I am often asked about tax deductions - particularly about tax deductions related to major purchases, a.k.a capital assets. Examples of very common questions are, “If I buy a van for my business, can I deduct the total cost of it?” or “When I sell my van that I use entirely for business, what sort of taxes do I have to pay for selling it?” Well, those questions can be pretty complex to answer, hence the reason most people are not sure of the answers. So here’s a quick overview in three parts. First we will determine what constitutes a capital asset. Second we will cover how much you can deduct on your tax return when you purchase a capital asset. Finally we will touch on how you will be taxed when you sell your capital asset.
Capital Asset Defined
There is a general rule for determining whether or not something is tax deductible: If you purchase something for business use, it’s generally deductible. If you purchase something for use around the house or to get to and from work, it’s generally not deductible. The use and treatment of property determines whether or not it is considered a capital asset. Capital assets are things a taxpayer purchases to use in his or her trade or business that will last for more than one year, such as a vehicle, furniture, or machinery.
Investments are also considered capital assets, but there are special rules for how they are taxed. Investments do not have to be used in a trade or business to receive capital asset treatment; however, there are different rules for individuals, partnerships, and corporations. Here we will just talk about investments at the individual level.
If you hold inventory for sale, no matter how expensive each item is, none of your inventory qualifies as a capital asset.
Capital Asset Loss and Tax Deductions
Keep in mind that for purchases to be deductible, they have to be used in a trade or business. Because capital assets last for more than one year, you usually cannot deduct their total cost in the year of purchase. There are special elections you can make that allow for accelerated deductions, but those elections change from year to year. For assets such as a car or furniture, you have to spread your deductions out over two or more years depending on what you purchased. If you realize a loss from the sale of a capital asset such as a car or furniture, the full amount of that loss is deductible.
Investments, as noted earlier, are special. You can’t deduct the cost of an investment until you sell it, and even then there are special rules. If you personally hold investments and you sell your investments at a loss, you may deduct up to $1,500 (if single) or up to $3,000 (if married) of your loss each year. If you lost more than your allowed deduction, you can deduct the rest of your loss in the coming years.
Capital Gain Tax Treatment
When you sell your capital asset for a profit, the difference between your basis (original cost minus depreciation) and the selling price is considered a capital gain. The profit or gain from your sale is taxed at a lower tax rate than your regular income (such as your wages). Also, depending on whether you held your capital asset for longer than one year, your tax rate will vary. It is usually better to hold a capital asset for more than one year for tax purposes. Profits from sales of capital assets changes from time to time, but it is usually somewhere around 15%.
This information really just scratches the surface of capital assets. You should contact your tax professional for a more in-depth discussion.