What Is a Capital Asset?

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 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.

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.

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. However, an individual cannot claim a loss from the sale of their primary residence. 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.

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.

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 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.

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.