As you operate a business, you’ll accumulate assets. These might include equipment, machinery, computers, furniture, vehicles, and buildings. These are not garden-variety expenses. They belong in a category for items with extended periods of use and more than nominal cost.
These assets are in contrast to minor expenditures, such as computer keyboards, staplers, or small chairs. While these items may last a long time, their costs are too low to count as assets. They are expensed in the same way as disposable items that you purchase. These minor expenditures are found on the statement of income and expenses, while asset costs are found on the balance sheet.
For many entrepreneurs, this accounting gets tricky when it comes time to disposing assets. The process is shrouded in mystery, and unraveling it is essential to achieving accurate bookkeeping and tax filing. Here are the basics.
Fixed Asset Facts
Knowing the value of an asset is of course essential when selling it. But the market value price tag you place on the asset is not the same as the value your company’s accounting has for the asset. Your business bookkeeping reports the original cost of the asset and the amount by which it has depreciated in value since it was acquired. That depreciation was a tax-deductible expense over the time your business owned the asset.
When you sell a business asset, the price you receive gives back the past amount of depreciation you’ve deducted. For example, let’s say you paid $10,000 for a piece of equipment two years ago, and you have depreciated it by $7,000.
If the useful life of the asset is about 10 years, it still has a market value of $8,000. The balance sheet for your business, however, only has a remaining value of $3,000 (the $10,000 cost less the $7,000 of depreciation). If you sell it for $8,000, that is $5,000 more than the remaining value on your balance sheet. So, you have $5,000 of income, but you sold the equipment for $2,000 less than your original cost, which seems like a loss.
The solution to this problem is two distinct steps in the transaction, which must be appropriately accounted for in your tax records.
Asset Sale Steps
First, you have income from getting back the depreciation previously deducted. In our example, the $8,000 selling price for the equipment returns to you $7,000 of past depreciation.
Second, you received $8,000 for equipment that originally cost $10,000, causing a $2,000 loss.
These separate elements offset to render a $5,000 profit. However, you have two components: the recaptured depreciation of $7,000 and the loss of $2,000. The $5,000 of income from recaptured depreciation is taxed differently than is the $2,000 loss.
Clearly, sound records of cost are crucial. Don’t forget to include the sales tax, shipping, and installation fees.
Also keep in mind that disposing of assets doesn’t only occur when selling them. If an asset wears out and you scrap it, that’s the same as selling it for zero dollars.
Your bookkeeping and tax return should report both sold and scrapped assets. The key is communicating with your bookkeeper and tax accountant to correctly record asset disposal and identify tax consequences.