When can I deduct Construction Period Interest?

A Brief History

The Tax Reform Act of 1976 prohibited the immediate deduction of real property construction period interest and taxes, and required the interest and taxes to be capitalized to the original cost of the constructed property and amortized over 10 years. Fast forward 10 years, the Tax Reform Act of 1986 disallowed the immediate deduction of all construction period expenses, as well as construction period interest and taxes, and removed the 10 year amortization rule. Today’s law requires the capitalization and depreciation of such expenses over the life of the constructed property.

What property qualifies for Construction Period Interest?

For purposes of this article (and to name a few), qualified property includes real property, personal property with a life of 20 years or more, personal property with an estimated production period of more than two years; or personal property with an estimated production period of more than one year if the estimated cost of production is more than $1 million. Real property is land or buildings, essentially real estate. Personal property is anything but real estate.

When does the construction period begin and end?

The construction period begins the earlier of the contract origination date or, for some taxpayers, the date at which 5% or more of total estimated contract costs have incurred. For certain property, the construction period begins when physical activity is performed on the property. The method to determine the construction period end date depends on the date the contract was entered into. If the contract was entered into on or after January 11, 2001, it is considered complete if: 1) the real property is used and at least 95% of the contract costs have incurred or 2) final completion and acceptance of the property has occurred.

De minimis rule

Taxpayers are not required to capitalize interest if the following are applicable:

Construction period does not exceed 90 days; and total construction expenditures do not exceed $1 million divided by the number of days in the construction period. As construction period is strictly limited, it is important to work with reliable contractors who can meet the deadlines.

For those taxpayers, interest may be deducted in the year it is incurred.

The above is a general overview of construction period interest and its tax treatment. Like any tax rule, construction period interest and the Uniform Capitalization Rules are dependent among many variables. Contact Sol Schwartz and Associates for more information and any questions you may have.

UNICAP Code Section 263A requires the capitalization of certain interest payments.