Is an amount paid by a business an expense that is currently deductible, or is it a capital expenditure that should be depreciated,, amortized or depleted? This issue is one of the most common issues in a tax audit with the Internal Revenue Service, as well as one of the most litigated issues in United States Tax Court. The article below has been prepared by a tax attorney to provide additional information related to this common issue. Please remember that this article is for informational purposes, and you should consult directly with your tax attorney and advisors related to your specific issues.
A currently deductible expense is an ordinary and necessary expense that is paid or incurred by the business during the taxable year in the ordinary course of operating the trade or business. Please reference Internal Revenue Code Section 162. In comparison, a capital expenditure would be the cost to acquire, improve or restore an asset that is expected to last more than one year. These capital expenditures are not allowed a deduction, but rather are subject to amortization, depreciation or depletion over the useful life of the property. See Internal Revenue Code Section 263.
That being said, how does one determine whether an expenditure is an expense to be deducted or a capital expenditure? The answer is, it is a question of fact. The Courts have applied the principles of deductibility versus capitalization on a case by case basis, and the facts and circumstances of each case will likely determine the outcome.
An example may help illustrate the difference between an expense that would be deductible versus one that would be capitalized. If a business owner bought certain office supplies such as pens and paper, they would be deductible. If the same business owner, purchased a building to operate the business, the building would be capitalized. Let’s look at a different example that might not be as obvious. Assume a business owns and rents property. In one property a hole was placed in the wall when a tenant moved. In another property, the owner decided to replace the walls with new drywall and paint. It is likely the fixing of the hole in the wall would be deductible as a repair or maintenance, whereas the cost to replace the walls would be capitalized by the business.
One further issue to consider beyond the matters discussed above is that the Internal Revenue Code requires books and records to be maintained to verify and substantiate the expense whether it be a deduction or capital expense. If the item or amount of the expense cannot be verified and substantiated by the taxpayer, the IRS may disallow the deduction or the capital expense.
If you have questions related to a deduction or capital expense, you can speak with a tax attorney or business attorney by contacting The McGuire Law Firm. The McGuire Law Firm offers a free consultation with a tax attorney to discuss your questions and issues.