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Can You Save With The De Minimis Safe Harbor Election?

It’s mid-February and for taxpayers, you’re hoping to take advantage of all the tax savings strategies at your disposal this tax filing season. Your CPA is diligently working to find tax savings for you but as a proactive investor, it’s equally important that you have a basic understanding of tax savings strategies available to you through your real estate portfolio. When it comes to capitalizing vs. expensing in real estate, there are a few safe harbors allowed by the IRS that can potentially save you money. In the spotlight today is the “De Minimis Safe Harbor” election.


As you’re likely already aware, many improvements to rental properties must be capitalized and depreciated over their useful life - meaning that you cannot recognize the entirety of the expense in the year incurred. Rather you spread that cost out over a period of time through depreciation. The de minimis safe harbor election allows you to expense certain expenses when incurred, as opposed to having to capitalize and depreciate said improvement over the life of the asset.


How does the De Minimis Safe Harbor Work?


You may use the de minimis safe harbor in your rental property to deduct repair and improvement expenses that do not exceed $2,500 per item (see example below) and the cost can be substantiated by an invoice or receipt. You’ll note that the dollar limit is ‘per item’ and not the entirety of an invoice so it is important to request itemized invoices so you are able to parse out the costs of each individual item.


Example:


You performed some renovations in one of your rental units which involved new flooring and cabinets. You used a contractor to assist you in these renovations and the total cost came to $3,000, the itemized invoice is as follows:


$1,000 - Flooring

$2,000 - Cabinets


So although the total invoice for these improvements is greater than $2,500 the cost of the individual items are less than $2,500 individually. As a result, you would be able to deduct these expenses when incurred.


It is also important to note that you cannot break down the cost of an item into each of its separate parts (i.e., you cannot break down the cost of an HVAC into its individual component parts, you’d have to treat the HVAC unit as an item).


How to apply the De Minimis Safe Harbor Election?


If you elect to apply the de minimis safe harbor election you should attach a statement to your filed tax return. You can title this statement “Section 1.263(a)-1(f) de minimis safe harbor election.” Most tax preparation software simplify this step for you or your tax preparer.


Why should you care about the De Minimis Safe Harbor Election?


The ability to deduct expenses when incurred will help you to reduce your taxable income. By utilizing the de minimis safe harbor you can deduct repair and improvement costs in the year they were incurred as opposed to capitalization and depreciation over a period of time. The latter might also impact you should you decide to sell your property, through depreciation recapture.


Not only does this safe harbor have the potential to save you money, it can save you time when it comes to bookkeeping. It can be a pain to maintain depreciation schedules for small items so the ability to deduct these expenses when they are incurred will save you time in the long run.


If you are curious to read more about the de minimis safe harbor election and other safe harbors available to real estate investors, the IRS website can serve as a great resource.


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