Question

IRS Code 1221 defines Capital Asset, but it does not give us a clear definition of what capital asset is; it defines capital asset by stating what is NOT a capital asset. Thus, a capital asset is anything that is not listed on the definition. Please review the code IRC Code 1221 and answer the following questions:

1. What is the benefit of classifying an assert as a Capital Asset?

2. Under IRC 1221(a), it list some items that are NOT capital assets. What do they have in common?

3. Provide you general understanding of Capital Assets?  

Answer 1

Ans:

1.Capitalizing asset has many benefits. Because long-term assets are costly, expensing the cost over future periods reduces significant fluctuations in income, especially for small firms. Many lenders require companies to maintain a specific debt to equity ratio. If large long-term assets were expenses immediately, it could compromise the required ratio for existing loans or could prevent firms from receiving new loans. Also, capitalising expenses increases a company's asset balance without affecting its liability balance. As a result, Many financial ratios will appear favourable. Despite this, it should not be the motivation for capitalising an expense.

2.Some assets that are not capital assets are:

a) Inventory

b) Accounts or notes receivable from trade or business

c) Real estate used in trade or business, rental property

d) Supplies used in a trade or business.

These assets have life less than one year, can be converted into cash easily.

3. A capital asset is generally owned for its role in contributing to the business's ability to generate profit. Furthermore, it is expected that the benefits gained from the asset will extend beyond a time span of one year. On a business's balance sheet, Capital assets are represented by the property, plant and equipment(PP&E) figure. Examples of PP&E include land, buildings and machinery. IN some cases, these assets are only liquidated in worst-case scenario, such as if a company is restricting or declares bankruptcy. IN other cases, a business disposes of capital assets if the business is growing and needs something better.