2007 Federal Tax Capitalization Rules
Tax capitalization is a complex concept that is best discussed with your business accountant. Tax capitalization is the increase in value of an economic asset directly through lower taxation. If a tax rate is lowered, the value of a real or personal asset increases over time as a result of this lowered rate. Although it applies to many different areas of business capital, it is often used when discussing commercial property. For example, a commercial building with a True Cash Value (TCV) of $2,000,000, but with a property tax assessment of 50 percent of its TCV would be assessed at $1,000,000. If a local tax rate is 30 mills, the annual property tax on this property would be $30,000. If the local tax authorities reduce the tax rate to 20 mills, the tax owed would be $20,000. This would result in a lower operating cost of the property of $10,000.
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Section 263A
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IRS regulations in Section 263A of the Federal Tax Code define the accounting rules used to calculate federal tax capitalization. This section defines the requirement of using tax capitalization instead of direct deduction for certain expenses related to real estate or certain tangible personal property.
Environmental Remidation
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Changes to the tax law in 2007 resulted in changes to tax capitalization rules related to environmental remediation, or the costs associated with dealing with existing or potential environmental damage. This is due to the expiration of a number of rules that allowed the direct deduction of certain costs related to environmental remediation.
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Materials & Supplies for Repair
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Before 2007, costs associated with repairs that are incidental and do not materially add property value or prolong its usable life could potentially be directly deducted from a tax bill. After 2007, these improvements must use tax capitalization rules if permanently improve or increase property value, increase the useful lifespan of the property, or adapt the property for a different use.
Transaction Costs
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Certain transaction costs that were previously deductible are now put under tax capitalizations rules if they are related to the acquisition or or real estate or tangible personal property. Examples would be expenses related to investigating a property or purchase, like shipping costs, appraisal costs, application fees and similar fees. Employment compensation and general overhead costs would not be affected and are still tax deductible.
Insurance Costs
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In general most insurance costs are directly deductible. However, changes in the tax regulations require capitalization to be applied to certain indirect costs or some production or resale activities. An example of an insurance expense that would need to be capitalized are insurance on the production facility, equipment, production materials, or things bought for re-sale.
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