Capital Expenditure

Are you ready to get serious about real estate investing? Your first step is to become educated on terms, lingo, and tax strategies that will become a part of your daily vernacular. A real estate business is about more than just owning property and collecting rent. Experienced and savvy investors know how to take advantage of certain tax strategies to deduct income and grow their businesses. 

One such strategy is accurately recording Capital Expenditures to help save money on taxes in the current and following years. Many new investors wonder, “what does capex mean?” So we are going to break it down, provide examples, and show you how capital expenditures can help you grow your real estate portfolio. 

Capital Expenditure Definition

Capital expenditure refers to the funds a company or organization uses to purchase, maintain, or upgrade their long-term assets such as property, vehicles, equipment, and land. This can include buying new assets or investing in repairs to prolong the life of existing assets.

What is a Capital Expenditure? 

Capital expenditure (CaEx) is money that a company or investor spends to build their business. It can be spent to acquire, maintain, or improve its long-term physical assets, including rental homes, warehouse, cars, appliances, or equipment. These investments are usually large expenditures that the company has to make in order to expand or modernize operations. CapEx is often used for new buildings, machinery upgrades, land purchases, or even the purchase of existing businesses. How CapEx is used depends on the type of business or in real estate, the type of investor.

For example, if a residential real estate investor purchases a dilapidated property that requires new insulation, a new HVAC system, and a new roof, these costs would be labelled as capital expenditures. Improving the asset will ensure that it is habitable, rentable, and can be used to generate income for years to come. 

Examples of CapEx

CapEx can represent several different types of expenses, including: 

• Land – purchasing land for development or business. Most accountants will consider land as an asset acquisition. 
• Building – whether building from scratch or improving upon an existing structure, buildings are a long-held asset. 
• Technical equipment – these could be computers or other machinery that are used to improve operations or production. 
• Furniture – for office, rental, or production use, the cost of furniture and other fixtures is typically considered a capital expenditure. 
• Vehicles – cars, vans, trucks, and other vehicles that are used for business purposes can be classified as CapEx. 
• Machinery – large and expensive machines such as manufacturing equipment, forklifts, and even delivery vehicles could be considered capital expenditures. 
• Patents – while patents aren’t necessarily physical, they are costly and considered an asset that is held long-term and helps a business grow and establish a competitive advantage. 

What is the difference between CapEx and general repairs and maintenance? 

The difference between general repairs and maintenance (R&M) and CapEx is that the latter focuses on upgrading an asset in order to extend its life, while R&M are costs associated with keeping an existing asset up to date and usable. Maintenance gets classified as a routine expense, something that is predictable. Instead of improving a physical asset, you are restoring it through R&M expenses. 

On the other hand, a capital improvement is a renovation or upgrade made to an asset with the goal of improving its condition beyond its current state. This can include increasing the asset’s functionality, extending its useful life, improving the quality of services provided, reducing operating costs, or upgrading key components of the asset. Examples of capital expenditures include upgrading elevator systems, installing energy-efficient lighting, a new roof, or making other major value-adding changes to the asset.

Let’s take a look at an example. If a landlord replaced a tenant’s lightbulbs or fixed a leaky faucet, then these costs would be classified as R&M. But if they replaced the entire plumbing system or invested in a solar energy water heater system for the property, those expenses would likely fall under CapEx. 

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CapEx vs OpEx 

To conduct business in any kind of company, whether it’s technology, hospitality, or real estate, there are many different kinds of expenses. Costs can be a one-off, such as the purchase of a new truck, or they can be recurring, such as a software subscription. To keep track of different types of expenses and define how they are recorded, two different accounting principals are used: capital expenditures and operating expenses (OpEx). R&M expenses almost always fall under OpEx. While OpEx and CapEx may sound like they serve similar purposes, they are different in their purpose and how they get recorded in a business’ accounting. 

As mentioned above, CapEx are major, one-time expenses that are used to improve a business over an extended period of time. On the other hand, OpEx are expenses that are required for the day-to-day running of a business. 

Why is it important to understand the difference between CapEx and OpEx?

Investors and businesses owners need to understand the difference between CapEx and OpEx because each type of expense carries its own tax implications. Additionally, understanding the difference allows a business to make more informed decisions when it comes to investments in long-term assets that will either take away from profitability now or provide returns over an extended period of time. 

