26 USC 263 - Capitalization and inclusion in inventory costs of certain expenses

View all text of Part IX [§ 261 - § 280H]

§ 263A. Capitalization and inclusion in inventory costs of certain expenses

(a) Nondeductibility of certain direct and indirect costs

(1) In generalIn the case of any property to which this section applies, any costs described in paragraph (2)—

(A) in the case of property which is inventory in the hands of the taxpayer, shall be included in inventory costs, and

(B) in the case of any other property, shall be capitalized.

(2) Allocable costsThe costs described in this paragraph with respect to any property are—

(A) the direct costs of such property, and

(B) such property’s proper share of those indirect costs (including taxes) part or all of which are allocable to such property.

Any cost which (but for this subsection) could not be taken into account in computing taxable income for any taxable year shall not be treated as a cost described in this paragraph.

(b) Property to which section appliesExcept as otherwise provided in this section, this section shall apply to—

(1) Property produced by taxpayer

(2) Property acquired for resale

For purposes of paragraph (1), the term “tangible personal property” shall include a film, sound recording, video tape, book, or similar property.

(1) Personal use property

(2) Research and experimental expenditures

(3) Certain development and other costs of oil and gas wells or other mineral property

(4) Coordination with long-term contract rules

(5) Timber and certain ornamental treesThis section shall not apply to—

(A) trees raised, harvested, or grown by the taxpayer other than trees described in clause (ii) of subsection (e)(4)(B) (after application of the last sentence thereof), and

(B) any real property underlying such trees.

(6) Coordination with section 59(e)

(7) Coordination with section 168(k)(5)

(d) Exception for farming businesses

(1) Section not to apply to certain property

(A) In generalThis section shall not apply to any of the following which is produced by the taxpayer in a farming business:

(i) Any animal.

(ii) Any plant which has a preproductive period of 2 years or less.

(B) Exception for taxpayers required to use accrual method

(2) Treatment of certain plants lost by reason of casualty

(A) In general

(B) Special rule for person with minority interest who materially participatesSubparagraph (A) shall apply to amounts paid or incurred by a person (other than the taxpayer described in subparagraph (A)) if—

(i) the taxpayer described in subparagraph (A) has an equity interest of more than 50 percent in the plants described in subparagraph (A) at all times during the taxable year in which such amounts were paid or incurred, and

(ii) such other person holds any part of the remaining equity interest and materially participates in the planting, maintenance, cultivation, or development of the plants described in subparagraph (A) during the taxable year in which such amounts were paid or incurred.

The determination of whether an individual materially participates in any activity shall be made in a manner similar to the manner in which such determination is made under section 2032A(e)(6).

(i) In generalIn the case of the replanting of citrus plants, subparagraph (A) shall apply to amounts paid or incurred by a person (other than the taxpayer described in subparagraph (A)) if—(I) the taxpayer described in subparagraph (A) has an equity interest of not less than 50 percent in the replanted citrus plants at all times during the taxable year in which such amounts were paid or incurred and such other person holds any part of the remaining equity interest, or(II) such other person acquired the entirety of such taxpayer’s equity interest in the land on which the lost or damaged citrus plants were located at the time of such loss or damage, and the replanting is on such land.

(ii) Termination

(3) Election to have this section not apply

(A) In general

(B) Certain persons not eligible

(D) Election

(e) Definitions and special rules for purposes of subsection (d)

(1) Recapture of expensed amounts on disposition

(A) In generalIn the case of any plant with respect to which amounts would have been capitalized under subsection (a) but for an election under subsection (d)(3)—

(i) such plant (if not otherwise section 1245 property) shall be treated as section 1245 property, and

(ii) for purposes of section 1245, the recapture amount shall be treated as a deduction allowed for depreciation with respect to such property.

(B) Recapture amount

(2) Effects of election on depreciation

(A) In general

(B) Related personFor purposes of subparagraph (A), the term “related person” means—

(i) the taxpayer and members of the taxpayer’s family,

(ii) any corporation (including an S corporation) if 50 percent or more (in value) of the stock of such corporation is owned (directly or through the application of section 318) by the taxpayer or members of the taxpayer’s family,

(iii) a corporation and any other corporation which is a member of the same controlled group described in section 1563(a)(1), and

(iv) any partnership if 50 percent or more (in value) of the interests in such partnership is owned directly or indirectly by the taxpayer or members of the taxpayer’s family.

(3) Preproductive period

(A) In generalFor purposes of this section, the term “preproductive period” means—

(i) in the case of a plant which will have more than 1 crop or yield, the period before the 1st marketable crop or yield from such plant, or

(ii) in the case of any other plant, the period before such plant is reasonably expected to be disposed of.

For purposes of this subparagraph, use by the taxpayer in a farming business of any supply produced in such business shall be treated as a disposition.

(B) Rule for determining period

(4) Farming businessFor purposes of this section—

(A) In general

(B) Certain trades and businesses includedThe term “farming business” shall include the trade or business of—

(i) operating a nursery or sod farm, or

(ii) the raising or harvesting of trees bearing fruit, nuts, or other crops, or ornamental trees.

