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The Internal Revenue Service stipulates that businesses must capitalize expenditures for big-ticket items and recover that cost over several years – a practice known as depreciation – to avoid dramatic changes in the financial statements of a business from one year to the next. Knowing when to depreciate and when to claim a special one-time expense deduction is critical for entrepreneurs.
Capital expenditures offer businesses an opportunity to expand operations — to modernize and grow — by buying the equipment and capital they need and deducting these costs on their income tax return. This fuels economic expansion.
Depreciation makes sense when a business makes a major capital investment that offers long-term benefits, but is purchased upfront or over the short-term. Typical candidates for depreciation include vehicles, buildings, furniture, equipment, and computer systems. Rather than frighten investors by recording the whole impact of a purchase in one financial period, where it can create a loss, a company can spread it out over many financial periods effectively matching the deduction to the period of benefit. It matters not how the loan is repaid; what matters is how long the investment is expected to provide an economic benefit.
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