7 min read
November 14th, 2025
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When your business makes a major purchase, the financial impact isn’t always obvious. Should it be recorded as an expense, hitting your income statement immediately, or capitalized as a long-term asset and depreciated over time? Understanding the difference between expense and capitalization is essential for making confident financial decisions that accurately reflect the health of your business.
In This Article
- When to Capitalize: Learn when it’s appropriate to capitalize and depreciate a purchase instead of expensing it.
- What Purchases Can Be Capitalized: Capitalize fixed assets that are long-term, used in daily operations, and represent a significant cost, including all acquisition expenses.
- Writing a Capitalization Policy: A written capitalization policy will help your bookkeeper and accountants properly present your financial statements in compliance with accepted accounting principles and IRS regulations.
Capitalize or Expense? Stop Guessing – Start Deciding Confidently
With every purchase, a business must decide whether to:
- Capitalize it as a fixed asset on the balance sheet and let it be depreciated over time
- Expense the purchase and let it hit the income statement all at once.
The decision whether to capitalize an asset or expense it can affect the business’s net worth, its tax liability and potentially debt covenants – the financial ratios required by a lender.
Read More: Capital Expenditure vs. Operational Expenditure: Key Differences for CEOs
Take control with a clear capitalization policy.
Capitalization
Capitalization involves “depreciating” or “amortizing” a portion of the purchase price of an asset over time. This is accomplished by recording the initial cost of an asset on the balance sheet and recognizing the expense over its useful life with a series of monthly or annual journal entries.
Expenses
An expense represents a business resource that is used up or consumed quickly, typically within a year. Unlike capitalized assets, which provide a long-term value, expenses are costs that impact your bottom line immediately. They are the day-to-day outflows that keep the business running, from salaries and utilities to office supplies and routine maintenance.
What Purchases Can Be Capitalized?
Fixed Assets
A fixed asset is a term for commonly capitalized assets. Any long-term resource used in the operation of a business such as property, plant or equipment, commonly known as fixed assets, is typically subject to review for capitalization.
The key qualifications of a fixed asset are:
- The item must have a useful life of one year or more
- Must be used in normal day-to-day business.
- Typically a major expense
- Includes the full cost to acquire and place fixed assets
IRS Fixed-Asset Guidelines
The Internal Revenue Service has established “tangible property” regulations governing a business’s fixed asset record keeping. The IRS requires that fixed assets, at certain thresholds, be capitalized by a business.
IRS Fixed-Asset Thresholds
The IRS suggests you chose one of two capitalization thresholds for fixed-asset expenditures, either $2,500 or $5,000. The thresholds are the costs of capital items related to an asset that must be met or exceeded to qualify for capitalization.
A business can elect to employ higher or lower capitalization thresholds. However, the IRS requires that a business uses the same threshold for tax purposes that it uses for accounting purposes.
Consult with your tax CPA when selecting the correct threshold for the capitalization for your business.
Learn how to identify and manage your fixed assets.
How Capitalization Works
Now that you know how to identify fixed-asset expenditures in your business, how should you go about capitalizing them? You must go through the following exercise for each major business purchase:
- Find out the total acquisition cost of the fixed asset
- Establish an expected useful life for the fixed asset (in years or months)
- Divide the total cost of the fixed asset by the time factor
- Depreciate the resulting amount on the books.
- You can record depreciation annually or monthly. We strongly recommend monthly as it’s a true cost of the business and it’s needed to show the true profit or loss each month. Plus, a monthly entry avoids major adjustments at the end of the year just to get a tax return done.
For example, let’s say you own a lawn care business and you decide to purchase a new truck for $50,000. At first glance, you might think of this as just another business expense, like buying fuel or supplies. But in accounting, there’s an important distinction between purchases you should expense and purchases you should capitalize – and this truck falls into the latter category.
Because the truck will be used in your business for more than one year, and it plays a direct role in your operations (hauling equipment, transporting crews, etc.), it qualifies as a fixed asset. Fixed assets are long-term investments that help your business generate income over time.
Instead of deducting the entire $50,000 cost in the year you buy the truck, your accountant will capitalize the purchase. This means the cost is recorded as an asset on your balance sheet, and the expense is spread out over the truck’s useful life – the number of years you expect to use it.
If you estimate that the truck will last 10 years, you’d record $5,000 in depreciation expense each year ($50,000 ÷ 10 years). This gradual write-off matches the cost of the truck to the income it helps your business earn each year.
So, instead of your books showing a huge $50,000 hit to profits in one year, capitalization allows you to reflect the truck’s value and cost more accurately over time.
To contrast: if you spent $500 on fuel or $1,000 on new tires, those would be regular expenses, not capitalized, because they’re short-term costs that don’t provide long-term value.
Documenting Your Position
Once you finalize your capitalization plan, it’s time to get it on paper. A written capitalization policy will help your bookkeeper and accountants properly present your financial statements in compliance with accepted accounting principles and IRS regulations. In addition, the policy will provide these benefits:
- Ensure accounting consistency
- Assist in defense of the business in case of an IRS audit
The determination of whether to capitalize or to expense a significant purchase is not always straight forward and often requires professional insights and judgement. While potentially challenging, establishing and following a capitalization policy will improve financial insights while ensuring and maintaining regulatory compliance.
Now that you know how to set fixed-asset thresholds to properly account for significant purchases, put this into practice.
Work with an accounting professional to establish a clear capitalization policy tailored to your company, so your monthly financial reports reflect the true health of your business and guide you toward long-term success.
Start building your capitalization policy.
This content is for informational purposes only and should not be considered financial, legal, or tax advice. Contact us to speak with a qualified professional for guidance tailored to your needs.
