Change in accounting method nets rental real estate developer $2.3 million tax deduction on stagnant property

Our client's need

A national rental real estate developer appropriately capitalized the costs associated with their project, at the beginning of production period, under Sec. 263A rules regarding the capitalization and inclusion in inventory costs of certain expenses. Like many real estate developers though, recent economic conditions caused the developer’s project to become stagnant and production ceased.  Though production ceased, the costs associated with the project, such as property taxes, insurance, and interest on the loans, still became due. 

Baker Tilly solution

As a response to the ongoing costs, Baker Tilly’s specialized real estate tax team filed a Form 3115, Application for Change in Accounting Method, requesting permission to change our client's method of accounting for its interest capitalization. Under Reg. Section 1.263A-12(g)(1), there are special tax rules that relate to the capitalization of interest. According to the regulations, if a project's production period for the designated property ceases for at least 120 consecutive days, a taxpayer may suspend the capitalization of interest for that project. Instead, the taxpayer may expense the associated interest costs until production activities resume.

Results achieved

The IRS approved the change in accounting method and the developer was able to benefit from a current year deduction of roughly $2.3 million. This approach can be utilized again for any delayed projects that the interest costs associated with it continues to be capitalized.

For more information on this topic, or to learn how Baker Tilly real estate specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.