Dive into the critical distinctions between capital expenditures and business expenses in our enlightening guide, designed to sharpen your financial acumen and optimize your company's tax strategy—discover the path to smarter spending and saving.
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When it comes to navigating business taxes at tax time, there are lots of different terms to navigate, including capital expenses, business expenses, and more. “Capital expenses” can be a little confusing, as the term doesn’t just cover every piece of capital you purchase.
In this guide, we’ll cover the essentials of capital expenses, including what they are, how they differ from business expenses, and more.
Capital expenses are a type of business expenditure that acquire long-term assets or enhance existing ones. Capital expenses are different from regular operating expenses because they last more than a year. Examples of capital expenditure purchases include acquiring new vehicles, new land, a piece of factors to consider when buying equipment for manufacturing, or even renovating office space.
Often, capital expenses are fixed assets, or purchases that are difficult to convert into cash. They’re usually reflected that way on a company’s financial statements. However, in a few cases, capital expenses can include intangible assets like patents and other intellectual property. These aren’t necessarily reflected on a pro forma cash flow statement or income statement in any way, but they still offer long-term value to the business.
Capital expenditures do impact your business taxes, but they’re calculated differently. Many business owners are familiar with deducting expenses for daily operations like business-related mileage, office rent, or supplies needed to create your products. But capital expenditures work a little differently; you can’t deduct the whole expense the year you purchase it.Instead, you can use amortization to gradually deduct the asset’s value over a fixed period of time (typically multiple accounting periods). Calculating how much to deduct each year can be a bit complicated; the depreciation expense amount varies depending on the type of asset you’re deducting. We highly recommend consulting with an accountant or licensed tax attorney for help determining how much you can deduct each year.
“Business expenses” is the term used to describe expenses that are more short-term, such as office supplies, utilities, and employee wages. Sometimes they’re called operating expenses because they’re essential to the business’s operations. Even if they’re physical assets, these purchases usually last for a year or less.
Business expenses are often deductible from each year’s taxes without using amortization, depreciation, or depletion. For example, if you pay for nails, lumber, sandpaper, stain, and veneer for your woodworking business, you can deduct those costs on your taxes because they’re part of your day-to-day operations. You could also deduct the cost of rent if you rented studio space. However, if you outright bought a property for your business, that would qualify as a capital expenditure instead.
Deducting business expenses is a legal way to save on your taxes — provided you do so correctly. First, you’ll want to make sure you’re tracking qualified expenses, such as rent, office supplies, and even employee wages. Maintain a record of those expenses so you can take the qualifying deduction rate for them at tax time.Many business owners find it helpful to use accounting software to track their tax-deductible expenses for easy reference.
Tax deductions can be a little more complicated when property is involved. For example, small business start-ups that operate out of their home can deduct part of their expenses for the portion they use for business purposes (see start-ups definition). These calculations are primarily based on the amount of square footage your business uses.
You can also make deductions for property and improvements you make to it — regardless of whether you buy the property or lease it. Rent payments are usually considered short-term costs because they’re operational expenses. Buying property, or making improvements to it, usually qualifies as capital expenditures that you’ll use amortization to calculate your deductible amount for the year.
A vehicle is an indispensable part of some businesses; after all, you may need to drive to meetings with clients, transport supplies, and more. The difference between capital expenditure purchases and business expenses comes into play for vehicles, too.
For example, if you’re a small business owner and you use your personal vehicle for business purposes, you can deduct the mileage you drive for business purposes. Each mile is a one-time cost. Currently, miles can be deducted at a rate of 65.5 cents per mile for 2023. But to make these deductions, you have to accurately track your business-related mileage.
If you buy a vehicle exclusively for business purposes — say, for example, a pickup for your construction company — you wouldn’t deduct the whole vehicle expense at once. That purchase would qualify as a capital expenditure that you’d deduct through amortization. Whenever you make self-employment tax deductions, especially for the first time, we highly recommend consulting with a CPA or licensed tax attorney (see CPA definition). Professional, customized assistance can be a big help in maximizing your deductions, avoiding tax pitfalls, and more.
Running a small business is no small task, especially when it comes to taxes. But you don’t have to do everything alone. Here at ZenBusiness, we can’t file your taxes for you, but we can handle other red tape tasks like LLC formation service (for $0). With our support, you can focus on running your business and managing your finances. Better yet, use our Money app to easily track your expenses so you’re ready for tax time.
Capital expenditure isn’t considered an expense in the traditional sense of the word because it’s a long-term investment that increases the value of the business. It gives you a longer economic benefit.
For example, buying a piece of property for your business adds to your net worth, so it’s a capital expenditure. Instead of deducting this cost all at once like a regular business expense, you can gradually deduct these costs over time.
On your company balance sheet, expensing costs applies to costs that have no further economic value, such as buying supplies or paying employees. Sure, supplies and employees give you the future benefit of making more products, but they don’t add to your net worth. They’re simply operational costs. Capitalizing costs, however, applies when the purchase will be “consumed” over time. This applies to costs like real estate, cars, large machinery, and so on.
The category “capital expenditure” is reserved for types of expenses that provide long-term value to the business over a period of time. This can include buying property, vehicles, and other assets. One-time purchases like office supplies and rent or short-term expenses like employee wages can’t be classified as capital expenses.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Written by Team ZenBusiness
ZenBusiness has helped people start, run, and grow over 700,000 dream companies. The editorial team at ZenBusiness has over 20 years of collective small business publishing experience and is composed of business formation experts who are dedicated to empowering and educating entrepreneurs about owning a company.
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