Nondeductible Capital Expenditures
One of the principles underlying the tax rules for deductions
is that your income for the year should be offset by only those expenses
that contributed to earning that income.
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Example If you add floor space to your facility
or purchase a new delivery vehicle, you've acquired an asset that
will benefit your business for a number of years. If you were allowed
to deduct the full cost of such an asset in the year you acquired
it, you'd effectively be understating your income during that first
year and overstating your income during all the subsequent years that
you use the asset in your business. However, for many capital
expenditures made in 2014, you may be able to fully deduct the cost
using a combination of bonus depreciation and the expensing election.
As of this writing, the rules are far less favorable after 2014. |
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It may seem as though this shouldn't really be a problem,
because everything would come out even in the end. However, what
would have happened from the government's perspective is that you
would have reduced your taxable income inappropriately in the year
of acquisition and deferred the payment of some income taxes, which
is not something the IRS usually likes to allow.
So, instead
of letting you currently deduct your outlay for items of a more permanent
nature (that is, items that will benefit your business beyond the
current year), the tax rules provide that such expenditures generally
must be capitalized.
What does it mean to "capitalize" an
expense? Well, apart from the fact that it means the expense is not
fully deductible this year, the act of capitalizing an expense is
just an exercise in bookkeeping. The asset becomes a capital asset, against which you can take
depreciation deductions each year.
For now, let's just say
that for tax purposes, you'll eventually recover the benefits of a
capital expense through
- annual depreciation deductions for the property and/or
- a reduced amount of taxable gain or an increased amount of taxable
loss when you sell or otherwise dispose of the property.
Although these two results are helpful, they are usually
not as good as a current deduction in full for the expenses paid.
Unfortunately, you normally won't have a choice as to how to treat
a given expense. With certain exceptions, the tax rules specify whether
an expense must be capitalized or is deductible.
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