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Capitalizing Rent Expenses Under the uniform capitalization rules, you must capitalize the direct costs and part of the indi- rect costs for certain production or resale activi- ties. Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. You re- cover the costs through depreciation, amortiza- tion, or cost of goods sold when you use, sell, or otherwise dispose of the property. Indirect costs include amounts incurred for renting or leasing equipment, facilities, or land. Uniform capitalization rules. You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit. 1. Produce real property or tangible personal property. 2. Acquire property for resale. Effective for tax years beginning after 12/31/2017, if you are a small business tax- payer (see Cost of Goods Sold in chapter 1), you are not required to capitalize costs under section 263A. See section 263A(i). Producing property. You produce prop- erty if you construct, build, install, manufacture, develop, improve, create, raise, or grow the property. Property produced for you under a contract is treated as produced by you to the extent you make payments or otherwise incur costs in connection with the property. Example 1. You rent construction equip- ment to build a storage facility. If you are sub- ject to the uniform capitalization rules, you must capitalize as part of the cost of the building the rent you paid for the equipment. You recover your cost by claiming a deduction for deprecia- tion on the building. Example 2. You rent space in a facility to conduct your business of manufacturing tools. If you are subject to the uniform capitalization rules, you must include the rent you paid to oc- cupy the facility in the cost of the tools you pro- duce. More information. For exceptions and more information on these rules, see Uniform Capital- ization Rules in Pub. 538 and the regulations under section 263A. 4. Interest Introduction This chapter discusses the tax treatment of business interest expense. Business interest expense is an amount charged for the use of money you borrowed for business activities. Topics This chapter discusses: • Allocation of interest • Interest expense limitation • Interest you can deduct • Interest you cannot deduct • Capitalization of interest • When to deduct interest • Below-market loans. Useful Items You may want to see: Publication 537 Installment Sales 550 Investment Income and Expenses 936 Home Mortgage Interest Deduction Form (and Instructions) Schedule A (Form 1040) Itemized Deductions Schedule E (Form 1040) Supplemental Income and Loss Schedule K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc. Schedule K-1 (Form 1120S) Shareholder's Share of Income, Deductions, Credits, etc. 1098 Mortgage Interest Statement 3115 Application for Change in Accounting Method 4952 Investment Interest Expense Deduction 8582 Passive Activity Loss Limitations 8990 Limitation on Business Interest Expense Under Section 163(j) See chapter 13 for information about getting publications and forms. Allocation of Interest The rules for deducting interest vary, depending on whether the loan proceeds are used for busi- ness, personal, or investment activities. If you use the proceeds of a loan for more than one type of expense, you must allocate the interest based on the use of the loan's proceeds. 537 550 936 Schedule A (Form 1040) Schedule E (Form 1040) Schedule K-1 (Form 1065) Schedule K-1 (Form 1120S) 1098 3115 4952 8582 8990 Allocate your interest expense to the follow- ing categories. • Nonpassive trade or business activity inter- est. • Passive trade or business activity interest. • Investment interest. • Portfolio interest. • Personal interest. In general, you allocate interest on a loan the same way you allocate the loan proceeds. You allocate loan proceeds by tracing disburse- ments to specific uses. The easiest way to trace disburse- ments to specific uses is to keep the proceeds of a particular loan separate from any other funds. Secured loan. The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan. Example. You secure a loan with property used in your business. You use the loan pro- ceeds to buy an automobile for personal use. You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property. P.L. 115-97 sec. 11043 limited the de- duction for mortgage interest paid on home equity loans and line of credit. For more information, see Pub. 936. Allocation period. The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates. • The date the loan is repaid. • The date the loan is reallocated to another use. Proceeds not disbursed to borrower. Even if the lender disburses the loan proceeds to a third party, the allocation of the loan is still based on your use of the funds. This applies whether you pay for property, services, or any- thing else by incurring a loan, or you take prop- erty subject to a debt. Proceeds deposited in borrower's account. Treat loan proceeds deposited in an account as property held for investment. It does not matter whether the account pays interest. Any interest you pay on the loan is investment interest ex- pense. If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds. Example. Celina, a calendar year taxpayer, borrows $100,000 on January 4 and immedi- ately uses the proceeds to open a checking ac- count. No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. On Septem- ber 4, Celina uses an additional $40,000 from the account for personal purposes. Under the interest allocation rules, the entire $100,000 loan is treated as property held for in- vestment for the period from January 4 through April 1. From April 2 through September 3, TIP CAUTION ! 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