There are two main types of expenses for business tax purposes. Current expenses involve the daily cost of operating a business, such as paying for electricity or rent for your office space. By contrast, capitalized expenses consist of purchases that are more similar to investments, since they will produce income for the business in the future. Some common examples include real estate, vehicles, and certain types of equipment. The difference between current and capital expenses is critical because you can deduct a current expense in the year in which you incur it, while you will need to deduct a capital expense over multiple years in a process known as depreciation. In most cases, an item will be classified as a capital expense if it will be useful to your business for at least one year.
Rules for Repairs and Improvements
Repairs are generally considered to be current expenses, while improvements are usually capital expenses. Thus, a business or its owners can deduct a repair cost in the year in which the cost arose, whereas an improvement may need to be deducted over multiple years. An improvement will be classified as a capital expense if it adapts the asset to a different use, increases its value, or extends the time period in which the business can use the asset. You might think of an improvement in connection with business real estate, but improvements may involve some types of business equipment as well.
Deducting a Capital Expense
Spreading a deduction over multiple years is known as depreciation. Unfortunately, the rules for depreciating an asset tend to be very specific and complicated. There are different rules for different types of assets that control how many years the depreciation period lasts. In some cases, a business can apply a depreciation deduction only up to a certain dollar limit. The type and size of the business do not affect the length or size of a deduction.
Section 179 of the Internal Revenue Code provides an exception to certain types of depreciation for small businesses. Not all types of assets qualify for this exception, though. It only applies to personal property that was used at least 51 percent of the time for the business. You can read more here about how Section 179 works.
Another useful concept to understand is known as bonus depreciation. This allows a business or its owners to apply a larger amount of the deduction in the first year after an asset that qualifies as a capital expense is purchased. The Tax Cuts and Jobs Act, which went into effect in 2018, greatly increased first-year bonus depreciation. These amounts are set to decline with time and eventually expire, but Congress may extend bonus depreciation again. You can consult the page on Section 179 to find out more about bonus depreciation.