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Understanding Section 263A Regulations

Under the Internal Revenue Code (IRC), Section 263A requires large taxpayers to capitalize certain costs — that is, include them in the property’s basis — rather than write them off as expenses. Also known as the uniform capitalization (UNICAP) rules, Section 263A outlines which costs must be capitalized, as well as which costs and businesses are exempt from the rules. Here, CCH® CPELink provides an overview of Section 263A and explains why it’s so important to stay up to date on the UNICAP rules.

What Is Section 263A?

The Section 263A UNICAP rules require businesses to capitalize the direct and indirect costs associated with producing, acquiring, and maintaining their inventory. In general, Section 263A applies to real or personal property produced by a taxpayer and real or personal assets acquired by a taxpayer for resale. UNICAP is implemented as a positive or negative tax adjustment to the year-end inventory. Because the process requires capitalizing certain costs that would normally be expenses, implementing Section 263A increases taxable income.

Who Does Section 263A Affect?

The Section 263A UNICAP rules affect businesses that are producers or resellers. Producers create inventory by constructing or manufacturing their own products, while resellers buy their inventory and then sell it to consumers. Specifically, Section 263A applies to any taxpayer that:

  • Constructs real property to sell
  • Produces personal property to sell
  • Acquires personal property for resale

Taxpayers in 2021 with $26 million or less in average annual gross receipts for the last three years are not subject to the UNICAP rules. The $26 million amount is adjusted for inflation annually.

There are several additional exceptions to the UNICAP rules, including:

  • Certain costs incurred by agricultural businesses
  • Certain costs associated with natural gas and mineral property
  • Costs of authors, photographers, and artists
  • Property produced for personal use by the taxpayer

What Costs Must Be Capitalized Under Section 263A?

The Section 263A UNICAP rules require taxpayers to capitalize all direct and indirect costs associated with producing, acquiring, and maintaining real or personal property. If a business incurs one of the following costs as a result of creating, acquiring, or maintaining its inventory, it may be subject to Section 263A:

Direct costs

Producers’ direct costs include the direct labor and materials costs that are integral to the property or product being produced. For resellers, direct costs are the costs of acquiring the property.

Indirect costs

Indirect costs include all costs that are not defined as direct but directly benefit the property being produced or sold or are incurred because of its production or resale. Costs such as employee benefits, rent, taxes, interest, and insurance are all considered indirect costs. Under a de minimis rule, certain taxpayers do not have to capitalize any indirect costs under a $200,000 threshold.

Mixed service costs

Mixed service costs are types of indirect costs related to the business’s administrative and service departments. These departments are not directly involved in the manufacturing process, but they do indirectly support the overall function of the business. Some of these costs can be written off as expenses, but others may need to be allocated to production activities and capitalized.

Property production costs

Costs incurred by a taxpayer during the development of a property must be capitalized. These include pre-construction and post-construction costs like taxes, zoning fees, and utility bills.

Learn More about Section 263A with CCH CPELink

A solid understanding of the Section 263A UNICAP rules is crucial to the success of your practice, which is why CCH CPELink makes it easy to stay up to date on the latest changes and developments. We offer a host of self-study courses that dive into a wide range of taxation topics, including Expense or Capitalize, which covers Section 263A. For more information, contact us today.