To recap our previous discussion of assets, assets are defined as things with current or future economic value. Fixed assets are items your business owns that you actually use in your business. Examples of fixed assets are:
- Office equipment like copiers and fax machines
- Computers
- Software
- Office furniture
- Buildings
- Equipment
Inventory is a different type of asset that is sometimes confused with fixed assets. Inventory is an asset that is specifically purchased for resale. So if you buy a computer to use in the day-to-day running of your business, it is a fixed asset. But if your business is Best Buy or Office Max, you buy some computers specifically to resell them. In this case, the computers bought for resale are inventory. Another example might be a lawn mower. If you are a landscaping business and using the lawn mower in your day-to-day business, it’s a fixed asset. If you are Home Depot and buying lawn mowers to sell, they are inventory.
You’re probably wondering what’s the big deal. They are all assets, right? Yes, they are all assets, but they are handled differently for tax purposes. Fixed assets depreciate over time. This means that you don’t get to deduct the entire cost as an expense in the tax year you purchase a fixed asset. For example, you spend $3,000 on some office furniture today. You can’t deduct the entire $3,000 as an expense this year. Furniture depreciates over 7 years. Using straight-line depreciation, you could deduct 1/7 of the cost each year for 7 years. That means of your $3,000 purchase, you only get to deduct $428.57 as a business expense in the current tax year. Depending on the current year’s tax laws and the depreciation method your CPA uses, this amount may be different.
Inventory is different. Let’s stay with the example of the $3,000 purchase of furniture. You’re not using the office furniture to furnish your own office, you purchased it for resale, so it’s inventory. The amount you get to deduct as a business expense depends on whether or not you sell it in the current tax year. Your tax year is the same as the calendar year. You sold the furniture prior to 12/31 of the year you purchased it. You get to deduct the entire amount as a business expense in the current tax year.
However, if 12/31 has passed and you haven’t sold the furniture you purchased as inventory, you can’t deduct a penny of the cost in the current tax year. That can really hurt come tax time if you have spent lots of money on inventory during the year and haven’t sold it. You essentially have to pay tax on that money (in our example the $3,000) because you can’t deduct it. This is why there are so many year-end sales and retailers lower prices to move inventory before the end of the year. It’s also why you don’t want to keep lots of inventory sitting around.