What is a 'Capital Asset'
Capital assets are significant pieces of property such as homes, cars, investment properties, stocks, bonds, and even collectibles or art. For businesses, a capital asset is a type of asset with a useful life longer than a year, that is not intended for sale in the regular course of the business's operation. For example, if one company buys a computer to use in its office, the computer is a capital asset, but if another company buys the same computer to sell, it is considered inventory.
BREAKING DOWN 'Capital Asset'On a business's balance sheet, capital assets are represented by the property, plant and equipment figure. Examples include land, buildings and machinery. In some cases, these assets are only liquidated in worst-case scenarios, such as if a company is restructuring or declaring bankruptcy. In other cases, businesses dispose of capital assets because 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.
How Do Capital Assets Relate to Capital Expenses?
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 they report the difference as their business income. However, most capital expenses cannot be claimed in the year of purchase, but instead must be capitalized or written off incrementally over a number of years.
What Happens When Businesses Dispose of Capital Assets
Businesses may dispose of capital assets by selling them, trading them, abandoning them or losing them in foreclosure. 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 cases, the IRS treats the gain like regular income.
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, he has a capital gain. The IRS requires individuals to report capital gains, and it levies capital gains tax on these earnings.
Even an individual's primary home is considered a capital asset, but as of 2016, the IRS gives couples a $500,000 exclusion and individuals a $250,000 exclusion on capitals gains earned through the sale of their primary residences. If an individual sells a capital asset and loses money, he can claim the loss against his gains. However, an individual cannot claim a loss from the sale of his primary residence.
For example, if an individual buys a $100,000 stock and sells it for $200,000, he reports a $100,000 capital gain, but if he buys a $100,000 home and sells it years later for $200,000, he does not have to report the gain. Although both the home and the stock are capital assets, the IRS treats them differently.