Separating short term from long term

A van bought for €26,000 four years ago, written down by €19,500, is sold for €11,000. The gain is €4,500, and it is entirely short term despite four years of ownership. The two-year test is therefore not enough to decide the question: it is the depreciation taken that governs the answer.

Two tests, not one

The first test is the period of ownership. An asset acquired or created less than two years ago produces a gain that is entirely short term, whatever its nature may be. The second test comes into play only beyond that period, and it bears solely on depreciable assets.

For a depreciable asset held for at least two years, the gain is split. The portion matching the depreciation actually deducted stays short term; only the excess, where one exists, falls under the long-term regime. That split explains why most disposals of equipment never produce any long-term element.

The reason is arithmetical. A long-term excess requires a sale price above the original acquisition cost, which happens for land or for goodwill and almost never for a machine. Looking for a long-term element on the disposal of ordinary equipment is therefore usually a waste of time.

Non-depreciable assets follow a simpler rule: held for less than two years the gain is short term; beyond that it is long term in its entirety. Land, participating interests and certain components of goodwill fall into this category.

Counting the two-year period

The period runs from the date the asset entered the balance sheet to the date of disposal, and not from one accounting year to another. An asset bought in September and sold the following July of the second year has been held for less than two years, even though three accounting periods were crossed.

For an asset received by contribution or by inheritance, the starting point is the date it entered the present business, not the date of the previous owner. That rule denies long-term treatment to many older assets transferred in a reorganisation, and it surprises people in the first year after the operation.

The depreciation used in the split is what was actually deducted, increased by anything excluded from expenses or wrongly deferred. A business that suspended its charges cannot therefore rely on that to shrink the short-term portion: the statutory floor applies here as well.

This closes a door that many believe open. Under-depreciating equipment in the hope of turning a future short-term gain into a long-term one achieves nothing: the undeducted portion is brought back into the computation as though it had been taken. Under-depreciation costs money; it never earns any.

• Depreciable asset held under two years: the gain is entirely short term
• Depreciable asset held two years or more: short term up to the depreciation deducted
• Non-depreciable asset held under two years: the gain is short term
• Non-depreciable asset held two years or more: the gain is long term

The year-end offsetting

The classifications do not feed the result disposal by disposal: they feed two separate offsetting exercises. Every short-term gain is set against every short-term loss, and the same exercise is carried out separately among the long-term items.

The two pools never mix. A long-term loss does not reduce a short-term gain, and the reverse is equally true. That is the whole point of the determination schedule, which sets the two columns side by side and never allows a transfer from one into the other.

The outcome of the first offsetting joins the operating result, taxed at the ordinary rate. The outcome of the second follows a regime of its own, and it is from that separation that the later schedules of the return follow, each devoted to the fate of one of these two net pools.

A classification error therefore does not merely change a box: it moves an amount from one tax regime into another. That is why the check bears first on the column chosen, before it bears on the amount, which follows mechanically from the net carrying amount and the sale price.