Capitalization of Interest

Under the uniform capitalization rules, you generally must capitalize interest on debt equal to your expenditures to produce real property or certain tangible personal property. The property must be produced by you for use in your trade or business or for sale to customers. You cannot capitalize interest related to property that you acquire in any other manner.

Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. Designated property is any of the following.

• Real property.
• Tangible personal property with a class life of 20 years or more.
• Tangible personal property with an estimated production period of more than 2 years.
• Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million.

Property you produce. You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property.

Capitalized interest. Treat capitalized interest as a cost of the property produced. You recover your interest when you sell or use the property. If the property is inventory, recover capitalized interest through cost of goods sold. If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method.

Partnerships and S corporations. The interest capitalization rules are applied first at the partnership or S corporation level. The rules are then applied at the partners' or shareholders' level to the extent the partnership or S corporation has insufficient debt to support the production or construction costs.

If you are a partner in a partnership or a shareholder in an S corporation, you may have to capitalize interest you incur during the tax year for the production costs of the partnership or S corporation. You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. You must provide the required information in an attachment to the Schedule K-1 to properly capitalize interest for this purpose.

Additional information. The procedures for applying the uniform capitalization rules are beyond the scope of this publication. For more information, see section 1.263A-8 through 1.263A-15 of the regulations and Notice 88-99 (as amended by Announcement 89-72). Notice 88-99 is in Cumulative Bulletin 1988-2. Announcement 89-72 is in Cumulative Bulletin 1989-1.

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