By distinguishing between the two types of expenses, businesses can plan more accurately for their future investments and allocate resources in a manner that aligns with their growth strategy. Ultimately, this will enable companies and real estate investors to maximize profits and build long-term success. 

The distinction between CapEx and OpEx is an important one for businesses of all sizes, whether you simply own one single-family rental property or a multinational corporation. An easy way to think of CapEx is that it is usually more expensive and more labor-intensive than OpEx. Often an expense that gets categorized as CapEx takes several days or weeks to complete, whereas an OpEx can be immediate. 

A great way toest test to tell if a cost is a CapEx or OpEx is to assess how long the item will be used. CapEx expenses are considered newly purchased items or assets that will be held by the businesses for more than one year, or if it is used as an improvement of a capital asset. The life of the asset becomes important when we start taking into consideration depreciation. 

Examples of OpEx in real estate.

Real estate businesses function like any other kind of business; they have CapEx and OpEx costs that need to be recorded appropriately so that business stakeholders and shareholders can have the best tax benefits. Examples of OpeEx in real estate include: 

• Utilities
• Property management costs
• Property taxes
• Routine maintenance
• Gardener 
• Snow removal
• Insurance
• Software subscriptions
• General maintenance such as light bulbs and air filters.

Think of OpEx as the regular expenses associated with a property. Some of these can either be charged back to a tenant or become a tenant’s responsibility as disclosed in the lease. However, others remain the landlord’s responsibility. 

Capital Expenditure Examples in Real Estate

Common capital expenditures in real estate include repairs or upgrades that provide long-term benefits such as: 

• Replacing an aging roof. 
• Upgrading plumbing systems
• Replacing a heating or cooling unit
• Upgrading electrical panels and wiring.
• Purchasing and installing new appliances. 
• Major backyard improvements. 
• Renovations that include an extension. 
• Adding another structure to a property, such as a sheet. 
• Building an ancillary dwelling unit (ADU). 

Other common CapEx investments may include landscaping improvements to increase the curb appeal of a property or major renovations to kitchens or bathrooms. 

The Tax Advantages of CapEx

The most important reason for you to know what is CapEx is that it can change the way the expense is recorded for accounting purchases and also change how the cost is deducted. 

Capital expenditures provide businesses and investors with tax advantages as they can be written off for a period of time as opposed to a single tax year. Depending on the type of expense, real estate investors can choose to amortize it over several years or fully deduct it in the year incurred. 

How do CapEx tax deductions work?

CapEx tax deductions are meant to incentivize businesses and investors to invest in long-term assets that will benefit their operations. To maximize the tax benefits, it is important for businesses to keep accurate records and track all CapEx expenditures carefully. A company can deduct the cost of an asset over a period of time (for example, depreciation over five years) or take an immediate tax deduction in the year that it was purchased. 

For example, if an investor purchases a new short-term rental property that needs new appliances, which they then purchase, the cost of those appliances can either be deducted from income earned that year, or they can be depreciated over the asset’s useful life. The IRS states that an appliance can be depreciated over the course of five years. Choosing to depreciate an asset over a set period of time will help reduce taxable income in the years to come. 

It is important to note that CapEx deductions can vary significantly from country to country, so it is important to research what tax benefits an investment can receive before making a purchase. Alternatively, many real estate investors will choose to write off the cost of a CapEx in a single year of they have high earnings and property income. CapEx can be an excellent tax strategy if it’s depreciated in a single year or over several years. 

It is important to note that not all capital expenditures are eligible for tax deductions; however, understanding what is CapEx and how it works can be a helpful tool for businesses as they plan their strategy and budget accordingly. 

How to Calculate Capital Expenditure Depreciation Expense

In accounting, depreciation is a non-cash expense. Accountants have various ways to determine the amount of depreciation expense for an asset. The method chosen will depend on the specific asset, how it will affect the income statement and the real estate investor’s preference. The two most common forms of depreciation are the straight line and accelerated depreciation methods. 

Straight line depreciation method. 

