Oregon Tax Consultants Practice Exam

What does the term "Capitalizing" mean in a tax context?

1. Reducing expenses

2. Adding to basis

3. Writing off debt

4. Deferring taxes

The correct answer is: Adding to basis

In a tax context, "capitalizing" refers to the practice of adding an expenditure to the basis of an asset rather than immediately expensing it. This means that instead of deducting certain costs in the year they are incurred, these costs are added to the value of the asset. This approach affects how the asset is treated for depreciation purposes over its useful life, ultimately impacting the amount of tax deductions a business can take in the future. When an expense is capitalized, it increases the asset's basis, which can lead to higher depreciation deductions in subsequent years as the asset is utilized in the business. This method allows businesses to spread the expense over time, aligning the costs with the revenue generated from the use of the asset. It serves to accurately reflect the investment in the asset on the financial statements and for tax calculations. Understanding capitalization is crucial for both tax reporting and compliance, as well as for strategic financial planning, since it can influence cash flow by affecting when and how much of the expense is recognized for tax purposes.