What is a capital expense?

The distinction between capital and current expenses is often tenuous. Typically, current expenses, also known as "deductible expenses," are the everyday costs associated with maintaining a business. Current expenses include the costs of electricity, rent and employee salaries. Current expenses also include the cost of making repairs to keep the property in normal operating condition, such as fixing a plumbing leak or a broken computer. Capital expenses, on the other hand, are expenditures that increase the value of the business in some way. For example, a plumbing repair would be treated as a capital expense if instead of fixing a leaky pipe, the plumber replaced and upgraded all the pipes in the building. Similarly, while the cost of maintaining a private gravel road may be deducted as a current expense, the cost of paving the road is treated as a capital expense.

Most business expenses are tax deductible if the business is operated to make a profit. However, establishing whether a cost is a current or capital expense allows a taxpayer to determine when they are eligible to take a federal tax deduction on that expense. Section 162 of the Internal Revenue Code gives businesses a current tax deduction for all ordinary and necessary expenses incurred in carrying out a trade or business. Section 162 allows the total cost of the expense to be deducted from the business's gross income in the year the expense was incurred. Capital expenditures, on the other hand, are not treated as "ordinary and necessary" business expenses and are not eligible for a current deduction under Section 162. Capital expenses may, however, be deducted through a process of depreciation, amortization or depletion. This means that rather than being deducted in the year the expense was incurred, the expense is deducted over a number of years. The precise number of years and the rate at which an expense is depreciated, amortized or depleted depends on the nature of the expense.

Capital expenditures increase the value of a business and are therefore considered an investment in the business that will generate revenue in future years. By deducting capital expenses over a number of years, the business is able to more accurately account for its profitability.

No. Section 179 of the Internal Revenue Code allows small businesses to take a current deduction on most types of capital expenditures. A small business may deduct up to $105,000 in capital expenses through 2007. In 2008, however, the annual deduction limit will be reduced to $25,000.