Capital Assets: A Key to Sustainable Growth
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 them 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 generate revenue over more than one year.
- They are recorded on the balance sheet and expensed through depreciation.
- Expensing over the asset’s life aligns costs and generated revenue.
- Includes both tangible (buildings, land) and intangible (stocks, patents) assets.
- Capital assets are crucial for long-term growth, unlike ordinary assets used in day-to-day operations.
Explore Types of Capital Assets in Business
Tangible Assets
A capital asset contributes to a business’s capacity to generate profit over many years. Represented by property, plant, and equipment (PPE) on a balance sheet, tangible assets include land, buildings, and machinery. These assets can be sold or liquidated if necessary, such as in a restructuring or bankruptcy.
Companies may develop their own capital assets by purchasing land and constructing buildings or manufacturing plants. Such structures offer long-term benefits.
Intangible Assets
Capital assets can also be intangible, like stocks, bonds, trademarks, or patents. Intangible assets require periodic evaluation to ensure they retain their value due to less liquid markets.
Maintain and Monetize Your Capital Assets
Businesses may dispose of capital assets by selling, trading, abandoning, or losing them in foreclosures or condemnation. Typically, selling an asset after owning it for more than a year results in a capital gain or loss. Tax implications include reporting capital gains, with certain scenarios treated as regular income.
Capital assets can become outdated or impaired, adjusting their book value on the balance sheet and recognizing a loss on the income statement.
Individual Capital Assets: Personal Investments and Tax Implications
Any significant asset owned by an individual is a capital asset. Selling a stock, art, or property results in capital gains, taxable by the IRS. The sale of primary residences benefits from tax exclusions, but individuals cannot claim losses from such sales.
Capital Assets Recording and Taxation
The cost of capital assets includes transportation, installation, and insurance expenses. For IRS purposes, these purchases are considered capital expenses, needing capitalization and incremental write-offs over several years.
Depreciation of Capital Assets
Through depreciation, businesses expense a portion of an asset’s value annually, aligning costs with revenue. The depreciation rate affects the book and market value.
Capital Asset vs. Ordinary Asset
Ordinary assets like cash, inventory, and accounts receivable are used within a year, crucial for daily operations. In contrast, capital assets provide long-term benefits and are listed as long-term on balance sheets.
Capital Asset vs. Fixed Asset
Fixed assets are a subset of capital assets, intended for extended use, like buildings or machinery. Capital assets include fixed and investment properties like stocks and bonds.
Defining a Capital Asset
A capital asset has long-term benefits, extending beyond one year, often with high dollar value, and not part of daily business transactions.
Examples and Scenarios
Is Gold a Capital Asset?
Gold can be a capital asset if held for investment. As inventory or raw material, it’s classified as an ordinary asset.
Capital Assets vs. Ordinary Assets
The utility of assets differs based on business goals: financial security favors capital assets, daily operations need ordinary assets like cash and inventory.
Acquiring Capital Assets
New companies can acquire capital assets through equity investments, utilizing the funds to purchase assets. Alternatively, mature companies can self-fund through operating income, creating a cycle of asset acquisition.
The Bottom Line
Capital assets, often tangible and illiquid, provide lasting value and are integral to business strategy. They signify essential investments for both companies and individuals, underpinning long-term prosperity.
Related Terms: capital expense, depreciation, fixed asset, tangible asset, intangible asset.
References
- Internal Revenue Service. “Topic No. 409 Capital Gains and Losses”.
- Internal Revenue Service. “Topic No. 701 Sale of Your Home”.
- Internal Revenue Service. “Capital Gains, Losses, and Sale of Home”.
- Internal Revenue Service. “Basis of Assets”, Page 2.
- Internal Revenue Service. “Publication 535: Business Expense (2019)”, Page 3.
