Uniform Capitalization Rules
However, what if instead of buying business assets, you create them? Does this mean you can avoid capitalization?
Under the uniform capitalization (UNICAP) rules, you have to capitalize the cost of creating assets, which means you capitalize the cost of labor, raw materials, and other direct and indirect costs attributable to the production of the assets.
Congress created the UNICAP rules to level the playing field between businesses that buy property and businesses that create property of their own. Regardless of the manner in which you acquire property, you have to capitalize the expense.
Property You “Produce”
Under the UNICAP rules, you have to capitalize the cost of any real or tangible personal property you produce in your business.1
Congress defined the term “produce” very broadly. The rule applies to any property that you “construct, build, install, manufacture, develop, improve, raise or grow.”2
Because of the rule’s broad scope, you should always keep UNICAP in mind when determining your deductions for the year.
Property You Acquire for Resale
The UNICAP rules also require you to capitalize the costs of property you buy for resale.
Big Exception. The resale rule only applies to large businesses. If your average annual gross receipts are less than $10,000,000, you are exempt from this requirement.3
Direct and Indirect Costs
UNICAP rules require you to capitalize both the indirect and direct costs of producing property. 4
Direct Costs. Direct costs include raw materials and labor.5
Indirect Costs. Indirect costs are all other costs you can attribute to creating the asset. For example, if you use a room in your office to produce the assets, you should capitalize the rent value of the room during the time of manufacture.6
De Minimus Rule. The good news is that you don’t have to capitalize any indirect costs unless they total more than $200,000.7
You are exempt from the UNICAP rules if you work in any of the following fields:8
Freelance writing, photography, or art
Development of oil and gas wells
Research and experimentation
1 IRC Section 263A(b)(1).
2 IRC Section 263A(g)(1); Reg. Section 1.263A-2(a)(1)(i).
3 IRC Section 263A(b)(2)(B). The gross receipts test averages the gross receipts of the previous three taxable years.
4 Reg. Section 1.263A-1(a)(3). Some indirect costs are exempt from capitalization.
5 Reg. Section 1.263A-1(e)(2).
6 See Reg. Section 1.263A-1(e)(3)(ii)(K).
7 Reg. Section 1.263A-2(b)(3)(iv). To take advantage of the $200,000 de minimus rule, you must use allocate costs using the simplified production method.
8 Reg. Section 1.263A-1(b).