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<TITLE>Depreciation and Capital Gains</TITLE>
</ARTHEADER>
<SECT1>
<TITLE> Depreciation and Capital Gains</TITLE>
<PARA> </PARA>
<PARA>This section provides a treatment of the handling of
depreciation and appreciation of assets in GnuCash.
<TITLE>Depreciation and Capital Gains</TITLE>
<PARA>
If you hold assets for business purposes, thier decline in value over
time can be treated as a deduction for tax purposes, called
Depreciation. On the other hand, if you own assets such as real estate,
collectibles (like paintings), and investments (like shares in
companies), you may see them appreciate in value over time. In this
case, you must recognize -- for tax purposes -- what are called
<EMPHASIS>Captial Gains</EMPHASIS>
</PARA>
<PARA>It also provides a brief introduction to the related tax
<PARA>This section discusses the handling of
depreciation and appreciation of assets in GnuCash.
It also provides a brief introduction to the related tax
issues.
</PARA>
@@ -21,45 +27,38 @@
tax/depreciation policies.</EMPHASIS>
</PARA>
<PARA>Note that appreciation and depreciation of assets tend to be
<PARA>Appreciation and depreciation of assets are
treated somewhat differently:
<ITEMIZEDLIST>
<LISTITEM>
<PARA> <LINK LINKEND="XACC-DEPRECIATION">Depreciation</LINK> is <EMPHASIS>usually</EMPHASIS>
<PARA><LINK LINKEND="XACC-DEPRECIATION">Depreciation</LINK>
is <EMPHASIS>usually</EMPHASIS>
recognized (the technical term is <EMPHASIS>accrued</EMPHASIS>) as an
expense on an ongoing basis, gradually reducing the value
of an asset towards zero.
</PARA>
<PARA>Depreciation tends to only get calculated on assets that
are used for professional or business purposes, because
ongoing expense, gradually reducing the value
of an asset toward zero.
Depreciation is usually only calculated on assets
used for professional or business purposes, because
governments don't generally allow you to claim depreciation
deductions on personal assets, and it's pointless to bother
with the procedure if it's not deductible.
</PARA>
</LISTITEM>
<LISTITEM>
<PARA> In contrast, <LINK LINKEND="APPR">Capital Gains,</LINK> which could
<PARA> <LINK LINKEND="APPR">Capital Gains,</LINK> which could
be called <EMPHASIS>asset value appreciation,</EMPHASIS> are typically
<EMPHASIS>not</EMPHASIS> recognized until some time down the road when
<EMPHASIS>not</EMPHASIS> recognized until
the asset is sold, and at that <EMPHASIS>instant,</EMPHASIS> the entire
gain becomes income.
</PARA>
<PARA>Unlike depreciation, governments tend to be <EMPHASIS>quite
Governments tend to be <EMPHASIS>quite
interested</EMPHASIS> in taxing capital gains in one manner or
another.
</PARA>
<PARA>(As always, there are exceptions. If you hold a bond
(As always, there are exceptions. If you hold a bond
that pays all of its interest at maturity, tax authorities
will often require that you recognize interest each year,
often require that you recognize interest each year,
and refuse this to be treated as a capital gain. The
phrases <EMPHASIS>accrued interest,</EMPHASIS> or <EMPHASIS>imputed
interest</EMPHASIS> are often there to scare those that are
interest</EMPHASIS> are often used to scare those who are
sensitive to such things...)
