Close

Tax News

Back to Article List

Current vs. Capital Expenditures

Share this article...

Current vs. Capital Expenditures

When you may deduct a given expense depends in part on whether it is considered a current or capital expense.

Bottom of Form

Tax rules cover not only what expenses can be deducted but also when -- in what year -- they can be deducted. Some types of expenditures are deductible in the year they are incurred but others must be amortized over a number of years into the future. The first category is called current expenses, and the second capital or capitalized expenditures. You need to know the difference between the two, and the tax rules for each type of expenditure. We'll try to make it easy on you, but there are some gray areas.

When Is an Expense Capitalized?

Current expenses. Generally, current expenses are everyday costs of keeping your business going, such as the rent 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.

Capitalized expenses. Other 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. They must be deducted over a number of years, or capitalized, as specified in the tax code (with certain important exceptions -- bonus depreciation and Section 179 -- discussed below). This, theoretically, allows the business to more clearly account for its profitability from year to year. The general rule is that if an item has a useful life of one year or longer, it must be capitalized.

Capitalizing Expenses

The amortization of an asset taken over a number of years is usually called depreciation, but in some cases it is called a depreciation or amortization expense. All of these words describe the same thing: writing off or depreciating asset costs through annually claimed tax deductions.

There are many rules for how different types of assets must be written off. The tax code dictates both absolute limits on some depreciation deductions, and over how many future years a business must spread its depreciation deductions for all asset purchases. Businesses, large and small, are affected by these provisions (IRC § § 167, 168, and 179).

Bonus depreciation. There is a special depreciation deduction for new qualified property called bonus depreciation. Bonus depreciation allows taxpayers to deduct in a single year a specified percentage of a long-term asset's cost in the first year the property is placed in service. Starting September 27, 2017 through January 1, 2023, you can deduct 100% of the cost of eligible property using first year bonus depreciation. After that, bonus depreciation will decrease as follows:

  • 80% in 2023
  • 60% in 2024
  • 40% in 2025
  • 20% in 2026.

Bonus deduction can be taken in addition to Section 179, although there are additional restrictions on its use.

Section 179 deduction. Another tax break creating an exception to the long-term write-off rules is found in IRC Section 179. A small business can write off in one year most types of its capital expenditures, up to $1,040,000 (2020). This is subject to a phase-out after you reach $2,590,000 (2020) 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. For more information, on bonus depreciation and Section 179.

Repairs and Improvements

Normal repair costs, such as fixing a broken copy machine or a door, are current expenses so they can be deducted in the year incurred. These are expenses to maintain the current working order of equipment.  On the other hand, the cost of making improvements to a business asset must be capitalized if the enhancement:

  • adds to the asset's value, or
  • appreciably lengthens the time you can use it, or
  • adapts it to a different use.

Improvements usually refers to real estate -- for example, putting in new electrical wiring, plumbing, and lighting -- but the rule also applies to rebuilding business equipment.

Example: Landlord James had a renter that really trashed his rental in the six months until he was able to be evicted.  The cost to repair the property to bring it back to rentable shape was 30,000.   This would be repair because it was an expense to bring the property back to rentable shape. 

James also decided to replace the roof while the property was down for repairs because it was a 30-year-old roof and really needed to be replaced.  James had the whole roof replace down to the rafters.  This would be an example of a capital improvement which would be depreciated in this case as a residential rental over 27.5 years.  James did not repair sections of the roof to make it inhabitable, he replaced to whole roof.    Now had James replaced sections of the roof because it had leaks and mold, that would have been a repair deductible in the current year.  

PDF
Printable PDF

Have a Question About This Topic?

I confirm this is a service inquiry and not an advertising message or solicitation. By clicking “Submit”, I acknowledge and agree to the creation of an account and to the Terms of Use and Privacy Policy.

NEVER MISS A STORY.

Sign up for our newsletters and get our articles delivered right to your inbox.

 

Track Your Refund

 
Track Federal Refund Check Federal Amended Return Refund

Check your State Refund

Client Login

 

Refer a Friend

.