FAQs on When to Expense vs. Capitalize Costs in Real Estate Development

Navigating the complexities of real estate development accounting can be challenging, especially with frequent changes in tax laws and incentives. This FAQ is designed to provide clear, up-to-date answers to the most common questions developers face when deciding whether to expense or capitalize costs. Whether you’re a small business or a large enterprise, you’ll find practical guidance on recent legislative updates — including the One Big Beautiful Bill Act (commonly referred to as the OBBBA or OB3), Section 179 expensing, Opportunity Zones and more.

The key factor is whether your business meets the $31 million gross receipts test. If your average annual gross receipts for the past three years are under $31 million, you can expense indirect costs like interest, real estate taxes and insurance as incurred. Above this threshold, you must capitalize these costs under Section 263A rules.

The production period begins when any physical activity starts on your property, such as clearing land, demolishing buildings or installing infrastructure. During this period, large taxpayers must capitalize interest and other indirect costs. The period ends when the property is placed in service or ready for sale.

Form 3115 is required when you change your accounting method for capitalizing costs. If your business previously exceeded the gross receipts threshold (historically $25 million, now $31 million under the OBBBA) and now qualifies as a small business, you must file Form 3115 in order to elect the new treatment, avoid continuing to capitalize costs unnecessarily and comply with updated IRS procedures.

Under the OBBBA (or OB3) changes, bonus depreciation rules have been modified for certain real estate improvements and qualified property. Real estate developers can now accelerate depreciation on specific components, potentially improving cash flow during development phases.

The Section 179 expensing limits were increased, allowing real estate developers to immediately deduct more equipment and certain property improvements. This provides immediate tax benefits rather than depreciating these costs over multiple years.

Yes, the OBBBA introduces enhanced tax credits and favorable capitalization rules for rural real estate development projects. These incentives include accelerated cost recovery and additional deductions for infrastructure improvements in designated rural areas.

Energy-efficient building improvements and renewable energy installations in real estate developments now qualify for expanded tax credits. These credits can offset capitalized costs and provide significant tax savings for environmentally conscious developments. It’s important to be aware of pending expiration dates for these provisions under the OBBBA.

The OBBBA extends and enhances Opportunity Zone benefits, allowing real estate developers to defer and potentially eliminate capital gains taxes. The changes also clarify which development costs qualify for favorable treatment within these designated zones.

Small business taxpayers (under $31 million) can deduct real estate taxes as incurred. Large taxpayers must capitalize these taxes if development is reasonably likely to occur, even before the production period begins.

If production stops for 120+ consecutive days, you can retroactively deduct previously capitalized interest.

If you have any questions on real estate capitalizing, whether an entity meets the exception, filing for the change in accounting method or how your costs should be recognized, please contact a member of Withum’s Real Estate Services Team.