</PARA>
@@ -71,40 +70,36 @@
<SECT1 ID="XACC-CAPITALGAINS">
<TITLE> Capital Gains - Asset Appreciation</TITLE>
<PARA> <ANCHOR ID="APPR">
</PARA>
<PARA>Appreciation of assets is, in general, a fairly tricky
matter to deal with. This is so because, for some sorts of
<PARA>Appreciation of assets is generally a tricky
matter because, for some sorts of
assets, it is difficult to correctly estimate an increase in
value <EMPHASIS>until you actually sell the asset.</EMPHASIS>
</PARA>
<PARA>If you invest in <LINK LINKEND="XACC-TICKER">securities</LINK>
that are traded on a daily basis on open markets such as stock
exchanges, prices may be quite exact, and selling the asset at
If you invest in <LINK LINKEND="XACC-TICKER">securities</LINK>
traded daily on open markets such as stock
exchanges, prices are often quite exact, and selling the asset at
market prices may be as simple as calling a broker and issuing
a <EMPHASIS>Market Order.</EMPHASIS>
</PARA>
<PARA>On the other hand, homes in your neighborhood are sold
somewhat less often, such sales tend to involve expending
On the other hand, homes in your neighborhood are sold
somewhat less often. Such sales tend to involve expending
considerable effort, and involve negotiations, which means that
estimates are likely to be less precise. Similarly, selling a
used automobile involves a negotiation process that makes
pricing a bit less predictable.
</PARA>
<PARA>Harder to estimate are values of collectible objects such as
jewelry, works of art, baseball cards, and "Beanie Babies." The
<PARA>Values of collectible objects such as
jewelry, works of art, baseball cards, and "Beanie Babies"
are harder to estimate.
The
markets for such objects are somewhat less open than the
securities markets.
</PARA>
<PARA>Worse still are one-of-a-kind assets. Factories often
Worse still are one-of-a-kind assets. Factories often
contain presses and dies customized to build a very specific
product that cost tens or hundreds of thousands of dollars;
this equipment may be <EMPHASIS>worthless</EMPHASIS> outside of that very
specific context. In such cases, there several conflicting
specific context. In such cases, several conflicting
values might be attached to the asset, <EMPHASIS>none</EMPHASIS> of them
unambiguously correct.
@@ -113,9 +108,7 @@
value, say a Degas painting, and want to track this. (The
insurance company will care about this, even if nobody else
does.)
</PARA>
<PARA>Properly tracking the continually-increasing value of the
Properly tracking the continually increasing value of the
Degas will require at least three, quite possibly the following
four accounts (plus a bank or cash account where the money for
the purchase comes from):
@@ -123,21 +116,19 @@
<ITEMIZEDLIST>
<LISTITEM>
<PARA>An <EMPHASIS>Asset Cost</EMPHASIS> asset account to track the
original cost of the painting,
original cost of the painting.
</PARA>
</LISTITEM>
<LISTITEM>
<PARA>An <EMPHASIS>Accrued Unrealized Gains on Asset</EMPHASIS> asset
account to keep track of increases in value, and
account to keep track of increases in value.
</PARA>
</LISTITEM>
<LISTITEM>
<PARA>An <EMPHASIS>Accrued Gain On Asset Income</EMPHASIS> income account
in which to record the income side of the annual gains in
your riches, and
your riches.
</PARA>
</LISTITEM>
<LISTITEM>
@@ -155,23 +146,21 @@
</PARA>
<SECT2>
<TITLE>The handling of capital gains in GnuCash</TITLE>
<TITLE>The Handling of Capital Gains in GnuCash</TITLE>
<PARA> </PARA>
<SECT3>
<TITLE>The Acquisition</TITLE>
<PARA>The first thing you have to do is to create the <EMPHASIS>asset
cost account</EMPHASIS>, then transfer the sum you paid for this
painting from your bank account to this asset account to record
the purchase.
<PARA>First, create the <EMPHASIS>asset
cost account</EMPHASIS>. To record the purchase, transfer the sum
you paid for this
painting from your bank account to this asset account.
</PARA>
<PARA>A month later, you have reason to suspect that the value of
your painting has increased by $1200. In order to record this
you transfer $1200 from your <EMPHASIS>accrued gains on asset</EMPHASIS>
income account to your asset account.
