I often am asked this question by bookkeepers and business owners alike. The Internal Revenue Service defines a fixed asset as property used in a trade or business or in an income producing activity that wears out or becomes obsolete and it must have a determinable useful life substantially beyond the tax year. This might include tangible real estate property and personal property and what is referred to as intangible property.
Examples of tangible real estate property would be of course buildings and the land they sit on as well as any improvements made to the property. And while land is considered a fixed asset, the IRS rules do not allow the value of the land to be depreciated. Therefore, with real estate property the value of the land is kept in a separate balance sheet account from the value of the building. Often in real estate transactions there are closing costs and legal fees. The IRS may consider these expenses to be part of the cost of buying the building and will expect those costs to be added to the value of the building and depreciated over the life of the building. Check with your tax preparer for further clarification.
If you rent space to operate your business in then the rent is an expense that can be written off in the accounting period it is paid or accrued. However, should you make improvements to your rental space then that expense is considered to be Leasehold Improvements and if your lease extends beyond a year then those improvements would be looked at as fixed assets. Be careful with this one as some business leases might go from year to year but if you are staying beyond the term of the one year lease (renewing your lease that is) those improvements could be looked at having a life that meets the definition of a fixed asset.
Some examples of personal tangible fixed assets are equipment, tools, office furniture, computer equipment, vehicles, etc. All purchases of these types of assets must be considered as fixed assets unless there will be no residual value to them after one year. When considering the cost of an asset include all costs involved in putting that asset into use. For example, if you purchase a computer system the fixed asset cost would include the CPU, monitor, and printer as well as any additional equipment purchased with the computer that defines its use.
Intangible property could include copyrights or patents that would expand beyond a tax year.
Remember the key to defining whether an item purchased is a fixed asset or an expense is the answer to this question: “Will this item have a monetary value after being used beyond one year?”. And while a $5.00 screwdriver might have value to you far beyond one year I doubt you would be able to sell it hence it has no discernable monetary value. While making this decision think of the use of the item and the cost of purchasing the item. Usually items costing less than $500.00 have no residual value after a year’s use. And of course should you have any question at all, check with your accountant or tax preparer.