Please note the information below is intended to provide generalized information that is appropriate in certain situations.  It is not intended or written to be used, and it cannot be used by the receipient, for the purpose of avoiding federal tax penalties that may be imposed on any taxpayer.  The contents of the information provided below should not be acted upon without specific professional guidance.  Please call us if you have any questions.

A set of tax rules known as the uniform capitalization (UNICAP) rules require certain business costs that are normally expensed as they’re incurred to instead be capitalized as part of the cost of inventory held for resale or noninventory items produced by a taxpayer for use in its own trade or business. Both real and tangible personal property are covered by these provisions.

The rules are far from new, having been around since the mid-80s. However, a recent Tax Court decision is a reminder that the rules can be a trap for the unwary. The taxpayer in the case was a homebuilder who capitalized the direct material and labor costs of constructing the homes, as well as post-completion carrying costs until the houses were sold. However, it failed to capitalize a whole host of generally indirect costs that the IRS and the Court found to be related to completing the homes (from front office salaries and overhead, to the cost of supervisors, designers, and decorators). The end result was the taxpayer faced a substantial additional tax bill.

Fortunately, there are several exceptions to the UNICAP rules that exempt numerous businesses from having to comply with them (including most service businesses, small to medium-sized retailers and even most homebuilders with sales of no more than $10 million, along with many in the farming and oil and gas businesses). However, many other businesses are subject to the rules and sometimes without even knowing it—for example, where the business previously qualified for an exemption but has outgrown it or otherwise no longer meets the requirements.

If you have questions about whether your business is subject to the rules or qualifies for an exemption, please call us. We’d be happy to make sure you’re taking advantage of any exemption to which you’re entitled but fully complying with the rules if they otherwise apply.