</PARA>
<PARA>Your main window will resemble this:
Your main window will resemble this:
<INLINEMEDIAOBJECT>
<IMAGEOBJECT>
<IMAGEDATA FILEREF="image/appr-main1.png">
@@ -196,45 +185,39 @@
</SECT3>
<SECT3>
<TITLE>While You Hold the Asset</TITLE>
<PARA>Asset appreciation is a sort of income but it is <EMPHASIS> not</EMPHASIS> cash in hand.
</PARA>
<PARA>The people that got "rich" in 1999 from IPOs of
<PARA>Asset appreciation is a sort of income but it is
<EMPHASIS>not</EMPHASIS> cash in hand.
The people that got "rich" in 1999 from IPOs of
Linux-related companies like Red Hat Software and VA Linux
Systems could verify this. They hold options or stock that are
<EMPHASIS>theoretically</EMPHASIS> valued at millions of dollars USD.
</PARA>
<PARA>That doesn't mean that they are actually millionaires; the
They aren't actually millionaires; the
principal participants have to hold their stock for at least
six months before selling <EMPHASIS>any</EMPHASIS> of it. The fact that
they <EMPHASIS>can't</EMPHASIS> sell it means that while it may in theory
be worth millions of dollars on paper, there is, as of late
1999, no way for them to legally <EMPHASIS>get</EMPHASIS> those
be worth millions of dollars on paper, there is
no way for them to legally <EMPHASIS>get</EMPHASIS> those
millions.
</PARA>
</SECT3>
<SECT3>
<TITLE>Selling the Asset</TITLE>
<PARA>Let&acute;s say another month later prices for Degas
<PARA>Let's suppose another month later prices for Degas
paintings have gone up some more, in your case about $2500, you
estimate. You duly record these $2500 as an income like above,
estimate. You duly record the $2500 as an income like above,
then decide to sell the painting.
</PARA>
<PARA>Now there arise three possibilities:
<PARA>Three possibilities arise:
<ITEMIZEDLIST>
<LISTITEM>
<PARA> Your optimistic estimate of the painting's value was
correct.
</PARA>
<PARA>The income account is left alone (or perhaps gets
transferred from an <EMPHASIS>Accrued Gain</EMPHASIS> income to a <EMPHASIS> Realized Gain</EMPHASIS> income account), and the recording is
rather like:
<PARA>Your optimistic estimate of the painting's value was correct.
The income account is left alone (or perhaps gets
transferred from an <EMPHASIS>Accrued Gain</EMPHASIS> income
to a <EMPHASIS>Realized Gain</EMPHASIS> income account), and
the recording would appear as follows:
<TABLE>
<TITLE>Turning an Accrued Gain into a Realized Gain</TITLE>
<TGROUP COLS="2">
@@ -262,7 +245,7 @@
</TABLE>
</PARA>
<PARA>And if any amounts had been accrued as <EMPHASIS>Accrued
<PARA>If any amounts had been accrued as <EMPHASIS>Accrued
Gains,</EMPHASIS> the asset amount should be closed out, offset
by a <EMPHASIS>negative</EMPHASIS> value for <EMPHASIS>Accrued Gain</EMPHASIS>
income. If the total that had been accrued was $5000, then
@@ -307,21 +290,15 @@
that the <EMPHASIS>current</EMPHASIS> income resulting from the
transaction is only $55. The remaining $5000 had previously
been recognized as <EMPHASIS>Accrued Gain Income.</EMPHASIS>
</PARA>
</LISTITEM>
<LISTITEM>
<PARA> You were over-optimistic about the value of the painting.
</PARA>
<PARA>Instead of the $16055 you thought the painting was worth
<PARA>You were over-optimistic about the value of the painting.
Instead of the $16055 you thought the painting was worth
are only offered $15000. But you still decide to sell,
because you value $15000 more than you value the
painting.
</PARA>
<PARA>The numbers change a little bit, but not too
The numbers change a little bit, but not too
dramatically.
<TABLE>
@@ -364,16 +341,13 @@
transaction turns out to be a <EMPHASIS>loss</EMPHASIS> of $1000.
That's fine, as you had previously recognized $5000 in
income.
