3 IRS Safe Harbors Landlords Need to Know About

Safe harbors are rules implemented by the IRS to allow qualifying entities, generally those with smaller incomes, to simplify their tax filings.

In this article we take a look at three safe harbors that real estate investors can use to streamline their taxes including the De Minimis Safe Harbor, Routine Maintenance Safe Harbor, and the Safe Harbor for Small Taxpayers.

These safe harbors offer real estate investors and landlords the opportunity to decrease their tax liabilities and increase cash flow. However, in order to successfully use these as part of a real estate tax strategy landlords need to understand the law surrounding them, know exactly how they work, and in what situations they can be used effectively.

Key Takeaways

• Safe harbors allow you to simplify your tax filing process and increase the amount you can deduct against your taxable rental income in any one year.
• Safe harbors are elections requiring investors to indicate their choice on their tax return each year. 
• The De Minimis Safe Harbor allows you to deduct smaller expenses that would otherwise need to be capitalized.
• The Routine Maintenance Safe Harbor allows for expenses related to regular or routine property maintenance to be deductible regardless of cost.
• Qualifying businesses can be use the Safe Habor for Small Taxpayers instead of the De Minimis Safe Harbor and the Routine Maintenance Safe Harbor.

About The De Minimis Safe Harbor In Real Estate

The De Minimis Safe Harbor (DMSH) (IRS Reg. § 1.263(a)- 1(f)) is a tax regulation enabling businesses to fully deduct tangible property expenses that fall below a specific threshold. This eliminates the need to capitalize and depreciate such expenses over an extended period.

The De Minimis Safe Harbor allows you to elect to deduct expenses up to the value of $2,500 per invoice. If you have an applicable financial statement this dollar amount is doubled to $5,000. These limits are intended as a way of determining whether a particular expense qualifies under the safe harbor, not as a ceiling as to what can be deducted. Expenses that don’t come under this safe harbor should likely be capitalized. This dollar limit is applied to each item on the invoice, not the invoice in the aggregate. As a result, it is critically important to itemize all invoices.

For example, if you needed to replace an HVAC unit for $4,000 this should be added to your property’s adjusted cost basis and depreciated rather than deducted at the end of the year.

However, it’s worth noting that not all expenses that exceed this limit must be capitalized. The de minis safe harbor election does not include amounts paid for the acquisition or production of tangible property that exceeds the safe harbor limitations. Additionally, the De Minimis Safe Harbor election does not include amounts paid for inventory and land.

Before the De Minimis Safe Harbor exception you were required to determine whether each expenditure for a property, regardless of amount, was required to be capitalized. The De Minimis Safe Harbor election eliminates this, so you no longer need to worry about whether every small-dollar expenditure for the acquisition or production of the property is properly deductible or capitalizable.

Benefits of De Minimis Safe Harbor for Real Estate Investors

Embracing the De Minimis Safe Harbor brings numerous advantages for real estate investors, simplifying tax record-keeping, reducing administrative costs, and minimizing audit risks.

1. Simplifies tax records, eliminating the need to track capitalized costs over extended periods for items (for items below the $2,500 threshold).
2. Reduces paperwork and necessary recordkeeping which can save time and lower professional accounting service fees.
3. Decreases the likelihood of IRS audits related to capitalization complexities.
4. Improves cash flow by reducing income taxes owed for the year. 

Limitations of De Minimis Safe Harbor for Real Estate Investors

While the De Minimis Safe Harbor offers numerous advantages, real estate investors should be aware of its limitations and consider certain factors before applying this rule.

1. The De Minimis Safe Harbor is llimited to items costing $2,500 or less per invoice or item, or $5,000 with an Applicable Financial Statement (AFS). 
2. The De Minimis Safe Harbor is an election, requiring investors to indicate their choice on their tax return each year. 
3. The rule only applies to tangible property, excluding intangible assets or inventory.
4. State and local tax laws may not align with federal tax laws, so property owners should check local rules or consult with a tax professional.

Essentially, the De Minimis Safe Harbor is simply an administrative convenience that generally allows you to elect to deduct small-dollar expenditures for the acquisition or production of property that otherwise must be capitalized under the general rules.

