Business owners need to understand how to save money at tax time with business deductions. Capital assets are a major form of tax write-offs that many entrepreneurs might not know about. With the right approach to your capital asset management and tax strategies, you can minimize your tax liability in the most effective way.
Let’s take a look at how different types of capital assets are classified and what you should know about writing off capital assets for tax purposes.
What Are Capital Assets?
Capital assets are substantial pieces of property owned by a business that are not intended to be sold as part of the regular course of business and that are intended to help generate revenue for the business over the course of a useful life longer than a year. Capital assets are not inventory or short-term investments for a business. Think of capital assets as being the “major purchase” or “long-term investment” category of business expenses.
A few types of capital assets include:
Buildings, real estate or facilities owned by a business
Business equipment used to manufacture products
Computers owned by the business
Typically, capital assets are longer-term assets — the capital assets definition is determined by whether or not an item purchased has a useful life of more than one year. Capital assets are also known as “fixed assets,” while shorter-term assets like inventory are known as “current assets” because they are expected to be sold or used within the current year.
Properly accounting for your business assets also helps other people evaluate and understand the real value of your business, which can factor into qualifying for business loans, completing mergers and attracting investors.
How Do You “Write Off” Capital Assets?
“Writing off” capital assets is the process of properly claiming deductions for the assets’ expenses, in accordance with tax laws and accounting rules. Some capital assets (such as property owned by the business) are written off slowly over time across multiple years’ tax returns, instead of all at once — this is called “depreciation.”
Capital assets require more complicated accounting when deciding whether you can deduct their expenses from your business taxes. Because capital assets are a longer-term commitment and tend to be more expensive to purchase, businesses typically have to account for the depreciation of their capital assets over time.
Depreciation lets businesses claim a portion of the value of the capital assets as a deductible business expense over several years throughout the course of the useful life of the asset. One of the most common types of capital assets is business equipment.
Not every business equipment expense can automatically qualify as a write-off on that year’s taxes. Some assets can be written off all at once, while others must be deducted over several years.
To keep it straight, think about the “useful life of one year” definition mentioned above. For example, pens, paper, ink cartridges and other quickly used office supplies qualify as a write-off for the fiscal year in which they were purchased since, in most cases, you’ll use these up within one year. These are not capital assets, they are “current assets” — expenses that can be deducted on your taxes for the current year.
For most small businesses, managing capital assets isn’t too complicated, since they typically have fewer fixed assets with simpler tax implications. However, there are asset management consulting firms that help businesses make smart financial decisions about their capital assets. Your accountant can evaluate your capital asset management practices and will tell you when additional support from an outside team may be necessary.
Possible Caveats for Writing Off Capital Assets
Tax laws and regulations regarding assets can change from year to year. That’s another reason why you want your accountant to be the decider when it comes to what you write off as an equipment asset, and whether you should write off 100 percent of the value immediately or deduct its value gradually over several tax years.
For example, under the Tax Cuts and Jobs Act tax law that took effect on January 1, 2018, business owners are allowed to immediately expense the full value of short-lived capital investments for five years. Starting with the 2020 tax year, the limit on the Section 179 deduction (for purchases of qualifying business equipment or property that can be immediately expensed in the current tax year) is $1,040,000 per year, and this limit is reduced by the amount by which the cost of Section 179 property placed in service during the tax year exceeds $2,590,000. Check the IRS website for more information and updated rules and limits on how to depreciate property.
Many of the smallest businesses do not own business equipment or property that is anywhere near these million-dollar limits. But depending on your business’ profitability and future growth projections, you have some flexibility around when you can claim deductions for the value of these business expenses. Be sure to talk with your accountant to evaluate which options are best for you.
Tips for Planning Capital Asset Management
There are a few things you can do to make sure your business is compliant with the rules for writing off capital assets. First, plan ahead by reviewing your purchases on an ongoing basis. Sit down and review your financials every month or quarter to see which purchases you should earmark for a write-off, and review those with your accountant.
You should also consider the timing of your equipment purchases (especially the big ones). For example, if you make a large $500,000 purchase of equipment on December 28 but don’t put it into service until after January 1, then it might not qualify as a write-off for the year of purchase.
Also, check the regulations for the particular state where you do business and pay taxes. Many states have specific rules in place regarding purchases of equipment from friends and family, as well as the variance in the tax laws pertaining to machinery that you lease instead of own. (This is another reason why hiring an accountant or capital asset management firm is often necessary for large-scale operations!)
Beyond what we’ve covered here, there is a complex array of issues related to managing capital assets and claiming deductions, so it’s important to understand what qualifies as an immediate vs. long-term tax write-off for capital assets. Particularly for your equipment purchases, there is a lot of money involved, so it’s important to get these distinctions right.
The information in this article is not intended to take the place of consulting with a CPA or other professional tax advisor; be sure to seek advice from professionals to help you take full advantage of federal and state tax laws related to writing off your capital assets.
Ben Gran is a freelance writer from Des Moines, Iowa. Ben has written for Fortune 500 companies, the Governor of Iowa (who now serves as U.S. Secretary of Agriculture), the U.S. Secretary of the Navy, and many corporate clients. He writes about entrepreneurship, technology, food and other areas of great personal interest.