Deduct, Capitalize and Amortize…What Does This Mean?

Katrina is starting her first business, a salon near her home.  She is not sure what it means to deduct, capitalize or amortize expenses and wants to make sure she is recording her expenses correctly.

Taking a deduction is simply subtracting the cost of an expense from your income in either the year it was paid (cash basis) or the year it was incurred (accrual basis).  Katrina would need to deduct expenses for shampoo, hair coloring, combs, scissors, laundry services and other smaller expenses that will be used up within the year.  She can also deduct up to $5,000 of her start-up costs.

Katrina may purchase larger items or assets that will last more than a year and will capitalize these expenses.  This will include startup costs over the $5,000 limit, workstations, chairs, a receptionist desk and any other purchases that fall into this category.  To capitalize an item means that you will add the amount to your basis (your contributions to the company), although you can take periodic deductions for amortization.

Katrina can amortize her start up costs by taking the full amount to be capitalized, $20,000, and divide it by 180 months (section 197 intangibles-license, permits, franchise or trademark).  In this case Katrina would deduct $111.11 per month for the entire 15-year period.  The workstations she purchased were $12,000 and she determines that they will last for at least 10 years, which means that she will deduct $100 each month over the next 120 months.

Repair and maintenance costs can be deducted or capitalized, whatever treatment Katrina chooses, she must remain consistent.  It would be a good idea for Katrina to implement a written policy outlining how expenses are to be handled, to include a dollar threshold for capitalized items.  This will ensure that she is consistent in her record keeping.

If all this terminology is making your head hurt, contact Excerebus CPA Firm at info@excerebus.com or 407-988-5647 and let us help you.

Categories: Tax Information

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