Small Business Safe Harbor Election
A significant change was made by the final regulations through the addition of a safe harbor to allow certain taxpayers to refrain from treating as improvement costs any costs paid or incurred for the repair, maintenance or improvement of building property.
Pursuant to Reg. section 1.263(a)-3(h), a qualifying small taxpayer may elect to not apply the improvement rules to an eligible building if the total amount paid during the taxable year for repairs, maintenance, improvements, and similar activities performed on the building does not exceed the lesser of:
(ii) 2 percent of the unadjusted basis of the building.
A qualifying small taxpayer includes a taxpayer whose average annual gross receipts for the three preceding taxable years are $10 million or less. An eligible building includes a building that is owned or leased by the qualifying small taxpayer if the unadjusted basis of the building property is $1 million or less. If the small taxpayer safe harbor is applicable and elected, a qualifying taxpayer is not required to apply the improvement standards to owned or leased eligible buildings.
In determining amounts paid for repairs, maintenance and improvements during the taxable year, taxpayers must include amounts falling within the de minimis safe harbor (if elected) and the routine maintenance safe harbor for buildings (if used under the taxpayer's method of accounting). Thus, while the safe harbors are meant to alleviate the burden of tracking certain expenditures, taxpayers should note that they will still need to be able to track costs for repairs, maintenance and improvement activities for purposes of determining whether they satisfy the small taxpayer safe harbor, even if such amounts escape capitalization under another safe harbor or provision.
The election to apply the small taxpayer safe harbor is made on an annual and eligible-building-by-building basis. Thus, qualifying taxpayers have a great amount of flexibility in choosing (1) whether to make the election, and (2) for which eligible buildings to apply the election. However, before an election to apply the safe harbor may be made, taxpayers will need to determine on an annual basis whether (1) they meet the definition of a qualifying small taxpayer, and (2) whether the amount paid for repair, maintenance, and improvement activities with respect to an eligible building falls below the ceiling amount. Further, if the relevant costs for a taxable year exceed the lesser of 2 percent of the building's unadjusted basis or $10,000, the safe harbor will not apply to any costs incurred with respect to the building for that year. Additionally, it's important to keep in mind that this safe harbor only applies to expenditures with respect to eligible buildings (i.e., building improvements) and cannot be used to avoid applying the improvement rules to expenditures with respect to any non-building property.
A qualifying taxpayer elects the small taxpayer safe harbor annually by including a statement in its timely filed, original tax return for the year of election.