Category: Accounting Periods & Methods Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com It is clear that a definitive election is required to capitalize interest in the cost of property under Section 266. The language of the statute makes reference to an election under regulations prescribed by the Secretary. Such regulations require an overt act of election. These are so-called "legislative regulations" because authority to make regulations in this matter was delegated to Treasury by Congress. As such, the regulations have the force and effect of law absent proof that the regulations are at odds with the intent of the statute. That is clearly not the case here. The law explicitly says the taxpayer has to make an election. The regulations are simply the source for the mechanics of the election required by the law. In Hale v. Cmr., 24 TCM 1497, the taxpayer was denied a capital loss attributable to the portion of the basis of land that represented capitalized interest for which no Section 266 election had been made. I think that taking the position that IRC Section 266 does not apply may be more helpful in your client's situation. Section 266 is rarely applicable to real property held for development. The UNICAP rules, specifically IRC Section 263A(f) enacted in 1986, generally apply. I would assume that your client is complying with those rules with respect to property actively under development. I assume that the UNICAP rules were not applied to the lots in question because little or no development activity was taking place. It seems to me if any activity at all was taking place with respect to these lots, we could take the position that Section 263A(f) applies (which is non-elective) with the result that interest costs associated with the property are properly capitalizable in basis. As you probably know, IRC Section 263A(f) only applies during the production period. This runs from the time any physical production activity takes place on the property until the time the property is ready to be placed in service or held for sale. The threshold of activity necessary to start capitalization of interest is extremely low. Production is deemed to start when any physical production activity is performed. Such activity may take the form of clearing, grading, excavation of the land, demolishing a building, gutting a standing building, engaging in construction of infrastructure such as roads or sewers, landscaping, or undertaking structural, mechanical, or electrical activities within a building. Reg. Sec. 1.263A-12(e)(2). On the other hand, certain specified activities are not considered production including planning and design, soil testing, blueprints or models, or obtaining permits or zoning rulings. Reg. Sec. 1.263A-12(f). I suggest finding out from your client exactly what happened on the properties for the years in question. In addition, the result of having Section 263A(f) apply is the requirement to capitalize interest based on the avoided cost method. In effect, interest must be capitalized as if the property were 100% financed whether that is the case or not. Obviously, this factor has to be taken into account in evaluating whether to take the position that Section 263A(f) applies. |
