As a business owner, it’s crucial to understand every opportunity to save money with appropriate tax write-offs. Do you know whether you’re managing your capital assets correctly to take advantage of this tax break? Many entrepreneurs don’t, but here’s the information you’ll need. Let’s take a look at how different types of assets are classified and what you should know about writing off capital assets for your new business venture.
Use the following as a digestible introduction to these complicated concepts, so you can make smart decisions in these areas as you build your business. Understanding the tax strategies for capital assets can help you maintain better oversight of your business and ask the right questions when discussing business finances with your team. Of course, this information is not meant to replace the advice of your trusted CPA or financial advisor; be sure to get professional advice about your specific tax situation before making any final decisions.
What Are Capital Assets?
An asset is something a company owns which holds value and is relevant to a company’s success. In general, assets can include all sorts of things. For example, these are all assets:
- A computer used for research or film editing
- Rights to music that received radio airplay
- A company vehicle
- Business equipment used to manufacture products
But what is a “capital asset?” 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.
All assets, capital or not, must be accounted for and tracked through the appropriate methods in accordance with state and federal tax law. 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.
Understanding Capital Assets
In the world of business and accounting, it seems like there are endless types of capital assets that are recognized and classified. For our purposes, let’s focus on equipment, which is considered a fixed asset for tax purposes.
Many business owners wrongly believe that any expense used for equipment can automatically qualify as a write-off on that year’s taxes. While this may be true in some respects, it’s not always so simple. Some fixed assets (such as property owned by the business) are written off slowly over time instead of all at once. The same thing is often true about equipment (like computers, desk chairs and printers), which can be used as a fixed asset over the span of several years.
It can sometimes be easy to confuse assets that can be written off all at once with those that 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 fixed assets; they’re simply expenses that can be deducted on your taxes for the current year.
For most small businesses, managing assets isn’t too complicated, since they typically have fewer fixed assets and fewer types of assets that they manage overall. However, there are asset management consulting firms that help businesses make smart financial decisions that impact their capital assets. Chances are, your accountant can make sense of your asset management and will tell you when additional support from an outside team may be necessary.
Possible Caveats for Writing Off Capital Assets
Any credible accountant will tell you that 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 new 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. In addition, 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) has been raised from $500,000 to $1 million per year. Depending on your business’ profitability and future growth projections, you have some flexibility in when you can claim deductions for the value of these business expenses. But it can still be complicated, so talk with your accountant to evaluate which options are best for you.
Tips for Planning Capital Asset Management
Even if you don’t fully understand the tax laws that relate to your business, there are a few things you can do to ensure you play by the rules. 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. (Now you can see why hiring an accountant or service that helps businesses organize assets for tax purposes 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. Again, 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 your capital assets.
Are you ready to start a business, form an LLC, or reorganize your business structure to be in the best possible position to save money at tax time? Talk to Incfile today! Our incorporation experts can help you evaluate your options, find a business structure that suits your goals and even assist with filing your taxes.