In the construction industry, for tax purposes, you do treat the purchase of a hammer and a cement mixer differently. Sure you may view them as “tools of the trade” – but the IRS thinks differently!
Construction is by nature a tool driven industry. Buying and providing them can get expensive. But how do you know when you can expense a tool and when you should capitalize a tool and depreciate (expense) it over time? Here are a few tips.
First off, let’s define expenses from the tax perspective. Any business expense that is considered to be ordinary and necessary is deductible. An “ordinary” expense is considered to be something that is common and accepted in your industry – in this case, the construction industry. To be considered “necessary”, an expense should be helpful and appropriate for your industry. It does not have to be indispensable to qualify or classified as necessary.
Second, let’s talk about capitalization and deprecation. When a tool is considered to be durable or useful beyond one year, it is typically capitalized (recorded as an asset on the balance sheet) and depreciated (expense is split out over several years instead of just one).
Here are a few examples of tools that are deductible in the year of purchase:
- Small tools expected to last one year or less
- Steel toe work boots
Here are a few other common business expenses that you will want to keep track of: Utilities, Car and truck expenses (like maintenance), Advertising, Employee salaries, Trade association dues, Rent expense, Supplies, Continuing education, and Business licenses…to name a few.
Here are a few examples of tools and equipment that you would most likely capitalize and depreciate:
- Cement mixer
- Other heavy machinery
To complicate matters, you can elect to expense a capital item in the year purchased using Section 179 Depreciation rules. That can get a little complicated so I’d advise that you check with a tax professional on those rules and if you should exercise them or capitalize and depreciate the asset.
Tools and taxes can be sticky and complicated but it really doesn’t have to be.
Look at the asset and be honest… is it durable beyond one year or not? If yes, capitalize it. If no, expense it.
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About the Author:
Joyce M. Washington is a CPA who has spent the better part of almost 20 years honing her craft as an accountant with various companies in the Greater Baltimore-Washington, DC area – growing, mentoring and managing accounting teams. It’s this experience that she brings to services and training programs, including QuickBooks Basics.