What are assets and capital?

1. What are assets and capital?

Capital assets are a crucial part of our financial world, encompassing significant possessions like homes, cars, investment properties, stocks, bonds, and even collectibles or art. In the business realm, capital assets are integral to a company's operations and include assets with a useful life longer than one year. This article delves into the nuances of capital assets, their types, and how they are handled in taxation. So, let's embark on this informative journey together!

2. Types of Capital Assets in Business

Tangible Assets

Capital assets are the cornerstone of business operations. They are assets that contribute to a company's profit generation and are expected to serve their purpose for more than one year. On a company's balance sheet, capital assets are represented by the category known as property, plant, and equipment (PP&E).

Examples of PP&E include land, buildings, and machinery. These assets, while long-term in nature, can still be liquidated in dire situations, such as bankruptcy. Alternatively, businesses may choose to dispose of these assets when they are expanding and in need of more suitable alternatives.

In some cases, businesses even construct their capital assets. For instance, a company may purchase land and then invest in building a manufacturing plant on it. Such structures are also considered capital assets as they promise long-term benefits for the company.

Intangible Assets

While capital assets are typically tangible, they can also encompass intangible assets. Stocks, bonds, trademarks, patents, or other non-physical assets may qualify as capital assets, depending on their intended use. Additionally, capital assets may also include claims on indebtedness, mutual funds, or tenancy rights.

It's important to note that intangible assets have distinct rules when it comes to expensing or depreciating their value. They require periodic evaluations to ensure they maintain their value. Valuing intangible assets can be more challenging compared to tangible assets due to the less liquid and robust markets for the former.

3. Selling or Maintaining Capital Assets

Businesses often make decisions about their capital assets, whether to sell, maintain, or dispose of them. The options include selling, trading, abandoning, or losing the assets in foreclosures. When a business owned the asset for over a year, selling it typically results in a capital gain or loss, with tax implications.

Capital assets can also suffer damage or become obsolete. Impairment of an asset leads to a decrease in its fair value, affecting the balance sheet's book value and resulting in a loss recorded on the income statement. If the carrying amount surpasses the recoverable amount, the difference is recognized as an impairment expense.

4. Individuals and Capital Assets

Capital assets aren't exclusive to businesses; individuals can also own them. When an individual sells a capital asset, such as a stock, artwork, or an investment property, and makes a profit from the sale, it's considered a capital gain. The IRS mandates the reporting of such capital gains, subjecting them to capital gains tax.

Even an individual's primary residence qualifies as a capital asset. However, there are tax exclusions for homeowners. For couples filing jointly, a $500,000 tax exclusion is applicable, while single individuals can claim a $250,000 exclusion on capital gains from the sale of their primary residences. Notably, individuals cannot claim losses on the sale of their primary residence.

5. Capital Assets Recording and Taxation

The cost of capital assets encompasses various elements, including transportation, installation, and insurance costs associated with the purchased asset. These expenses are added to the asset's cost, affecting its overall value.

For businesses, the IRS treats the purchase of capital assets as capital expenses. Unlike most other expenses, capital expenses cannot be deducted in the year of purchase. Instead, they are capitalized as assets and written off incrementally over multiple years. This approach aligns with the matching principle of U.S. generally accepted accounting principles (GAAP), ensuring that the cost of the asset is recognized over the same period as the revenue it generates.

6. Depreciation of Capital Assets

Depreciation is a critical concept when dealing with capital assets. It involves spreading the expense of the asset over its useful life, rather than recognizing the entire cost in the year of purchase. This approach ensures that the expense aligns with the revenue generated by the asset each year.

Depreciation acknowledges that assets lose value as they age. The rate at which a company chooses to depreciate its assets can lead to differences between the book value and the current market value of the assets.

7. Capital Assets vs. Ordinary Assets

Distinguishing between capital assets and ordinary assets is crucial. Ordinary assets are expected to be used within the next year and include items like cash, inventory, prepaids, and accounts receivable. They are typically short-term in nature.

On the other hand, capital assets are long-term assets, and their benefits extend beyond one year. Businesses rely on capital assets for their operations, and they are usually classified as long-term assets on the balance sheet.

8. Capital Asset vs. Fixed Asset

In accounting, a fixed asset is a specific type of capital asset. Fixed assets are tangible and are intended for use for more than one year. Examples include buildings and property, plant, and equipment (PPE). The key distinction is that capital assets encompass a broader range, including non-fixed assets like stocks and bonds held for personal gain.

9. The Bottom Line

Capital assets are the cornerstone of both businesses and individuals' financial landscapes. They include tangible and intangible assets that promise long-term benefits. Understanding the intricacies of capital assets and their taxation is essential for sound financial management. Whether you're a business owner or an individual, capital assets play a vital role in your financial success. So, make sure to navigate this complex terrain with care and expertise.