A capital asset is an investment of money in some kind of fixed asset. In the context of a business, a capital asset helps the company make products, is intended to be used for more than a year and is not inventory. In the context of individuals, a capital asset is an investment such as real estate, securities, a business or other such investment assets.
Here’s more about capital assets, why they’re important and how they’re taxed.
Business capital assets
Simply put, a capital asset is any asset that a business uses to generate income or profit rather than being sold immediately for a profit. This category includes tangible assets, such as property, equipment and vehicles, as well as intangible assets, such as patents, copyrights and trademarks.
Capital assets are typically long-term assets that a company expects to use for more than one year, and they are recorded on the balance sheet as non-current assets, often under the property, plant and equipment line (PP&E). They are often significant investments that require a substantial amount of capital, and a company typically has to continue to make capital expenditures to keep its capital assets up to date and in working order.
Why capital assets matter
The primary purpose of capital assets is to help generate revenue for a company, either through direct use in its operations or through the sale of products or services. For instance, a bread factory might purchase a new industrial oven to increase its production capacity, or a software company may purchase computers needed by its staff to program applications.
Capital assets are also often treated differently from regular operating expenses when it comes to their accounting. They are typically recorded on the balance sheet at their original cost, and their value is then depreciated over time to reflect their decreasing value as they are used up or become outdated. Depreciation allows companies to spread out the cost of an asset over its useful life, smoothing out fluctuations in profitability over time. In contrast, regular operating expenses are simply written off as they’re incurred.
In addition to depreciation, companies may also have to account for impairment of their capital assets. Impairment occurs when the value of an asset drops below its recorded book value, resulting in a loss for the company. Typically, impairment is unexpected damage, not expected depreciation, including natural disasters, such as an earthquake or tornado, that ruins equipment or property but also can be a bad business decision or miscalculation.
Examples of business capital assets
Business capital assets can take many forms, and generally fall into two categories: tangible assets (physical) and intangible assets. Capital assets can vary depending on the industry and the specific needs of the business. Here are some examples of business capital assets:
- Property: This includes land, buildings and other real estate assets that are used by a business for its operations. For example, a furniture company may own a factory, while a hair salon business may own a storefront.
- Equipment: This category includes machinery, tools and other equipment that are used by businesses to produce goods or provide services. To continue the example above, the furniture company may own lathes and sanders to help with building products, while the hair salon might have commercial grade hair dryers and sinks.
- Vehicles: Think cars, trucks and other vehicles — generally any vehicles that are used by a business for transportation, operations or delivery.
- Technology: This includes computers, software, and other technology assets that are used by a business to manage its operations or provide services.
- Intellectual property: This category includes intangible assets, such as patents, trademarks, copyrights and other assets that are used by the business to protect its ideas and products. These types of assets can be harder to expense, value and calculate depreciation on than tangible assets.
Overall, business capital assets are any assets that a company uses to generate income or profit over a period of time, rather than being sold immediately for a profit. These assets are typically long-term investments and they play a crucial role in the success of the business.
Individual capital assets
Capital assets matter on an individual level mainly when it comes to taxes. Otherwise, unless you’re a business owner or an investor, it’s generally not something that you’ll find yourself talking about on a daily or even weekly basis.
Examples of individual capital assets
Personal capital assets are possessions that can contribute to your financial net worth. They can include a variety of items, such as real estate, investment portfolios, business ownership, intellectual property and collectibles.
- Real estate: A home, vacation house or rental property you own is a personal capital asset.
- Investment portfolio: Your investments, including stocks, bonds, mutual funds and other types of investment assets.
- Business ownership: A business you own, whether it’s a small side hustle or a larger enterprise.
- Intellectual property: If you have created a lucrative original work, such as a book, a song, or a software program, the rights to those works could be considered personal capital assets.
- Collectibles: Items such as rare stamps, coins, artwork or antiques can also be considered capital assets.
Essentially, many things you own can be considered a personal capital asset. As the IRS puts it: “Almost everything you own and use for personal or investment purposes is a capital asset.”
How are capital assets taxed?
Depending on the type of asset and how it is used, it may be subject to capital gains taxes when it’s sold. In the case of businesses, many capital assets are sold for less than their depreciated value after they’ve been used or used up, meaning they generate a capital loss and are not subject to tax but rather create a tax break. Unlike an individual’s capital assets, a company’s capital assets are less commonly intended to generate a capital gain and often generate losses.
For individuals, capital gains taxes are levied on the profit earned from the sale of an asset, and they can vary depending on the length of time the asset was held and the tax laws in the jurisdiction where it was sold. In addition, different types of capital assets are taxed differently.
For example, stocks and other financial securities such as mutual funds, exchange-traded funds and others are taxed when you realize a gain on sale, and you may enjoy lower tax rates if you’ve held the property longer than a year. If you realize a loss on a capital asset, however, you can write off the loss in a process known as tax-loss harvesting.
Real estate sales are also subject to capital gains taxes, but the IRS has special rules that can help mitigate the burden. If you lived in your home for two of the five years leading up to the sale, you can exempt up to $250,000 in profits if you file individually, or up to $500,000 if you file as a married couple. On profits above those levels, you’d be taxed at the generally lower long-term capital gains tax rate.
House flippers, on the other hand, typically have to pay steeper short-term capital gains taxes if they buy and sell within a year or less. And for those with investment properties, the IRS allows tax breaks for depreciation, though some of that depreciation is later “recaptured” when the property is sold, making it subject to further taxes.
Collectibles such as art, antiques and the like are subject to their own tax rate.