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.
Eric Tydings
