Business assets, or, as the IRS calls them, "property," are items of value owned by a business. Assets come in several types, from cash to land and buildings. Every business needs assets to operate; without assets like furniture, machinery, or vehicles, you can't run your business. Here are 10 things every business owner needs to know about assets.
1) Assets Can Be Tangible or Intangible
The two broadest categories of business assets are those that are tangible and those that are not. Assets can be real, or tangible, like a car or a computer you use for business, or retail shelving. They can also be intangible, like intellectual property (trademarks, copyrights, patents).
One interesting asset is your business's goodwill. It's your good reputation, sometimes expressed in the value of your loyal customers. Goodwill is generally calculated as the difference between the purchase price of a company and its fair market value.
2) Assets Are Treated Differently for Tax and Accounting Purposes
For Accounting Purposes
You business assets are shown on the business balance sheet. The assets are listed according to their liquidity, which is a term relating to the ease of transferring the asset to cash because cash is the most "liquid" asset. Cash is listed first as the most liquid asset, then other current assets, and then fixed assets.
Current assets, including cash, accounts receivable, and inventory, are most quickly converted to cash. Fixed assets, like property and buildings, are less liquid and less easily converted to cash.
For Tax Purposes
The IRS distinguishes between assets (property) depending on whether or not they can be expensed or depreciated.
Expensing an asset means taking the tax deduction for it in the first year after you buy it. The cost of current assets and low-cost fixed assets are usually expensed. For example, you can take the entire cost of a cell phone in the first year.
Depreciation is an annual deduction from your business taxes to recover the cost of an asset over a certain number of years (the asset's useful life).
You can depreciate tangible property and some intangible property, like patents, copyrights, and computer software, if:
- You own the asset
- You use it for business purposes
- It has a useful life that can be determined, and
- It must be expected to last for more than one year.
Real property (land and buildings) cannot be depreciated, while personal property can be depreciated. The process of figuring out how to depreciate assets is called depreciation.
Listed property is a special kind of business asset. These are assets that can be used for both personal and business purposes, so the IRS keeps a close eye on them. Types of listed property:
- Passenger autos,
- Other property used for transportation, and
- Property used for entertainment, recreation, and amusement (including cameras and recording devices).
The IRS has detailed limits and rules about deducting and depreciating business property, including recovery periods (useful life) of different kinds of assets and different depreciation methods. See IRS Publication 946 How to Depreciate Property for more information.
3) Some Assets Are Depreciated; Others Are Amortized
As noted above, some assets can be depreciated; these are called depreciable assets. Depreciation of assets is an important bookkeeping and tax concept, because depreciation is an expense that can lower the value of an asset and accelerated depreciation can bring tax benefits.
Some assets must be amortized, which is similar to depreciation for certain kinds of intangible assets. Many intangibles are amortized over a 15-year period with no salvage value at the end of this period.
4) Assets Are Valued Differently, and Values Change
Fair Market Value: The most common way to value individual assets is by determining their fair market value (FMV). This value is the price an asset brings in a sale between a willing buyer and willing seller, neither of them compelled to buy or sell.
Appraisal: Some assets can be valued by a specialist called an appraiser, creating an appraised value for the purpose of using the asset as collateral or to substantiate depreciation deductions. Artwork, jewelry, stock, and buildings are examples of assets that might be appraised.
Liquidation: Liquidation of assets is the process of getting cash for them during a bankruptcy. The liquidation value is considered as cash value, and it's considerably less than the fair market value because the seller is usually being forced to sell.
Obsolescence: Business asset values can change with age and obsolescence, or just with market conditions. An asset is obsolete if it isn't used anymore (like old machinery you can't get parts for) or has been replaced by something newer and better or more fashionable.
Disaster: The IRS sets specific rules for claiming the value of assets for disaster loss purposes. For this purpose, you'll need to value your business assets before and immediately after the disaster.
The IRS has a Business Casualty, Disaster, and Theft Loss Workbook you can use to gather information on your business assets in case of a disaster.
5) It Doesn't Matter How You Buy the Asset
The value of an asset on your business accounting system isn't related to the way the asset was purchased. For example, an asset like a company vehicle that is purchased with cash is valued and depreciated the same as a vehicle purchased with a loan.
6) You Must Use the Asset if You Want to Deduct or Depreciate the Cost
The IRS requires that you place the asset in service to claim expenses and depreciation deductions. "Placed in service" means the time that the asset is ready and available for a specific use, even if you aren't using it yet. For example, if you buy a computer in Year 1, but you don't install it and make it operational until Year 2, you can't begin to depreciate the computer until Year 2.
7) Gains on the Sale of Assets Are Capital Gains
If you sell certain assets (called "capital assets") for a profit, you must pay capital gains tax on that profit. Most business property is considered a capital asset, including furniture, stocks and bonds, vehicles, and buildings. Assets that are not capital assets include:
- Items in inventory for sale to customers
- Accounts or notes receivable
- Depreciable property
- Real estate
- Patents, trade secrets, copyrights, and similar items.
If the asset was sold within 12 months of purchase, the capital gain is short-term; otherwise, you must pay the long-term capital gains rate.
In order to calculate the gain or loss on the sale of an asset, you must first get the basis (original cost) of the item. The basis includes all costs involved with the purchase of the item, including commissions, fees, setup, and training on the item's use.
Capital gains are taxed at a different rate than other types of income. The tax rate depends on the owner's income. For most taxpayers, the rate will be up to 15%.
It's important to keep excellent records and include all costs for the purchase of a capital asset. The more costs you can include, the higher the basis, and the lower the capital gain. See IRS Publication 551 Basis of Assets for a complete list of all allowable asset costs and other information.
8) Assets Can Be Used as Collateral for a Business Loan
If you are asked to put up an asset as security for a business loan, a lien is put against the asset. The lien gives the lienholder first right to the asset and requires the loan to be paid off before you can sell the asset and get your money from it. Car loans are a good example of collateral (the value of the car) being used for a loan.
9) Assets Can Be Analyzed to Show Company Profitability
How a company uses its assets to generate income can show its profitability. A financial ratio called net return on assets is a good measure of how the company puts its assets to work.
You can get a value of your current assets (those you can quickly turn into cash) with a quick ratio. Add up your current assets, not including inventory, and divide the total by your current liabilities (what you owe and must pay back within a year). This number shows you how much cash you might be able to get quickly in an emergency.
10) It's Important to Keep Excellent Records of Your Business Assets
It's important to keep excellent records of business assets, starting with the purchase of the asset. Include all information on asset costs, on depreciation, on salvage value, repairs and maintenance, and any appraisals of the asset.