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What qualifies as a capital purchase?
For the sake of both budgeting and taxes, I need some info on what a capital purchase is and where I can avoid getting into a gray area that might attract IRS attention.
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2 Answers
Capital Purchase or more commonly Capital Expenses or Expenditures are expenditures by a business for fixed assets, which by definition are assets that have a useful life greater than one year. An example would be buildings, furniture, computer equipment, manufacturing/ plant equipment, etc. Typically the item, the costs necessary to put the item into service (i.e. fit out, facility alterations, installation services from vendors, etc.) are all part of the asset to be capitalized.
Items that typically don't last a year such as office supplies, or expenditures such as utilities costs, consumables, and leasing costs (however there are instances when a lease based on terms and payment may be considered a capital lease) would not qualify.
Also, maintenance costs for normal wear and tear are not considered capital expenditures, however, costs which add to the functionality of an existing asset or increase its useful life may be considered a capital improvement. See the IRS website for additional examples.
http://www.irs.gov/publications/p535/ch01.html#en_US_publink1000208617
The above discussion provides a useful definition of capital equipment for most business.
The IRS will be interested if you fail to classify a capital purchase properly as in theory you will deduct from your tax return in the current year the whole cost of the capital item than would otherwise be captured by depreciation over say five years. However for a small business using Section 179 deductions, much capital equipment can be deducted in the current year anyway. If you are just getting started, I would not worry at this stage too much about the IRS, particularly if you take your business tax return to a good tax preparer that handles business returns.
To avoid getting into grey areas, have accurate books. Each capital item should be charged to a fixed asset account in your general ledger and a depreciation rate set for it. In general, you should work out this rate with your tax accountant or use straight line depreciation which your tax provider can convert to tax. Records should be kept of each item, it should be tagged with an item number and a depreciation schedule kept for it.
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