</PARA>
</LISTITEM>
<LISTITEM>
<PARA> You manage to sell your painting for more than you thought
in your wildest dreams.
</PARA>
<PARA>The extra value is, again, recorded as a gain, <EMPHASIS> i.e.</EMPHASIS> an income.
<PARA>You manage to sell your painting for more than you thought
in your wildest dreams.
The extra value is, again, recorded as a gain,
<EMPHASIS>i.e.</EMPHASIS> an income.
<TABLE>
<TITLE>Accrued Gain Becomes Handsome Realized Gain</TITLE>
@@ -414,10 +388,11 @@
</ITEMIZEDLIST>
</PARA>
<PARA>In practice, it truly is important to keep the <EMPHASIS>Accrued
<PARA>In practice, it is very important to keep the <EMPHASIS>Accrued
Gain Income</EMPHASIS> separate from the <EMPHASIS>Realized Gain
Income,</EMPHASIS> as the former is likely to be ignored by your tax
authorities, who will only care to charge you on the <EMPHASIS> Realized Gain.</EMPHASIS>
authorities, who will only care to charge you on the
<EMPHASIS>Realized Gain.</EMPHASIS>
</PARA>
<PARA>Below, we show the second case discussed.
@@ -443,50 +418,37 @@
</SECT2>
<SECT2>
<TITLE>Caution about Valuation</TITLE>
<PARA> </PARA>
<PARA>As we see in this example, for non-financial assets, it may
be difficult to correctly estimate the ``true'' value of an
asset.
</PARA>
<PARA>It is quite easy to count yourself rich based on
It is quite easy to count yourself rich based on
questionable estimates that do not reflect "money in the
bank."
</PARA>
<PARA>Thus, when dealing with appreciation of assets,
<PARA>When dealing with appreciation of assets,
<ITEMIZEDLIST>
<LISTITEM>
<PARA> Be careful with your estimation of values.
</PARA>
<PARA>Do not indulge in wishful thinking.
<PARA>Be careful with your estimation of values.
Do not indulge in wishful thinking.
</PARA>
</LISTITEM>
<LISTITEM>
<PARA> Never, ever, count on money you do not have in your bank or
as cash.
</PARA>
<PARA>Until you have actually sold your asset and got the
money, any numbers on paper (or magnetic patterns on your
hard disk) are merely that.
</PARA>
<PARA>If you could realistically convince a banker to lend you
money, using the assets as collateral, that is a pretty
reasonable evidence that the assets have value, as lenders
are professionally suspicious of dubious overestimations of
value.
</PARA>
<PARA>Be aware: all too many companies that appear
"profitable" on paper go out of business as a result of
running out of <EMPHASIS>cash,</EMPHASIS> precisely because "valuable
assets" were not the same thing as cash.
<PARA>Never, ever, count on money you do not have in your bank or
as cash.
Until you have actually sold your asset and got the
money, any numbers on paper (or magnetic patterns on your
hard disk) are merely that.
If you could realistically convince a banker to lend you
money, using the assets as collateral, that is a pretty
reasonable evidence that the assets have value, as lenders
are professionally suspicious of dubious overestimations of
value.
Be aware: all too many companies that appear
"profitable" on paper go out of business as a result of
running out of <EMPHASIS>cash,</EMPHASIS> precisely because "valuable
assets" were not the same thing as cash.
</PARA>
</LISTITEM>
@@ -500,14 +462,11 @@
<PARA>Taxation policies vary considerably between countries, so it
is virtually impossible to say anything that will be
universally useful.
</PARA>
<PARA>However, it is <EMPHASIS>common</EMPHASIS> for income generated by
However, it is <EMPHASIS>common</EMPHASIS> for income generated by
capital gains to not be subject to taxation until the date that
the asset is actually sold, and sometimes not even then.
