New code subsection 263A(i) excludes a company whose average gross receipts do not exceed $25,000,000 from IRC 263A. I don’t think the accounting world has a good handle on how far reaching this can be.
For example: most people are discussing this in terms of the 263A adjustment. The 263A adjustment to include mixed service expenses in inventory is a small part of 263A. 263A is the code section that requires a manufacturing firm to capitalize direct and indirect costs in WIP and finished goods. Without 263A, we are left with very broad instructions under IRC 263 and the related regulations. I haven’t found many people defining this law change so broadly, but the way I see it, 263A(i) excludes certain taxpayers from ALL provisions of 263A.
263A(f)(1) is the reason we capitalize construction period interest. Capitalization shouldn’t be required for a small business under the new law.
263(a) requires the capitalized of all costs to acquire an asset or improve an asset. 263(a) applies to real and tangible property. Reg 1.263(a)-2 pertains to amounts paid to acquire or produce tangible property. Produce is defined as “construct, build, install, manufacture, develop, create, raise, or grow. This definition is intended to have the same meaning as the definition used for purposes of section 263A(g)(1) and Sec. 1.263A-2(a)(1)(i), except that improvements are excluded from the definition in this paragraph (b)(4) and are separately defined and addressed in Sec. 1.263(a)-3.”
The code and regs under 263(a) define costs as the materials and the work performed prior to the building being placed in service. An example in the regs, example 4: “Acquisition or production cost. D purchases and produces jigs, dies, molds, and patterns for use in the manufacture of D’s products. Assume that each of these items is a unit of property as determined under Sec. 1.263(a)-3(e) and is not a material and supply under Sec. 1.162-3(c)(1). D is required to capitalize under paragraph (d)(1) of this section the amounts paid to acquire and produce the jigs, dies, molds, and patterns.”. They define cost to acquire or produce in 1.263(a)-2(d): “Amounts paid to acquire or produce a unit of real or personal property include the invoice price, transaction costs as determined under paragraph (f) of this section, and costs for work performed prior to the date that the unit of property is placed in service by the taxpayer (without regard to any applicable convention under section 168(d)). A taxpayer also must capitalize amounts paid to acquire real or personal property for resale.”
Another interesting example in 1.263(a)-2(d) is example 8: “Production of building; coordination with section 263A. J constructs a building. J must capitalize under paragraph (d)(1) of this section the amount paid to construct the building. See section 263A for the costs required to be capitalized to the real property produced by J.” So in this example they defer to 263A. For a small business 263A does not apply.
It appears that the IRS can interpret 263(a) as requiring the capitalization of direct costs. However, 263A governs indirect costs. With this interpretation, a manufacturer would capitalize direct costs, but not indirect costs, such as manufacturing overhead, indirect labor, etc.
Michael Frost, CPA, is a former shareholder of MDA Professional Group, PC, of Alabama, where he was a leader in the small business tax field. Mike has 28 years of public accounting experience, mostly in the small business tax field, and utilizes that experience in authoring and teaching continuing education courses in the tax arena. Mike has led continuing education courses through webinars, webcasts, and live presentations for over 15 years.