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Small Businesses Need to be Aware of UNICAP Rules

Author: Scarinci Hollenbeck, LLC

Date: July 14, 2016

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What You Need to Know About UNICAP Rules

If a small business designated as a C corporation, partnership, S corporation or limited liability company is not aware of uniform capitalization rules, they will need to read closely. The IRS has UNICAP rules that require partnerships to capitalize some costs instead of deducting them as they are incurred during pre-production, pre-sale and actual production periods. These UNICAP rules apply to direct and indirect expenses incurred during these periods.

Business activity subject to UNICAP rules

There are several actions in trade or business or activities conducted for profit that qualify for UNICAP rules. These actions specifically involve the production of real or tangible personal property for use in the business or activity, production of real or tangible personal property for sale to customers or the acquisition of property for resale. With this last action, UNICAP rules do not apply to personal property with average annual gross receipts under $10 million.

It is also worth noting that UNICAP rules are not applicable for items that are classified as inventory, which are considered non-incidental materials and supplies. In the event that UNICAP rules do not apply to a business, both its direct and a portion of indirect costs need to be capitalized. That will raise the basis of the produced property or the inventory costs.

In this way, UNICAP rules are a temporary difference in those costs. What this means is that these costs incurred and capitalized during the pre-production, pre-sale and actual production periods are delayed until a later accounting date, instead of being disallowed. Furthermore, these capitalized costs to produced property used in business or trade actions will be expensed in the future as either amortization or depreciation. In turn, the capitalized costs for produced property to be sold to customers, or acquired property for resale purposes, will be expensed in the future as the costs of goods sold – in the event that the property is sold.

Direct vs. indirect costs for accounting purposes

The capitalized direct costs are classified as material and labor expenses that are involved in the costs to produce the asset.

For the portion of the capitalized indirect costs that were incurred during the production or resale process, there are several accounting methods involved in expensing these amounts.

Difficulties presented by UNICAP rules

It is challenging for businesses to determine the costs properly allocated to produced property. These rules for capitalization of interests as allocable costs are complex. That is largely due to the fact that the rules have potentially significant ramifications on deductible interest cost amounts, as opposed to interest costs that need to be capitalized.

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