As a business owner, it’s important to understand how capital expenses and their subsequent depreciation can affect your business. Both capital expenses and depreciation are tax deductible, which can save you money come tax time. However, it’s important to know the difference between the two and how they can affect your business.
What are Capital Expenses?
Capital expenses are defined as funds used to purchase, improve, or extend the life of a business asset. These assets could include buildings, machinery, vehicles, computers, and office furniture. Basically, anything that your business uses to generate income can be considered a capital asset.
Capital Expenses vs Operating Expenses
It is important to note, that Capital Expenses and Operating Expenses are handled differently by the IRS. Operating expenses are the costs of running your business on a day-to-day basis and are typically deducted in the year they are incurred. This could include things like rent, utilities, payroll, and marketing costs.
Capital expenses, on the other hand, are considered long-term investments in your business. They are typically used to purchase or improve assets that will be used for more than one year. Because they are long-term investments, capital expenses are usually deducted over the life of the asset through depreciation.
Depreciating Capital Expenses
Capital expenses are not deductible in the year they are incurred. However, they can be depreciated over time. The depreciation schedule is set by the IRS and depends on the type of asset being depreciated. For example, office furniture has a depreciation schedule of 7 years, while buildings have a depreciation schedule of 39 years.
The depreciation deduction is taken each year over the life of the asset, until the full purchase price has been deducted. For example, if you purchased a piece of office furniture for $1,000, you could deduct $142.86 each year for 7 years until the full purchase price has been deducted.
Depreciation vs. Amortization
It’s important not to confuse depreciation with amortization. Amortization is the process of spreading the cost of intangible assets, like patents and copyrights, over the life of the asset. Intangible assets are not physical and do not have a depreciation schedule set by the IRS. Depreciation is used specifically for tangible assets and are subject to a depreciation schedule.
How Capital Expenses and Depreciation Can Affect Your Business
Now that you understand what capital expenses and depreciation are, let’s look at how they can affect your business.
Capital expenses can be a great way to invest in your business and save on taxes. By depreciating the asset over time, you can deduct a portion of the purchase price each year, which can save you money come tax time.
However, it’s important to keep in mind that capital expenses are long-term investments. This means that you won’t see the benefit of the deduction until you file your taxes at the end of the year. And the value of the deduction will be limited to the value depreciation schedule set by the IRS.
It’s also important to remember that capital expenses can have an impact on your business’s financial statement. Because they are considered long-term assets, they will be recorded as such on your balance sheet. This can affect your business’s ability to obtain financing, as lenders will look at your balance sheet when considering a loan.
Overall, capital expenses and depreciation can be a great way to invest in your business and save on taxes. However, it’s important to keep in mind the long-term nature of the deduction and the impact it can have on your financial statements.
Speak With an Expert
Have more questions about capital expenses and depreciation? We can help. Schedule a consultation with one of our expert CPAs today. They can guide you through the decision-making process for large capital expenditures to ensure that the asset meets your long term financial goals. Additionally, our tax professionals can help you take advantage of depreciation benefits to minimize your tax liability.