When can I deduct an expense & when does it need to be depreciated?
This is a very common accounting question most people have when they are making purchases for their business. The type of purchase will determine how you accurately record the transaction.
- Current expenses
Generally, accounting for current expenses are considered everyday costs of keeping your business going. Expenses such as the rent, insurance and electricity bills. Rules for deducting current expenses are fairly straightforward; you subtract the amounts spent from your business’s gross income in the year the expenses were incurred. Expenses that don’t have a useful life of more than a year can normally be deducted in the current year. For example things like pens, paper and staples would be deductible in the year purchased.
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Capitalized expenses
Business expenditures, such as the cost of equipment, land, and vehicles to name a few, cannot be deducted in the same way as current expenses. Asset purchases, since they are expected to generate revenue in future years, are treated as investments in your business. These must be deducted over a number of years, or capitalized, as specified in the tax code (with one important exception — Section 179 – see below). This, in theory, allows accounting for the business to reflect more accurately for its profitability from year to year. General rule to follow, if an item has a useful life of one year or longer, it must be capitalized.
- Section 179 deduction
The long-term write-off rules, found in IRC Section 179, can be very beneficial on a tax return. A small business can write-off in one year most types of its capital expenditures. The maximum in one year is a total of $500,000. This is subject to a phase-out after you reach $2,000,000 or more of eligible Section 179 expenditures. Some assets don’t qualify for this deduction: real estate, inventory bought for resale, and property bought from a close relative. It’s almost always a good idea to take full advantage of Section 179 when you can, unless your business doesn’t have enough income to offset the deduction.
Also, knowing if you need to capitalize a purchase or you can write it off is important for tax planning. Accounting accurately for year end can help reduce your tax debt and save you money.
