What, Exactly, Is a Capital Expenditure?

The most common type of capital expenditure occurs when you purchase or otherwise acquire any asset that will benefit your business for more than one year. New equipment, a car, computer, office furniture, or even business real estate are the things that most commonly come to mind when you hear the words "capital asset."

Expenses that add to the value or useful life of an item of property also are considered capital expenditures. If you have a capital expenditure that pertains to a particular asset in some year after the asset is purchased, you must treat the expenditure as a separate asset and depreciate it under the rules applicable to that type of asset in the year you place the expenditure into service.

In contrast, an expense that keeps an asset in an ordinarily efficient operating condition and that does not add to its value or substantially prolong its useful life is generally considered a currently deductible repair or maintenance expense.

Deciding whether a particular item should be classified as a capital expenditure or as a currently deductible expense is not always easy, particularly if it's debatable whether the expense represents a repair, or an improvement to a capital asset.

Recently, the IRS provided guidance that attempts to clarify the “tangible property” rules. However, this continues to be a complex area of taxation. There are many rules, definitions, de minimus safe harbors, and exceptions. In some cases, you need to make the appropriate elections. Consult your tax advisor to determine what costs are currently deductible and what should be capitalized and depreciated over time.

Tip Some special rules. In some cases, the tax laws depart from the general deduct-or-capitalize analysis by providing specific rules that govern how you may or must treat certain expenditures. For small business owners, the most commonly applied of these rules are: an expensing election that allows you to deduct, rather than to capitalize, a specified amount of your costs in acquiring certain business equipment amortization of startup costs, including those associated with organizing a corporation or a partnership an election to capitalize, rather than deduct, taxes and interest you pay to carry or develop real property or to carry, transport, or install personal property

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