Current vs. Capital Expenses
When you may deduct a given expense depends in part on whether it is considered a current or capital expense.
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 taken over a number of future years. 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.
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.
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 one important exception -- 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 deduction 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.
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