Business property depreciation is one area that creates an incredible amount of confusion among otherwise savvy business owners. Entrepreneurs typically see tangible item purchases in one of two ways: Some believe the cost of any business item is a regular expense. Others think everything is a fixed asset. But, in fact, it depends on the situation.
This confusion results from a lack of understanding about the difference between capitalized costs and expenses. Ordinarily (but not always), an item with a useful life of more than one year is not deducted as an expense. Rather, these purchases are fixed assets presented on the business balance sheet.
The company has simply traded one asset – cash in the bank – for equipment, which is another asset. Similarly, a financed acquisition of equipment has traded borrowed money (a liability on the company’s books) for the purchased asset. Either way, profit is not affected because the equipment cost is not an expense – at least, not immediately. The cost is expensed over time as depreciation.
To determine the correct amount of annual depreciation, your accountant will expect you to categorize your purchases as capitalized fixed assets instead of expenses. To know how to categorize requires an understanding of the IRS de minimis safe harbor rule.
In general, this provision permits you to expense purchases of up to $2,500 per item. Small equipment under this limit is treated as an expense for office supplies, not as an outlay for a fixed asset. And that’s an important – and potentially rewarding – difference.