Under the straight line method, a fixed amount is deducted from an asset’s value each year over its useful life. The calculation of the expense is (cost – salvage value) / estimated useful life. For example, if an HVAC system cost $5,000 and has an estimated useful life of 5 years with no residual value, the depreciation expense each year would be $1,000. 

Accelerated depreciation method. 

Under the accelerated method, more of an asset’s cost is deducted in the earlier years of its life. This method can be beneficial for businesses to maximize their tax deductions in the current year but who also want the extended benefit of tax deductions. 

For example, if an HVAC system cost $5,000 and has an estimated useful life of five years with no residual value, instead of a $1,000 depreciation expense under the straight line method, the first year of depreciation expense could be as high as $4,000 with a much smaller amount in each of the following four years. 

The decision to use either the straight line or accelerated method of depreciation depends entirely on individual preference and understanding of the tax implications of each and how they will impact a real estate business’ bottom line for a specific year and the years to come. It is important to consult a qualified CPA or tax professional when deciding which method would be the most beneficial for any given asset. 

Modified Accelerated Cost Recovery System (MACRS)

The standard system for depreciation in real estate is the modified accelerated cost recovery system (MACRS). Two types of MACRS systems are used, general depreciation system (GDS) and alternative depreciation system (ADS), but we will focus on GDS as this is the most used system.

Residential property can be depreciated over 27.5 years, while commercial can be depreciated over 39 years, which is what the IRS has deemed the useful life for these assets. The depreciation timeline starts when the property is rented, not at the time construction is completed. Depreciate ends went the property is taken out of service either because it’s destroyed, becomes inhabited by the owner, or sold.  While MACRS is usually used on the entire real estate asset, the straight line method is usually applied to other items. 

Rental Property Tax Depreciation Schedule

Depreciation of real estate is an important tool for owners but it can be complicated to keep track of. A Rental Property Tax Depreciation Schedule will value assets and calculate depreciation expenses. It will also differentiate between land value and improvements (like buildings) as land value isn’t depreciable. These schedules include: 

• Type of property being depreciated
• Depreciation method
• Cumulative depreciation date, which indicated how much of the asset’s value has been depreciated from the time it was put in service to the current date. 
• Depreciation forecast for how much depreciation will occur in future dates. 

Why is CapEx important? 

CapEx is a major factor in determining how much money a company or investor has available to invest in its future growth and success. Although it can be expensive, these investments are necessary stay competitive in rental real estate and to grow your business. It’s important to keep an eye on your real estate business’ CapEx budget so that you can know what expenses are coming up and how you can best manage them. Additionally, CapEx is an essential part of tax planning as certain types of CapEx may qualify for generous deductions or credits that could save you money in the long run. 

Knowing when to use capital expenditure and how it works with other tax strategies is key to becoming a successful real estate investor. Through careful planning and budgeting, you can use CapEx to your advantage and grow your business in the long run.

Why is CapEx important in real estate investing? 

CapEx is important for real estate investors as it allows them to deduct certain expenses from their income taxes. This means that when a real estate investor makes a capital expenditure, such as renovating a property, they may be able to deduct the cost of that purchase from their taxable income for years to come. By using CapEx strategically, real estate investors can save money and grow their businesses. For example, if a real estate investor purchases a vacant lot and then develops a warehouse, the cost of that warehouse would be considered a capital expenditure. If five years later, the property owner sells the warehouse for a profit, they will be able to deduct the cost of construction from their taxable income. 

CapEx allows investors to upgrade and improve their properties and benefit through tax deductions. By investing in capital improvements, investors can increase the value of their holdings and make them more profitable while receiving additional tax advantages. 

What does CapX mean?

CapX is just another abbreviation for Capital Expenditure or CapEx. Different professionals in the finance and real estate industries may use different abbreviations for CapEx when talking about it. However, no matter what abbreviation is used, the meaning remains the same: money spent on long-term physical assets like land, buildings, and machinery. 

CapEx is important for businesses and investors alike because it can provide them with significant tax advantages. If you’re a real estate investor, you need to be accurately tracking and recording your capital expenditures and operational expenditures. CapEx is a powerful tool for businesses and investors seeking to maximize their profits and minimize the amount of tax they owe. By carefully planning and budgeting, you can make smarter investments that will benefit both in the short-term and long-term.