For purposes of clause (ii), an evergreen tree which is more than 6 years old at the time severed from the roots shall not be treated as an ornamental tree.

(5) Certain inventory valuation methods permitted

(f) Special rules for allocation of interest to property produced by the taxpayer

(1) Interest capitalized only in certain casesSubsection (a) shall only apply to interest costs which are—

(A) paid or incurred during the production period, and

(B) allocable to property which is described in subsection (b)(1) and which has—

(i) a long useful life,

(ii) an estimated production period exceeding 2 years, or

(iii) an estimated production period exceeding 1 year and a cost exceeding $1,000,000.

(2) Allocation rules

(A) In generalIn determining the amount of interest required to be capitalized under subsection (a) with respect to any property—

(i) interest on any indebtedness directly attributable to production expenditures with respect to such property shall be assigned to such property, and

(ii) interest on any other indebtedness shall be assigned to such property to the extent that the taxpayer’s interest costs could have been reduced if production expenditures (not attributable to indebtedness described in clause (i)) had not been incurred.

(B) Exception for qualified residence interest

(3) Interest relating to property used to produce property

(4) Exemption for aging process of beer, wine, and distilled spiritsFor purposes of this subsection, the production period shall not include the aging period for—

(A) beer (as defined in section 5052(a)),

(B) wine (as described in section 5041(a)), or

(C) distilled spirits (as defined in section 5002(a)(8)), except such spirits that are unfit for use for beverage purposes.

(5) DefinitionsFor purposes of this subsection—

(A) Long useful lifeProperty has a long useful life if such property is—

(i) real property, or

(ii) property with a class life of 20 years or more (as determined under section 168).

(B) Production periodThe term “production period” means, when used with respect to any property, the period—

(i) beginning on the date on which production of the property begins, and

(ii) except as provided in paragraph (4), ending on the date on which the property is ready to be placed in service or is ready to be held for sale.

(g) ProductionFor purposes of this section—

(1) In general

(2) Treatment of property produced under contract for the taxpayer

(h) Exemption for free lance authors, photographers, and artists

(1) In general

(2) Qualified creative expenseFor purposes of this subsection, the term “qualified creative expense” means any expense—

(A) which is paid or incurred by an individual in the trade or business of such individual (other than as an employee) of being a writer, photographer, or artist, and

(B) which, without regard to this section, would be allowable as a deduction for the taxable year.

Such term does not include any expense related to printing, photographic plates, motion picture films, video tapes, or similar items.

(3) DefinitionsFor purposes of this subsection—

(A) Writer

(B) Photographer

(i) In general

(ii) CriteriaIn determining whether any expense is paid or incurred in the trade or business of being an artist, the following criteria shall be taken into account:(I) The originality and uniqueness of the item created (or to be created).(II) The predominance of aesthetic value over utilitarian value of the item created (or to be created).

(D) Treatment of certain corporations

(i) In generalIf—(I) substantially all of the stock of a corporation is owned by a qualified employee-owner and members of his family (as defined in section 267(c)(4)), and(II) the principal activity of such corporation is performance of personal services directly related to the activities of the qualified employee-owner and such services are substantially performed by the qualified employee-owner,

this subsection shall apply to any expense of such corporation which directly relates to the activities of such employee-owner in the same manner as if such expense were incurred by such employee-owner.

(ii) Qualified employee-owner

(i) Exemption for certain small businesses

(1) In general

(2) Application of gross receipts test to individuals, etc.

(3) Coordination with section 481

(j) RegulationsThe Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section, including—

(1) regulations to prevent the use of related parties, pass-thru entities, or intermediaries to avoid the application of this section, and

(2) regulations providing for simplified procedures for the application of this section in the case of property described in subsection (b)(2).

(Added Pub. L. 99–514, title VIII, § 803(a), Oct. 22, 1986, 100 Stat. 2350; amended Pub. L. 100–647, title I, § 1008(b)(1)–(4), title VI, § 6026(a)–(c), Nov. 10, 1988, 102 Stat. 3437, 3438, 3691–3693; Pub. L. 101–239, title VII, § 7816(d)(1), Dec. 19, 1989, 103 Stat. 2420; Pub. L. 106–170, title V, § 532(c)(2)(B), Dec. 17, 1999, 113 Stat. 1930; Pub. L. 108–357, title III, § 338(b)(2), Oct. 22, 2004, 118 Stat. 1481; Pub. L. 109–58, title XIII, § 1329(b), Aug. 8, 2005, 119 Stat. 1020; Pub. L. 114–113, div. Q, title I, § 143(b)(6)(H), Dec. 18, 2015, 129 Stat. 3064; Pub. L. 115–97, title I, §§ 13102(b), 13207(a), 13801(a), (b), Dec. 22, 2017, 131 Stat. 2103, 2113, 2169, 2170; Pub. L. 116–94, div. Q, title I, § 144(a)(1), Dec. 20, 2019, 133 Stat. 3234; Pub. L. 116–260, div. EE, title I, § 106(a)(1), Dec. 27, 2020, 134 Stat. 3041.)