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The de minimis safe harbor allows you to save thousands in taxes by immediately deducting tangible property under $2,500 that would normally be capitalized and depreciated over many years.
As real estate investors, we are looking to pay Uncle Sam as little tax as possible, while at the same time simplifying our record keeping process.
The de minimis safe harbor helps us do both!
This is one of three safe harbors every real estate investor must know.
What is the De Minimis Safe Harbor?
Typically, you must capitalize and depreciate capital improvements. But the de minimis safe harbor allows you to make an annual election to immediately deduct tangible property (i.e. appliances) under a certain dollar threshold.
If you have an applicable financial statement (AFS), usually an audited financial statement, the de minimis safe harbor threshold is $5,000. However, for most of us without an AFS, the threshold is currently $2,500 (as of 2018).
The de minimis safe harbor threshold applies per invoice, or per item should multiple items appear on an invoice. If additional costs such as shipping or installation fees appear on the same invoice, you must use a reasonable method for applying the cost to each item. But, if these costs are on a separate invoice, you don't have to include them.
You receive an invoice with the following items:
- Refrigerator - $1,299
- Stove - $377
- Dishwasher - $299
- Delivery & Installation - $199
In this case, you will need to allocate the $199 delivery and installation cost to each item on the invoice. A reasonable method of doing this is to simply divide the cost between each item on the invoice ($199/3 = $66.33). Then add $66.33 to the cost of each item.
Because appliances have a useful life of more than one year, you would normally have to capitalize and depreciate them. But under the de minimis safe harbor, you can immediately deduct these appliances because each item (including shipping and installation) is under the $2,500 threshold.
Why the De Minimis Safe Harbor is Important to Real Estate Investors
When you purchase tangible property to use in your investment real estate, the cost comes out of pocket today. And as an investor, you want to immediately deduct as many expenses as you can in order to reduce your net income, and thus taxable income.
But if the item has to be capitalized and depreciated, the cost of the tangible property will not be completely tax deductible in the period you pay for it, but instead will be deprecated little by little over its useful life.
To make matters worse, later when you sell the property, you may be subject to depreciation recapture, which means you will have to pay back 25% of the accumulated depreciation.
Also, from a recordkeeping perspective, the de minimis safe harbor saves you, or your bookkeeper, from having to keep many depreciation schedules for small items, which is often tedious and time-consuming.
The Bottom Line
The de minimis safe harbor is essential to real estate investors because it allows you to immediately deduct certain rehab expenses that would normally have to be capitalized and depreciated. And this ultimately reduces your taxable income.
If you are unsure how to utilize the de minimis safe harbor for your rental properties, then it best to get in touch with a qualified accounting or tax professional to discuss how it applies to your specific circumstances.