Many business owners struggle with the question of whether an expense is deductible in the year it is incurred or whether it is a deduction taken over time.  This determination has a direct bearing on the business’ income and resulting taxes in that given year.

 

Certain expenditures are deductible in the year incurred; these are referred to as current expenses.  Other expenditures require depreciation over a certain number of years; these are referred to as capital or capitalized expenses.

 

The purpose of this article is to provide a brief overview of these two types of expenses.

 

 

Essentially, current expenses include the day-to-day costs of running the business, including utility bills, rent or mortgage expenses, salaries, accounting fees, life insurance premiums, most advertising expenses,  business gifts up to $25 per recipient each year, dues to professional societies and subscriptions to professional journals, and supplies.  Current expenses are deducted from your business’ gross income in the year incurred.

 

The cost of repairing or maintaining assets is generally treated as a deductible expense in the year such expenditure is incurred. However, if the work adds to or improves the asset, this may constitute capital expenditure, with the cost having to be capitalized and depreciated over future years. The issue of what constitutes repairs and maintenance and what is a capital improvement can be a grey area in certain circumstances.

 

 

Unlike current expenses, those expenses that add to the value or useful life of property, or adapt property to a new or different use, are referred to as capital or capitalized expenses.  Equipment, vehicles, land and certain repairs and improvements, architect’s fees, copyright costs, and costs of defending or perfecting title to property are examples of capital expenses.  Unlike current expenses, capital expenses are depreciated or written-off over a certain number of years.  Internal Revenue Code Sections 167, 168, and 179 dictate the number of years over which a particular expense deduction is spread.

 

Under Internal Revenue Code Section 167 (IRC Section 167) the general rule is that “there shall be allowed as a depreciation deduction a reasonable allowance for an exhaustion, wear and tear (including a reasonable allowance for obsolescence) – (1) of property used in the trade or business, or (2) of property held for the production of income.”

The most commonly used items are classified as shown in the chart that follows:
 

 

*15-year Depreciation on Qualified Leasehold, Restaurant, and Retail Improvements: The Emergency Economic Stabilization Act (EESA) of 2008 extends the provision to the end of 2009 and allows retail owners and new restaurants to receive the shortened recovery period for 2009 only. The extension is effective for property placed in service after December 31, 2007. The allowance of the 15 year depreciation to retail and new restaurants is effective for property placed in service after December 31, 2008.