Owners decide expense vs. asset treatment of purchases

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I own a little business. When I purchase tools
and equipment for the business, I make kind of arbitrary decisions about when to
depreciate the items and when to expense them. What are the rules for deciding
if something is expensed or depreciated?

A.H., Greenwood

So much of accounting and its underlying principles is black and white, with rules that are straightforward and often unbending, that it always seems strange to me when a situation occurs where clear guidelines aren't present. Such is the case, however, in determining whether a purchase should be charged to an expense account or an asset account.

A business owner is expected to make decisions about the expense vs. asset treatment of purchases, based on several general guidelines:

Longevity. If the item is expected to last for several years, both in the sense of its durability and of its usefulness, the tendency is to depreciate the item rather than expense it.

Materiality. If the cost of the item is minimal, when compared to income and the other expenses of the business, the tendency is to expense the item rather than depreciate it.

Consistency. When deciding to expense or depreciate an item, consider how similar items have been treated by your business in the past.
Conservatism. When in doubt, be conservative and depreciate the item rather than expense it.

When considering the above guidelines, bear in mind not just your own experiences with your business, but traditions of your industry in general. Find out how other businesses like yours treat the kinds of purchases you are making. If you are unfamiliar with other businesses like yours, or are reluctant to consult with competitors about accounting issues, consider purchasing some time from an accountant, a professional who deals with many such businesses and who can provide insight into industry practices.

One other factor to keep in mind is that many assets which can be depreciated can also be deducted as a current expense under Section 179 of the Internal Revenue Code. Under the rules of this section, you can elect to treat all or part of the cost of certain depreciable assets as an expense. The election and the expense deduction must be taken in the year in which you place the property into service.

For 1998, up to $18,500 in qualifying depreciable assets can be expensed under the rules of this section. The Section 179 deduction is calculated on Form 4562, where other depreciation expense is also calculated.

Certain assets are limited under the Section 179 rules, vehicles and other transportation property, for example, some computers and cellular phones, so that the entire cost of the asset may not be eligible for the deduction. Other assets don't qualify at all, such as buildings, certain investment properties, assets acquired from relatives, and assets which are used less than 50% for your business.

If you take a Section 179 expense deduction for some of your assets, the assets should still be presented on your company's balance sheet with the rest of your assets, offset by the total amount of depreciation claimed, including the Section 179 amount.

My daughter's best friend's family is moving to
California this summer and we have offered to let the girl stay with us for the
school year, so that she can finish school here and graduate with her
classmates. Are there any tax issues we need to address regarding this temporary
"member of our family?"

J.A., Indianapolis

I think you're probably asking if this girl can qualify as a dependent while she lives with you, and the answer is "no." A non-related person must live with you for the entire year, and that means a calendar year, not a school year, before you can consider claiming her as a dependent.

I rented a piece of farm equipment to a friend,
who paid me for the use of the equipment. I assume I have to report this as
income on my tax return, does it go on Schedule F with my other farm income?

H.C., Rush County

Yes, you must report the income on your tax return for the year in which you receive the income (presumably, 1998's tax return). Since you file a Schedule F, Profit or Loss From Farming, with your tax return, you can show this income on the line for Custom hire (machine work) income. However, if this is the only time you rent equipment, you may want to show this income on page one of your tax return, as Other Income, instead of on your Schedule F. The income on your Schedule F is subject to self-employment tax, income earned in a one-time-only transaction, such as this rental, is not required to be included with your regular farm income, and can therefore avoid being subject to this extra tax.

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