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Timestamp: 2019-04-19 22:31:16+00:00

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The allocation of project costs in cost segregation studies for self-constructed assets may be impacted by the Uniform Capitalization (UNICAP) rules of IRC § 263A(a). In addition, the interest capitalization rules of IRC § 263A(f) may also apply. A brief summary of these provisions is presented below.
The uniform capitalization (UNICAP) rules require the capitalization of all direct costs and certain indirect costs properly allocable to real property and tangible personal property produced by the taxpayer. For purposes of the uniform capitalization rules, to "produce" means to construct, build, install, manufacture, develop, improve, create, raise or grow [§ 263A(g)(1); Treas. Reg. § 1.263A-2(a)(1)(i)]. Self-constructed assets and property built under contract are treated as property "produced" by the taxpayer and the rules under IRC § 263A(a) govern.
In addition, § 263A(f) requires the capitalization of interest expense when the taxpayer produces certain property. The interest capitalization rules under Treas. Reg. § 1.263A-8 contain precise definitions of designated property and include inherently permanent structures in the definition of real property. In summary, all real property and certain tangible personal property are subject to the interest capitalization rules. Therefore, any change in the allocation of costs between real and tangible personal property may have an impact on the amount of capitalized interest. Many taxpayers attempt to exclude all § 1245 property from interest capitalization arguing that the § 1245 property is tangible personal property that does not meet the classification thresholds of Treas. Reg. § 1.263A-8(b)(1). Most of the § 1245 property in these situations are inherently permanent structures (real property) subject to interest capitalization without any restrictions.
The following text summarizes the capitalization rules of § 263A(a) and the interest capitalization rules of § 263A(f). Further detail and updates can be obtained from Jim Peschl, § 263A Technical Advisor, at (763) 549-1020 (James.F.Peschl@irs.gov); or Barbara J. Martin, § 263A (Inventory) Technical Advisor, at (708) 503-3540 x205 (Barbara.J.Martin@irs.gov).
How does § 263A identify the costs subject to capitalization? As a threshold requirement, one must determine whether the costs would, but for § 263A, be otherwise deductible. A cost that is not otherwise deductible may not be allocated to property produced or acquired for resale.
In addition, any cost required to be capitalized under § 263A may not be included in inventory or charged to capital accounts or basis any earlier than the taxable year during which the amount is incurred within the meaning of § 1.446-1(c)(1)(ii).
Producers must capitalize costs (other than interest) whether incurred before, during, or after the production period of property. Interest is only capitalized during the production period of property. Pre-production costs are subject to capitalization if the property is held for future production or if it is reasonably likely that the property will be produced at a future date. Thus, costs of storing raw materials and carrying costs of realty held for development are required to be capitalized. Some issues may arise in determining the taxpayer's intent and the taxpayer’s change in intent. Production period costs are costs incurred beginning on the date on which production of the property begins and ending on the date on which the property is ready to be placed in service or is ready to be held for sale. Post-production costs are costs incurred after the actual production and may include costs of storage, warehousing, insurance, materials, and handling.
Treas. Reg. § 1.263A-1(f) sets forth various detailed or specific cost allocation methods that a taxpayer may use to allocate direct and indirect costs to property produced. Under § 1.263A-1(f) a taxpayer may use a specific identification method, burden rate method, standard cost method, or any other reasonable method to allocate costs. In addition, in lieu of these methods, producer taxpayers may use the simplified production method provided in § 1.263A-2(b).
Treas. Reg. §§ 1.263A-8 through 1.263A-15 provides guidance with respect to the capitalization of interest under IRC § 263A(f). These regulations are effective for 1995 and after, or at taxpayer's election, 1994. For years prior to the final regulations, Notice 88-99, 1988-2 C.B. 422, and temporary regulations provide guidance with respect to the capitalization of interest.
the amount of outstanding debt on each measurement date.
In determining the amount of outstanding debt, traced debt is considered first. The excess expenditure amount is the amount (if any) by which the accumulated production expenditures exceed the amount of traced debt. Interest on non-traced debt, up to the excess expenditure amount, must be capitalized, based upon a weighted average interest rate.
Property with an estimated production period exceeding 1 year and estimated cost of production exceeding $1,000,000.
Note: All real property is subject to the rules of § 263A(f); the classification thresholds only apply to tangible personal property.
The classification thresholds are applied individually to each unit of property.
Treas. Reg. § 1.263A-8(c)(1) defines real property. Real property includes land, unsevered natural products of land, buildings, and inherently permanent structures. Any interest in real property, including fee ownership, co-ownership, a leasehold, an option, or a similar interest is real property. Unsevered natural products of land include growing crops and plants (that have a preproductive period in excess of 2 years), mines, wells, and other natural deposits. Real property includes the structural components of both buildings and inherently permanent structures.

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