Rahul Gupta (CA Final Student) (1780 Points)
08 April 2008
Examples of Capital ExpendituresTo assist you with your deduct-or-capitalize analysis, we've put together the following list of items that the IRS or the courts have determined to be capital expenditures under certain circumstances.
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Rahul Gupta
(CA Final Student)
(1780 Points)
Replied 08 April 2008
What, Exactly, Is a Capital Expenditure?The most common type of capital expenditure occurs when you purchase or otherwise acquire any asset that will benefit your business for more than one year. New equipment, a car, computer, office furniture, or even business real estate are the things that most commonly come to mind when you hear the words "capital asset." Expenses that add to the value or useful life of an item of property also are considered capital expenditures. If you have a capital expenditure that pertains to a particular asset in some year after the asset is purchased, you must treat the expenditure as a separate asset and depreciate it under the rules applicable to that type of asset in the year you place the expenditure into service.
In contrast, an expense that keeps an asset in an ordinarily efficient operating condition and that does not add to its value or substantially prolong its useful life is generally considered a currently deductible repair or maintenance expense. Deciding whether a particular item should be classified as a capital expenditure or as a currently deductible expense is not always easy, particularly if it's debatable whether the expense represents a repair, or an improvement to a capital asset. However, over time, the IRS and the courts have classified, on a case-by-case basis, some categories of items commonly considered to be capital expenditures, which we provide as a guide. Some special rules. In some cases, the tax laws depart from the general deduct-or-capitalize analysis by providing specific rules that govern how you may or must treat certain expenditures. For small business owners, the most commonly applied of these rules are:
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Rahul Gupta
(CA Final Student)
(1780 Points)
Replied 08 April 2008
One of the principles underlying the tax rules for deductions is that your income for the year should be offset by only those expenses that contributed to earning that income.
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It may seem as though this shouldn't really be a problem, because everything would come out even in the end. However, what would have happened from the government's perspective is that you would have reduced your taxable income inappropriately in the year of acquisition and deferred the payment of some income taxes, which is not something the IRS usually likes to allow.
So, instead of letting you currently deduct your outlay for items of a more permanent nature (that is, items that will benefit your business beyond the current year), the tax rules provide that such expenditures generally must be capitalized.
What does it mean to "capitalize" an expense? Well, apart from the fact that it means the expense is not fully deductible this year, the act of capitalizing an expense is just an exercise in bookkeeping. The asset becomes a capital asset, against which you can take depreciation deductions each year.
For now, let's just say that for tax purposes, you'll eventually recover the benefits of a capital expense through (1) annual depreciation deductions for the property and/or (2) a reduced amount of taxable gain or an increased amount of taxable loss when you sell or otherwise dispose of the property.
Although these two results are helpful, they are usually not as good as a current deduction in full for the expenses paid. Unfortunately, you normally won't have a choice as to how to treat a given expense. With certain exceptions, the tax rules specify whether an expense must be capitalized or is deductible.
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