11/19/2020 What Is a Capital Asset?

CORPORATE FINANCE & ACCOUNTING FINANCIAL STATEMENTS

Capital Asset
By ALICIA TUOVILA | Reviewed By DAVID KINDNESS | Updated Nov 12, 2020

Capital assets are significant pieces of property such as homes, cars, investment properties,
stocks, bonds, and even collectibles or art. For businesses, a capital asset is an asset with a
useful life longer than a year that is not intended for sale in the regular course of the
business's operation. This also makes it a type of production cost. For example, if one
company buys a computer to use in its office, the computer is a capital asset. If another
company buys the same computer to sell, it is considered inventory.

KEY TAKEAWAYS
Capital assets are assets that are used in a company's business operations to
generate revenue over the course of more than one year.
They are recorded as an asset on the balance sheet and expensed over the useful life
of the asset through a process called depreciation.
Expensing the asset over the course of its useful life helps to match the cost of the
asset with the revenue it generated over the same time period.

Businesses and Capital Assets

A capital asset is generally owned for its role in contributing to the business's ability to
generate profit. Furthermore, it is expected that the benefits gained from the asset will
extend beyond a time span of one year. On a business's balance sheet, capital assets are
represented by the property, plant, and equipment (PP&E) figure.

Examples of PP&E include land, buildings, and machinery. These assets may be liquidated in
worst-case scenarios, such as if a company is restructuring or declares bankruptcy. In other
cases, a business disposes of capital assets if the business is growing and needs something
better. For example, a business may sell one property and buy a larger one in a better
location.

Businesses may dispose of capital assets by selling them, trading them, abandoning them, or
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losing them in foreclosures. In some cases, condemnation also counts as a disposition. In

most cases, if the business owned the asset for longer than a year, it incurs a capital gain or
loss on the sale. However, in some instances, the IRS treats the gain like regular income. [1]

Capital assets can also be damaged or become obsolete. When an asset is impaired, its fair
value decreases, which will lead to an adjustment of book value on the balance sheet. A loss
will also be recognized on the income statement. If the carrying amount exceeds the
recoverable amount, an impairment expense amounting to the difference is recognized in
the period. If the carrying amount is less than the recoverable amount, no impairment is
recognized.

Individuals and Capital Assets

Any significant asset owned by an individual is a capital asset. If an individual sells a stock, a
piece of art, an investment property, or another capital asset and earns money on the sale,
they realize a capital gain. The IRS requires individuals to report capital gains on which a
capital gains tax is levied. [1]

Even an individual's primary home is considered a capital asset. However, the IRS gives
couples filing jointly a $500,000 tax exclusion and individuals filing as single a $250,000
exclusion on capitals gains earned through the sale of their primary residences. [2] However,
an individual cannot claim a loss from the sale of their primary residence. [3] If an individual
sells a capital asset and loses money, they can claim the loss against their gains, but their
losses cannot exceed their gains. [1]

For example, if an individual buys a $100,000 stock and sells it for $200,000, they report a
$100,000 capital gain, but if they buy a $100,000 home and sell it years later for $200,000,
they do not have to report the gain due to the $250,000 exemption. Although both the home
and the stock are capital assets, the IRS treats them differently.

Recording Capital Assets

The cost for capital assets may include transportation costs, installation costs, and insurance
costs related to the purchased asset. If a firm purchased machinery for $500,000 and incurred
transportation expenses of $10,000 and installation costs of $7,500, the cost of the machinery
will be recognized at $517,500. [4]

When a business purchases capital assets, the Internal Revenue Service (IRS) considers the
purchase a capital expense. In most cases, businesses can deduct expenses incurred during a
tax year from their revenue collected during the same tax year, and report the difference as
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their business income. However, most capital expenses cannot be claimed in the year of

purchase, but instead must be capitalized as an asset and written off to expense
incrementally over a number of years. [5]

Using depreciation, a business expenses a portion of the asset's value over each year of its
useful life, instead of allocating the entire expense to the year in which the asset is
purchased. The purpose of depreciating an asset over time is to align the cost of the asset to
the same year as the revenue generated by the asset, in line with the matching principle of
U.S. generally accepted accounting principles (GAAP). This means that each year that the
equipment or machinery is put to use, the cost associated with using up the asset is
recorded. In effect, capital assets lose value as they age. The rate at which a company
chooses to depreciate its assets may result in a book value that differs from the current
market value of the assets.

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