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Since deductions can have a huge impact on your final tax bill, it’s vital to explore all your options, so you can take advantage of the deductions you’re eligible for.
Here’s how safe harbor works, and how you can use this option to decrease this year’s tax bill.
Sum it up for me
- Safe harbor allows you to deduct an entire expense in one year instead of capitalizing it over several
- There are three categories of safe harbor that can apply to repair and maintenance expenses: small invoices, small projects, and routine maintenance
- In general, you can deduct repair and maintenance expenses on invoices of up to $2,500; there are additional criteria you can meet to deduct invoices of up to $5,000
- You don’t need to fill out a separate form, but you will need to attach a statement to your Schedule C stating that you are electing to take safe harbor for expenses of up to $2,500 (or $5,000) or for routine maintenance
What is “safe harbor”?
Safe harbor is a term used in several different contexts, including legal, accounting, and tax regulation. In tax regulation, safe harbor rules refer to a simplified way to write off expenses if you meet certain conditions.
For repair and maintenance expenses, these conditions involve the “BRA Test,” which stands for Betterment, Restoration, and Adaptation. If a repair or maintenance expense makes property or equipment better, restores it to its original condition, or adapts it for a new use, you will need to capitalize the expense. If it does not fall into any of these categories, then you can expense the full amount that same year, provided the expense does not exceed the required financial thresholds.
An oft-used example to explain the BRA Test is maintenance on a vehicle. If you change your car’s oil or get the transmission flushed, you’re performing routine maintenance to keep it running in its existing condition. This would be covered by the safe harbor. If, however, you replaced the transmission, you would have to capitalize the expense because you’re bettering the car, so it will last longer.
Here, we’ll go through the two types of safe harbor rules that are relevant for small business owners:
- Safe harbor for small invoices, or the de minimis election
- Safe harbor for small projects
- Safe harbor for routine maintenance
Repairs and maintenance are inevitable costs for any business. From fixing a leaky roof to routine equipment upkeep, these expenses can quickly accumulate. The financial impact of tax deductions for these expenditures is substantial. By maximizing your allowable deductions, you reduce your taxable income, ultimately leading to lower tax liability.
For businesses, this means more cash in hand to reinvest, expand operations, or weather economic uncertainties.
Safe harbor for small invoices, or de minimis safe harbor election
The safe harbor for small invoices, or de minimis safe harbor election, is a provision that allows businesses to immediately deduct expenses related to routine repairs and maintenance as long as the total cost of the invoice is $2,500 or less. However, if you have an applicable financial statement (an AFS), you can deduct invoices up to $5,000.
According to the IRS, an applicable financial statement would be a statement required to be filed with the SEC, a statement used to apply for a loan or report to shareholders, a certified audited financial statements accompanied by a report from a CPA, or a statement required to be sent to another government agency besides the IRS or SEC.
If your business incurs an expense below this threshold, you can deduct the entire amount in the year it was paid or incurred as a business expense, rather than capitalizing and depreciating it over several years.
Safe harbor for small projects
Similar to the safe harbor for small invoices, this rule allows businesses to immediately deduct the full cost of repairs and maintenance for tangible property that are considered routine and recurring activities. To be eligible for this safe harbor, the project's total expense must not exceed $10,000 or 2 percent of the property's unadjusted basis, opting for the lower amount in each case.
Safe harbor for routine maintenance
This safe harbor allows businesses to deduct routine, regular maintenance expenses that meet four specific criteria outlined by the IRS.
- The expenses must be for regularly recurring activities that you would expect to perform.
- They must be required to maintain equipment or property in its normal operating condition.
- Normal wear and tear triggers repairs and maintenance.
- They should occur multiple times within 10 years for buildings or structures associated with buildings, or exceed a single occurrence during the IRS-designated depreciation lifespan for assets that are not buildings.
How to claim safe harbor for eligible expenses
Regardless of which safe harbor election you’re taking, you’ll need to let the IRS know you’re deducting your expenses instead of capitalizing them.
The election statement should clearly state your election to apply the safe harbor rules under Sections 1.162-3(d)(1) and 1.263(a)-3(d) of the Treasury Regulations. Without this statement, your tax return could be flagged for underpayment, or trigger an audit.
There is no form to fill out—instead, all you need to do is attach a simple statement saying you are electing to deduct specific expenses entirely in year one, in line with the de minimis safe harbor rules.
Here’s a template you can use:
Section 1.263(a)-1(f) De Minimis Safe Harbor Election
Your name
Your address
EIN or Social Security Number
For the year ending Dec. 31, 20XX, I am electing the de minimis safe harbor under Treas. Reg. Section 1.263(a)-1(f) for my business expenses of less than $2,500.
If you are also attaching a financial statement to deduct expenses of up to $5,000, or if you are taking routine maintenance expenses because they meet the four criteria, you’ll add another sentence stating that to your statement.
Documentation and compliance for safe harbor expense deductions
While the safe harbor rules do provide a simplified approach to claiming deductions, you’ll still need to maintain accurate and up-to-date records for all your expenses. These guidelines will help ensure you’ve got what you need to maximize your eligible expenses, not to mention support your claims in the case of an audit.
1. Keep copies of your invoices and payment receipts for all repair and maintenance expenses.
2. Make sure you’re categorizing expenses properly—this may require additional information than what is recorded on the invoice, so don’t be afraid to make additional notes.
3. Determine which safe harbor rule each expense falls under, and categorize them appropriately. If you’re using a tax preparer or working with Bench’s tax team, this will be taken care of for you.
4. Don’t forget to include an election statement using the template above.
Electing to deduct repair and maintenance expenses under safe harbor rules can be highly advantageous for your small business, reducing your taxable income in a given year rather than spreading the deduction out over several years. If you’d like to see more expenses you can deduct, check out our Big List of Small Business Tax Deductions.
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