Are You Being Haunted By Them?
If You Are It’s Costing You Money
The tax law allows taxpayers to write off the cost of business assets over time. This important tax deduction is called “depreciation expense.” Almost every business has a document called a depreciation schedule which keeps track of the cost of assets, when they were purchased, and how they are being depreciated.
The IRS has established useful lives for various types of assets. For example, vehicles are classified as a five year asset, most business equipment as a seven year asset, and land improvements like paving as a fifteen year asset. Commercial buildings and improvements to them are treated as a 39 year asset. Assets only live so long and then expire.
IRS Publication 946 has comprehensive information on how to depreciate business property. Depreciation consists of a set of rules for writing off the cost of assets over time and keeping track of all the relevant information for each asset.
When a business owner buys a new asset this event is easy to recognize and therefore easy to handle properly. A new asset is “capitalized”, i.e., treated as property with a useful life extending past one year. Minor repairs, on the other hand, are not capitalized and are simply expensed. Painting and routine maintenance costs are examples of repair expenses that are not capitalized and not depreciated over time.
It’s easy for accountants to spot new assets: they will see a check used to buy a computer, or they will see a new loan used to acquire a business vehicle.
But a terrible problem occurs when assets are scrapped, taken out of service or disposed of: getting rid of an asset is not an obvious transaction. There is no check or loan to signal to an accountant that the asset is gone.
And so the phenomenon of ‘ghost assets’ occurs. Ghost assets are business property that was capitalized and depreciated in the past but that has been disposed of. These assets hang around on depreciation schedules but don’t physically exist. Ghost assets are hard to spot and may haunt a business for years. Further, they have a tendency to accumulate over time.
Ghost assets may cost you money. You might be continuing to depreciate an asset that no longer exists. Assets that are scrapped or sold may give rise to a net loss. Losses from the disposition of business assets are tax deductible and are generally reported on IRS Form 4797. By not deleting ghost assets from your depreciation schedule you are potentially missing out on a tax write-off.
Another cost of ghost assets is that your depreciation expense may be over-stated. It is unsurprising that the IRS will not let you claim depreciation expense for an asset that doesn’t exist anymore!
You need to put a stop to being haunted by ghost assets. To do this you have to actively search for them by reviewing in detail your depreciation schedules. For each asset shown in the schedule ask the question: Does this asset still exist? Is it still being used by the business? If not, remove it from the depreciation schedule and report the disposal on Form 4797.
End of year is a great time to review depreciation schedules for ghost assets. I recommend performing this task every Halloween. This will get your business records cleaned up and ready for the following year when it will be time to prepare tax returns.
New Rules for Capitalizing Property
On September 17, 2013 the IRS issued final Regulations which provided greater clarity on when to capitalize versus simply expense certain costs.
These new rules established a de minimis safe harbor that applies to many small businesses. Under the safe harbor, a taxpayer may simply deduct the cost of an item that costs $2,500 or less. (Prior to 2016 the de minimis amount was $500).
If the taxpayer has qualifying financial statements prepared by an accountant the de minimis amount is increased to $5,000.
If the cost relates to improvements to real estate the de minimis amount is the lesser of 2% of the total cost of the property or $10,000.
The de minimis safe harbor rule simplies recordkeeping and allows many businesses to claim a full deduction for costs incurred to acquire or improve property. Without this favorable rule these costs might have to be capitalized and depreciated over many years.
You must file an election statement with your tax return to claim the de minimis safe harbor.
For further information see:
The Matching Problem
Here is another problem that may result in ghost assets haunting your business depreciation schedules: matching. Assume a business owner sells a piece of equipment. The auction sheet records what was sold and describes the asset as a “2014 front loader.” But the business depreciation schedule may describe the equipment as a “John Deere 2014.” Matching up descriptions is like solving a puzzle.
The solution is clarity. Use vehicle ID numbers or serial numbers to uniquely identify equipment and make it easy to match up disposed equipment to what’s listed in a depreciation schedule.
Certified Public Accountant Master of Business Administration
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