Industry Insights

We have all read the headlines and know the construction and development industries face significant challenges, with many projects stalling for months or years. Many will not be completed until the market improves. While labor and material costs can be deferred until construction resumes, costs such as insurance, taxes and interest remain subject to capitalization even while projects sit idle.

Capitalizing costs, including costs for labor, materials, insurance, taxes and interest, to develop property for resale is required under the tax law. Assuming project financing remains in place during the idle stage, continuing to capitalize interest can be costly.

The tax law provides some relief from interest-cost capitalization if an idle project meets certain conditions. To qualify for this relief, production activities must cease for at least 120 days. Production activities begin when physical activities such as clearing or demolition occur on the property. Obtaining permits, preparing blueprints and soil testing do not constitute production for interest capitalization purposes. For purposes of these rules, production does not cease under normal adverse conditions or when temporary complications, such as weather, scheduled plant shutdowns or delays caused by design or construction flaws, arise. These delays are considered normal and inherent to the construction process. However, delays of 120 days or longer related to economic factors or other conditions not considered part of the production process may allow a taxpayer to deduct the interest during the idle period.

In addition to the extended work stoppage, taxpayers must be able to trace underlying debt proceeds to the production of the appropriate unit of property. A unit of property can be a condominium, apartment, lot or home, depending on how each property unit is sold. Typically, the debt is easy to trace to the unit of property when a developer or builder draws down a construction loan or line of credit as property is constructed. Your BKD advisor can help you navigate the full scope of the interest-tracing rules.

In the end, you may not be able to do anything about an idle project or current state of the market. What you can do is contact your BKD advisor to discuss how these rules may benefit you and your project.