Some business owner purchases are meant to help the business create revenue in future years. These are known as “capitalized” expenses because they actually become assets of the business over time. As a business uses capitalized assets, the assets’ cost is “matched” to the revenue they help the business to earn. In theory, this helps the business to more accurately account for its real profitability from one year to the next.
Sometimes it is unclear which kind of expense rules to apply to a particular expense. For example, routine costs for equipment repairs seem to be obvious current expenses. But, the IRC states that the cost of making improvements to a business asset must be capitalized if the improvement
- adapts it to a different use
- increases its value
- significantly extends the time a business can use it
If the routine repair to, say, a computer or phone line does any of the above three things, then the expense should be capitalized
The costs associated with acquiring business equipment are usually considered capital expenses if the equipment will have a useful life of more than one year. However, Section 179 of the IRC permits taxpayers to deduct a certain amount (up to $24,000 in 2001) of its capital assets per year against the business’s income. Taxpayers should check with their tax advisor about the rules, advantages, and disadvantages for making this sort of deduction.