</PARA>
<PARA>North American home owners <EMPHASIS>usually</EMPHASIS> find that when
North American home owners <EMPHASIS>usually</EMPHASIS> find that when
they sell personal residences, capital gains that occur are
exempt from taxation. It appears that other countries treat
sale of homes differently, taxing people on such gains. German
@@ -522,15 +481,14 @@ and expected a <EMPHASIS>considerable</EMPHASIS> tax bill that turned
out to be virtually nil due to having owned the property before 1971
(wherein lies a critical "Valuation Day" date in Canada) and due to it
being a <EMPHASIS>dairy</EMPHASIS> farm, with some <EMPHASIS>really
peculiar</EMPHASIS> resulting deductions. </PARA>
<PARA>The point of this story is that while the presentation here is
peculiar</EMPHASIS> resulting deductions.
The point of this story is that while the presentation here is
fairly simple, taxation often gets terribly complicated... </PARA>
</SECT2>
</SECT1>
<SECT1 ID="XACC-DEPR">
<TITLE> Depreciation of assets</TITLE>
<TITLE>Depreciation of Assets</TITLE>
<PARA>Compared to the often uncertain estimates one has to do
where appreciation of assets is concerned, we are on somewhat
firmer ground here.
@@ -539,7 +497,6 @@ fairly simple, taxation often gets terribly complicated... </PARA>
<LISTITEM>
<PARA>Governments tend to set up precise rules as to how you
are required to calculate depreciation for tax purposes.
</PARA>
</LISTITEM>
<LISTITEM>
@@ -565,9 +522,8 @@ fairly simple, taxation often gets terribly complicated... </PARA>
</PARA>
<SECT2>
<TITLE>Depreciation schemes</TITLE>
<PARA> </PARA>
<SECT3>
<TITLE>Linear depreciation</TITLE>
<TITLE>Linear Sepreciation</TITLE>
<PARA>Linear depreciation diminishes the value of an asset by a
fixed amount each period until the net value is zero. This is
the <EMPHASIS>simplest</EMPHASIS> calculation, as you estimate a useful
@@ -636,9 +592,7 @@ fairly simple, taxation often gets terribly complicated... </PARA>
percentage in the first period.</EMPHASIS> On the other hand, in
Canada, this is reversed, as they permit only a <EMPHASIS>half</EMPHASIS>
share of "Capital Cost Allowance" in the first year.
</PARA>
<PARA>The result of this approach is that asset value decreases
The result of this approach is that asset value decreases
more rapidly at the beginning than at the end which is <EMPHASIS> probably</EMPHASIS> more realistic for most assets than a linear
scheme. This is certainly true for automobiles.
@@ -744,8 +698,7 @@ fairly simple, taxation often gets terribly complicated... </PARA>
</SECT3>
</SECT2>
<SECT2>
<TITLE>The handling of depreciation in gnucash</TITLE>
<PARA> </PARA>
<TITLE>The Handling of Depreciation in GnuCash</TITLE>
<PARA>In order to keep track of the depreciation of an asset, you
need :
@@ -771,14 +724,12 @@ fairly simple, taxation often gets terribly complicated... </PARA>
</ITEMIZEDLIST>
</PARA>
<PARA>The first step, again, is to record the purchase of your
<PARA>The first step is to record the purchase of your
asset by transferring the money from bank bank account to the
<EMPHASIS>asset cost</EMPHASIS> account. Afterwards, in each accounting
period you record the depreciation as an expense in the
appropriate account.
</PARA>
<PARA>The two windows below show your asset account and the main
The two windows below show your asset account and the main
window after the third year of depreciation using a "sum of
digits" scheme for the example above.
<INLINEMEDIAOBJECT>
@@ -802,8 +753,7 @@ fairly simple, taxation often gets terribly complicated... </PARA>
</PARA>
</SECT2>
<SECT2>
<TITLE>A word of caution</TITLE>
<PARA> </PARA>
<TITLE>A Word of Caution</TITLE>
<PARA>Since depreciation and tax issues are closely related, you
may not always be free in choosing your preferred method.
Fixing wrong calculations will cost a whole lot more time and