Navigating tax regulations can be particularly challenging for landlords due to the unique complexities involved in managing property-related expenses. Understanding the concept of safe harbors—provisions designed to simplify compliance and minimize penalties—will empower property owners to optimize their tax strategies effectively.
What Is a Safe Harbor?
A safe harbor provides specific guidelines that help taxpayers comply with IRS regulations and reduce the risk of penalties. For landlords, these provisions offer ways to handle expenses like repairs and maintenance, ensuring smooth tax filings and minimizing disputes with the IRS.
The three key safe harbor options under the Tangible Property Regulations (TPRs) include:
- Routine Maintenance Safe Harbor
- De Minimis Safe Harbor Election
- Safe Harbor for Small Taxpayers
For landlords seeking personalized guidance on maximizing deductions and ensuring compliance with IRS regulations, our tax planning services provide expert support for navigating safe harbor elections and other tax strategies for real estate.
Routine Maintenance Safe Harbor
This safe harbor allows landlords to deduct expenses for routine maintenance necessary to keep a property in efficient operating condition. Routine maintenance must be expected to be repeated at least once every 10 years to qualify for this deduction, such as:
- Inspecting, testing, and cleaning building systems (e.g. HVAC)
- Replacing worn parts (e.g. roofing tiles, electrical components)
Under the “no betterment or restoration rule,” landlords cannot deduct capital improvements or any expenses that enhance the property’s value. This rule ensures that rehabilitation or improvement costs aimed at upgrading the property are excluded from being classified as routine maintenance and must instead be capitalized.
How To Claim
To claim the Routine Maintenance Safe Harbor, landlords must adopt it as their accounting method. Once applied, the safe harbor is consistently used for routine maintenance deductions moving forward and doesn’t require an annual election.
De Minimis Safe Harbor Election
The De Minimis Safe Harbor (DMSH) is designed as an administrative convenience that lets landlords deduct small-dollar expenditures for tangible personal property instead of capitalizing it. This election applies to all eligible expenses, including materials and supplies, and cannot be selectively applied to specific items.
Landlords with an applicable financial statement (AFS) audited by a CPA firm can deduct amounts paid up to $5,000 per item or invoice, with no limit on the number of items that can be claimed.
Key Requirements for AFS Holders
Requirements include the following:
- Written Policy: This must be in place from the first day of the tax year, categorizing items below a certain dollar threshold or assets with a useful life of 12 months or less as expenses.
- Consistency in Accounting Method: Expenses must be treated the same for tax and financial reporting purposes.
- Detailed Invoices: Critical for applying this election, invoices must clearly list items and the amounts paid for each one.
Example
If you purchase 12 water heaters costing $1,200 each for a total of $14,400, you may deduct the entire amount under this safe harbor if all conditions are met.
What If You Don’t Have an AFS?
Landlords without applicable financial statements can deduct up to $2,500 per item or invoice. They also need a policy in place at the beginning of the tax year that is consistently applied and aligns with tax regulations. However, it doesn’t need to be a formal written document.
How To Claim
To use the De Minimis Safe Harbor, you must file an election with your timely-filed tax return annually.
Safe Harbor for Small Taxpayers
The Safe Harbor for Small Taxpayers (SHST) offers a valuable option for landlords managing multiple expenses, particularly for deducting repair and maintenance costs on owned or leased buildings.
To qualify for the SHST:
- The taxpayer must have average annual gross receipts of below $10 million for the three preceding tax years.
- The unadjusted basis of the eligible building property must be $1 million or less.
- The deduction cannot exceed $10,000 or 2% of the property’s unadjusted basis, whichever is lower. The good news is this limit is applied to each eligible building property, no matter how many you own.
How To Claim
Landlords must make an annual election with their timely-filed income tax return.
Important Note about the Safe Harbor Threshold
If the taxpayer elects to use the Safe Harbor for Small Taxpayers, they must consider all annual expenses for repair and maintenance as part of the total deduction limit under SHST. This means the total deduction from all applicable TPR safe harbors combined must not exceed $10,000 or 2% of the unadjusted basis of the building, whichever is lower.
Safe Harbor for the 199A Pass-Through Deduction
In addition to the tangible property safe harbors, landlords can benefit from the Section 199A Qualified Business Income (QBI) deduction, which offers a potential 20% reduction in taxable income for rental activities classified as a trade or business.
The IRS introduced a safe harbor under Revenue Procedure 2019-38 to clarify when rental activities qualify as a trade or business for this deduction. You can read more about this safe harbor and its requirements under point 4 of “7 Tax Planning Tips for Real Estate Investors.”
Combining Safe Harbors
Landlords can combine multiple safe harbors to maximize tax benefits. For instance, you could use the Routine Maintenance Safe Harbor for servicing the building’s HVAC system and apply the SHST for larger repairs or improvements. Consulting with an experienced tax advisor offering real estate CPA services ensures you take full advantage of these provisions while staying compliant with IRS rules.
Maximize Deductions, Minimize Hassles
IRS safe harbors offer landlords valuable tools to simplify tax compliance and lower their taxable income. By strategically using these safe harbors, landlords can deduct the entire cost of certain business expenses in a single year and avoid complex depreciation rules over multiple years.
Navigating these regulations can be challenging, so an experienced CPA, like Alpine Mar, can be invaluable in maximizing deductions while ensuring compliance with IRS regulations. An experienced tax advisor can help you avoid costly mistakes and ensure that all safe harbor elections are properly executed for the best tax outcome.
