routine maintenance on an asset to be expensed.
- It is not an annual election and all taxpayers are deemed to be already following the safe harbor.
- Routine maintenance is defined as any expenditure that is expected to be repeated within ten years.
- The one rule is that the expenditure cannot make the building component materially better, larger, or more efficient.
If you have owned a building and spent money improving or repairing your property, you should be “scrubbing” your depreciation schedule. You may be sitting on tax savings that will result when you comply with the TPRs.
If you plan to improve a property, you should be aware of the tax savings available to you when you follow the TPRs to the fullest extent.
If you do not have a real estate-oriented tax professional who understands and applies the TPRs properly, you may be missing out on substantial tax savings and you may have exposure from being out of compliance.
Follow this link for more tax-related Strategies for Commercial Real Estate Owners.
Stacy Sherman received her bachelor’s degree in Philosophy from Michigan State University. Since 2015 she has represented CSSI® as a National Account Executive. In 2019, she earned the honor of being in CSSI®’s President’s Club, and she also received the Award of Excellence in recognition for not only her achievements but her passion for the quality of work CSSI® performs. Stacy enjoys helping building owners and working with tax professionals, bankers, and real estate professionals to make them aware of their client’s potential tax savings.
In Stacy’s free time, she enjoys taking advantage of the Florida weather, beaches, fresh air, and exercise.