If you build property, or hire a contractor to build it for you, your basis in the property includes all costs related to the construction, including the cost of the land, architect’s fees, building permit charges, the cost of labor and materials, payments to contractors, payments for rental equipment, and inspection fees. If you use employees, materials and equipment from your business to build an asset, your basis will include wages paid to the employees for their work on the construction, business materials and supplies used in the construction, operating and maintenance costs on machinery and equipment, and depreciation on that equipment for the period it was used in the construction. If you are a sole proprietor and work on the construction yourself, or if other persons worked on the construction without pay, you cannot include the value of that labor in the basis.
Uniform Capitalization Rules
These are rules that define what costs must be capitalized for tax purposes in certain circumstances. If your business involves any of the following activities, you are subject to the uniform capitalization rules:
Producing real or tangible personal property for use in the business
Producing real or tangible personal property for sale to customers
Acquiring property for resale
Producing property has a broad definition for these purposes, and includes constructing or building property, as well as installing, manufacturing, developing, improving, creating, raising, and growing property. Tangible personal property includes physical goods or products and also includes intellectual works, such as films, recordings, video tapes, books, and similar property.
Under the uniform capitalization rules, you include in the property’s basis all the direct costs and an allocable portion of most indirect costs involved in your production or resale activities. Indirect costs include rent, interest, taxes, storage, purchasing, processing, repackaging, handling, and administrative costs. These capitalized costs are then recovered through depreciation or amortized as the property is used, or through cost of goods sold, when you sell the property.
Exceptions
The following types of property and expenses are not subject to the uniform capitalization rules:
Property you produce that is not used in your trade or business
Qualified creative expenses as a free-lance writer, photographer, or artist, which can be deducted as expenses on your tax return
Property you produce under a long-term contract
Research and experimental expenses allowable as a deduction
Costs of personal property acquired for resale if your average annual gross receipts for the three previous tax years do not exceed $10 million