Capitalizing costs under UNICAP may reduce interest disallowance

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August 2019

Overview

The 2017 tax reform act amended Section 163(j) to limit the amount of business interest a taxpayer may deduct. Taxpayers may be able to reduce the amount of interest subject to disallowance by capitalizing interest into the basis of certain self-constructed property under Section 263A.  Capitalized interest is not subject to disallowance.  At the same time, depreciation increases the Section 163(j) limitation and may reduce the amount of otherwise disallowed interest.  Therefore, capitalizing interest and other costs, such as mixed service costs, into the basis of self-constructed property and recovering those costs through depreciation may reduce the amount of a taxpayer’s disallowed interest.

The takeaway

A taxpayer may reduce the amount of interest disallowed under Section 163(j) by increasing the amount of costs capitalized under Section 263A.  Capitalized interest is not subject to disallowance.  Interest and other costs, such as mixed service costs, capitalized to self-constructed property are recovered as depreciation, which may increase adjusted taxable income and the disallowance limitation under Section 163(j).  The direct allocation method for mixed service costs may significantly increase the capitalized amounts.  A taxpayer may change to the direct allocation method by filing a Form 3115, Application for Change in Accounting Method, under the automatic procedures.

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Christine Turgeon

Partner, Federal Tax Services Leader, PwC US

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