An asset or a property is “capitalized” when it is listed on the balance sheet as a fixed asset and depreciated over time.  The periodic charge to the value of the asset is referred to as “depreciation”.  Depreciation represents the “using up” of the asset, and the length of time over which an asset is depreciated very roughly approximates its useful life.

One side of a depreciation transaction records the reduction in value of the asset, while the other records depreciation expense.  Depreciation expense is listed on the income statement; however, it does not represent actual cash that is spent by the company.  Instead, depreciation represents the arbitrarily chosen fraction of the useful life of the asset used up during the accounting period.  For this reason, depreciation (and amortization and depletion) are referred to as “non-cash” expenses.

Let’s say you buy a piece of real estate.  For accounting purposes, you must separate the land from the buildings and the equipment.  You may depreciate buildings and equipment, but land is not depreciable.  Many property-owners neglect the extra step that allows them to accelerate depreciation on some assets.  Any equipment, appliances, furniture, tools, and lawn-mowers may be depreciated much more rapidly than the buildings.  Since depreciation is a non-cash expense, you minimize your income taxes by maximizing depreciation without actually spending extra cash.

Some repairs are deductible as expenses, while others must be capitalized and depreciated.  Property-owners usually prefer to write repairs off as expenses, since they receive the full tax benefit right away as opposed to receiving it over multiple years.  So, if you repair the corner of a roof, then you will deduct this as an expense.  However, if you replace the roof, then the value of your property and the length of its life have increased.  Therefore, you must capitalize and depreciate a full roof replacement.