What is a Capitalization Policy and Why Does My Small Business Need One?
- morgan03815
- 6 days ago
- 3 min read
A capitalization policy is a simple but powerful financial tool for small business owners. It helps you decide when to expense a purchase right away and when to capitalize it—meaning you track it as an asset and depreciate its cost over time. Implementing a capitalization policy can make your bookkeeping cleaner, improve tax accuracy, ensure compliance with IRS regulations, and save you from unnecessary headaches.
Understanding Capitalization in Business
A capitalization policy allows a business to categorize assets above a certain threshold as capital assets. These assets appear on your business balance sheet and are depreciated over time, rather than being listed as expenses on your profit and loss statement.
In simpler terms, a capitalization policy sets the rules for:
Which purchases should be tracked as long-term assets
Which purchases can be recorded as immediate expenses
For example, if you buy a $500 printer with a useful life of over a year, you might normally be required to depreciate it over several years. But with a capitalization policy, you can expense it immediately—saving time and reducing complexity.
The IRS established a safe harbor rule to reduce the administrative burden of tracking and depreciating small-dollar assets. This rule helps small businesses stay compliant without needing to track the long-term value of lower-cost items. It also allows small businesses to deduct eligible purchases in the year they are made, rather than depreciating them, if they fall under specific dollar thresholds. If you have a written capitalization policy, you may qualify for the IRS de minimis safe harbor election.
Here are some key points to keep in mind regarding capitalization policies for your small business:
Most businesses are eligible to deduct up to $2,500.
In certain circumstances, you may be eligible to deduct up to $5,000 per item, depending on your financial statement reporting requirements.
The limit applies per item, not per invoice.
The election must be made annually on your tax return (it’s not a one-time setup).
It is important to make sure your policy is thought through. If the amount in your capitalization policy is less than the safe harbor amount, you are limited to the amount in your policy.
Most professional tax preparer software has the ability to check a box and create this election for you.
Why Your Small Business Needs a Capitalization Policy
Here are some reasons why having a capitalization policy in place is helpful:
Simplified Bookkeeping: Small, long-lasting items (like office equipment or tools) can be expensed right away, making your records easier to maintain.
Tax Benefits: With a formal policy in place, your business can take advantage of the IRS de minimis safe harbor election.
Consistency: A written policy helps ensure you treat similar purchases the same way, year after year.
IRS Compliance: To qualify for certain tax deductions, the IRS requires that your capitalization policy is in place at the start of the year.
What Should a Capitalization Policy Include?
A basic capitalization policy generally covers:
Effective date
Purpose of the policy
Definition of capital assets and the dollar threshold
Capitalization method and procedures
Recordkeeping guidelines
How Overman Bookkeeping Can Help
Need a starting point? The AICPA has created a sample capitalization policy that can be customized for your business; Overman Bookkeeping is here to help you tailor this policy to fit your business’s unique needs and ensure it aligns with current IRS guidelines. Contact us today for assistance.