About the Routine Maintenance Safe Harbor

The Routine Maintenance Safe Harbor allows for expenses related to regular or routine property maintenance to be deductible regardless of cost. There is no annual dollar limit and any landlord can use this safe harbor regardless of income levels.

Maintenance expenses need to qualify as “routine” to be deductible under this specific safe harbor. So, what is routine maintenance?

Routine maintenance is recurring work that a landlord carries out on a building in order to keep that building in ordinarily and efficient operating condition.

The main two activities under which routine maintenance is generally classified are:

• Inspections, cleaning, and testing of the building’s units of property,
• Replacement of damaged or worn parts with comparable and commercially available replacement parts.

Actions and expenses that fall under that first point are generally deductible anyway – however, it’s that second bullet point that really helps landlords. Previously, a landlord may have had to capitalize and depreciate an expense related to the replacement of a part. However, under this condition, landlords may currently deduct replacement parts as long as the purpose of the replacement is in order to – as we stated above – keep the property in an ordinary working condition.

There are several limits to this safe harbor that are important to note. The first is the 10-year rule which states that the replacement of a part will only qualify as routine maintenance after it has been in service for 10 years, and by replacing the part you are declaring that you won’t be replacing again within the next 10 years.

The second is the no betterment or restorations rule. This prevents landlords from deducting any capital improvements under this safe harbor. All costs under this safe harbor must and can only be for regular property maintenance and cannot improve the property’s value. This limitation excludes rehabilitation costs from being classified as routine maintenance.

Costs deducted under the Routine Maintenance Safe Harbor also count against the annual allowance under the Safe Harbor for Small Taxpayers.

To claim the Routine Maintenance Safe Harbor, you must adopt it as a method of accounting. Unlike the Safe Harbor for Small Taxpayers, you do not make an annual election with your tax return.

About the Safe Harbor for Small Taxpayers

The Safe Harbor for Small Taxpayers (SHST) (IRS Reg. § 1.263(a)-3h) is the final safe harbor we’re going to talk about in this article and was enacted by the IRS in 2013.

The SHST allows landlords to deduct on their Schedule E all annual expenses for repairs, maintenance, improvements, and other costs for a rental building.

There are several restrictions that are applied to determine if an expense qualifies and landlords need to ensure they keep careful track and records of all their annual expenses for repairs, maintenance, and improvements to justify the use of this safe harbor.

Rental Business Size Limitations

Landlords cannot use this SHST in any year that the following limitations are exceeded:

• $1 Million limit on an unadjusted basis – note that unadjusted excludes land, land improvements, and personal property identified through a cost segregation study
• Annual expenses for repairs, maintenance, and improvements, cannot exceed the lesser of $10,000 or 2% of the building’s unadjusted basis
• Annual gross income for the landlord must be less than $10MM for the three preceding tax years.

If you qualify for the SHST, you won’t have to worry about determining if you have repairs or improvements nor will you have to worry about the De Minimis Safe Harbor or Routine Maintenance Safe Habor.

Final Words: About Safe Harbors in Real Estate

The De Minimis Safe Harbor, Routine Maintenance Safe Harbor, and the Safe Harbor for Small Taxpayers can not only simplify tax preparation but also lower administrative costs, potentially freeing up cash flow to enhance your real estate business's bottom line.

However, the effectiveness of these safe harbors can vary based on individual circumstances, expense types, and state tax laws. Seeking guidance from a tax professional is essential to navigating these nuances and maximizing the benefits.

At Landlord Studio, our property management and accounting software are designed to empower landlords in handling day-to-day aspects of their portfolios. From rent collection and tenant management to rental accounting and tax reporting. By seamlessly integrating our tools rental property management, Landlord Studio can help you turn tax complexities (like these IRS safe harbors) into opportunities for growth and increased returns on investment.

Create your free Landlord Studio account today.

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Disclaimer

We hope you found this blog interesting. However, do note that the information in this article does not constitute advice. This blog is for general informational and educational purposes only and should not be used as a substitute for competent legal and/or other advice from a licensed professional.