For many business owners and employers, the difference between current and capital expenses is a subtle one. In the framework of your tax return, however, correctly making this distinction is critical to accurately and completely filling out your return. Whether a deduction is classified as current or capital in nature determines what calendar or fiscal year it can be deducted in, and whether it can be deducted in one year or over a series of years. In order to assess which category your deductions fit into, read the guidelines below and consult an accountant or tax professional for more information that is specific to your situation.
Current vs. Capital Expenses
Fundamentally, the difference between current and capital expenses comes down to the issue of time. Current expenses can be deducted in the same year as they are incurred by the business, while capital expenses are those that ought to be broken up and listed as deductions for several years in a row.
Basic, everyday expenses such as building rental, office supplies, and short-term company necessities are considered current expenses, and should appear on the tax return for the year that they occur. Expenses that are considered investments in the company’s future, however, and are expected to be useful for more than just one year are deemed capital expenses. Good examples of capital expenses might include a fleet of company vehicles, a new business computer, or a warehouse that will give the company the ability to expand its production facilities. Capital expenses are considered assets because they are generally purchased with the intention of increasing the company’s revenue over time. Therefore, their cost must typically be divided into parts, and these parts accounted for over several consecutive tax returns.
Are There Any Exceptions?
There is one exception to the current vs. capital rule about what can be deducted from a tax return and when. It is under the heading Section 179. Section 179 states that small businesses can classify certain capital expenses as current expenses and deduct them in the year that they are incurred.
There are a number of exclusions, restrictions, and terms surrounding the correct use of Section 179. For example, a Section 179 deduction is not permitted to exceed a business’s total income for the year.
Small businesses will need to look into the clause to see how exactly they might fit into its regulation. It’s wise to use the assistance of a tax professional in order to prevent making any mistakes.
The issue of current or capital deductions gets somewhat more complex when you take into account the necessity of maintenance and improvement of certain capital expenses. For instance, while a company vehicle is likely to be considered a capital expense and therefore stretched out over a number of tax returns, any repairs that are done to it are considered a current expense and therefore deducted during the year they are done. However, improvements that are done to capital purchases also count as capital expenses. For example, if a company warehouse is purchased and a new production room is added on to it, this must be counted as an asset and capitalized on a tax return. For tax purposes, improvements are considered changes that enable a new use of the capital expense, increase its value, or extend its life.
When determining whether your business expenses are current or capital, remember to consider all the relevant qualities of the purchase before you make your decision. Is it a long-term investment or a quick fix? Is it an everyday expense or something that may make the company more money in the future? Careful consideration and documentation of these expenses will make completing the deductions section of your next tax return a breeze.
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