A capitalization policy serves many purposes. Just as a business plan is key to most successful start-ups, capitalization policies create clean, consistent, and accurate fixed asset schedules. Here’s a quick overview of the key components of a capitalization policy which should be customized to your business and industry needs.
When creating a policy, it is best to follow the intake process for a capital improvement. When an invoice appears, you need to establish whether the asset should be capitalized. To determine if the asset should be capitalized, you must know what capitalization threshold has been established.
Under the final tangible property regulations, de minimis safe harbor is set at $5,000, but the Internal Revenue Service may allow a higher threshold if supported by facts and circumstance. If the invoice is above that threshold, it must pass the capitalization test for betterment, restoration or adaption. If it meets one of those qualifiers, then you must establish an asset classification and the corresponding life.
Having a list of common classifications and their asset lives will create consistency and accuracy amongst fixed assets. Establishing book and tax lives will be necessary if maintaining multiple schedules. Finally, in some instances, a placed in-service date will need to be determined. For singular assets this will be easy to identify, but for constructed assets this date is hard to determine. Guidance should be provided as to when these constructed assets are in-use.
The policy should go through the entire asset life, which means including guidance on dispositions and partial dispositions. Regular review of fixed assets for dispositions will create a cleaner schedule and minimize tax burden. As your company grows, renovations of your spaces will likely occur. A renovation creates the opportunity for a partial disposition. This is an election made by doing and is reflected on the 4797. This election allows the associated removal costs to be expensed in the current tax year and cannot be made retroactively.
Your capitalization policy should be a living document. As seen with the Tax Cuts and Jobs Act of 2017 and the Inflation Reduction Act, tax laws frequently change so capitalization policies should be regularly reviewed and updated. Eide Bailly offers a capitalization policy review that provides analysis of policy for relevant tax regulations, base elements, and industry insights. We can also provide partial disposition analysis along with cost segregation services.
Questions about creating capitalization policy?